Warner Bros. Discovery Inc (WBD) — Q4 2019 Earnings Call Transcript

Good morning, everyone. Thank you for joining us for Discovery’s Fourth Quarter 2019 Earnings Call. Joining me today are David Zaslav, our President and Chief Executive Officer; Gunnar Wiedenfels, our Chief Financial Officer; JB Perrette, President and CEO of Discovery Networks International; and Peter Faricy, CEO, Global Direct-to-Consumer. 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, JB and Peter to take questions. Before we start, I’d 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 they 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 Form 10-K for the year ended December 31, 2019, and our subsequent filings made with the U.S. Securities and Exchange Commission. And with that, I would like to turn the call over to David.

Good morning, everyone, and welcome to our Q4 and Full Year 2019 Earnings Conference Call. We delivered a quarter and year of outstanding progress. For 2019, I’m pleased to report that we met or exceeded all of our core guidance metrics and strategic objectives, and we feel terrific looking ahead into 2020. We continued to deliver on the many promises we made to our shareholders over the last few years. Promises made, promises kept. On free cash flow, we set a goal of $3 billion for the combined Discovery and Scripps. And this year, we over-delivered with $3.1 billion of free cash flow, which is even more impressive given the substantial direct-to-consumer investments we are making. We are a free cash flow machine. I said when we closed on Scripps that free cash flow will be like a moat in turbulent times, the $3 billion plus in free cash flow, like bullets or weapons that we could use. Promises made, promises kept. On leverage, we had promised to bring leverage down from 4.8 times following our deal to our target range of three times to 3.5 times by the end of 2019. And by the end of Q4, our leverage was all the way back down to three times, in large part driven by the $1.1 billion in free cash flow that we generated in Q4 alone. Promises made, promises kept. We expressed our strong desire to return capital to shareholders once we reached our target leverage range. And in only 10 months, we exhausted our initial $1 billion authorization, and we are reloading as our Board just approved an additional $2 billion authorization. Promises made, promises kept. We identified international expansion as a key upside opportunity for our Scripps acquisition. This year, we expanded distribution of our lifestyle brands to an additional 100 million new households across both free-to-air and pay, with food and home content and channels supporting our significant international growth in 2019. All of which speaks to the truly unique position we enjoy within the industry, supported by the best and most stable management team in media today. We continued to deliver consistent execution even in the face of a rapidly changing ecosystem. In the U.S., we delivered solid advertising growth in the face of difficult domestic ratings trends. And 5% domestic affiliate revenue growth was supported by our broad coverage across the virtual MVPD landscape, with better carriage more broadly than virtually any other media company in the U.S. International advertising revenue growth of 5% was in part driven by continued strength in our commercial share, while international affiliate growth once again achieved double digits, reflecting underlying tailwinds for both linear and direct-to-consumer. In 2019, we also accelerated our direct-to-consumer pivot with a focus on two key pillars: Number one, big scalable view products like our broad aggregated apps in Europe, Dplay, Joyn and the TVN Player. These are local language, local sports, Hulu-like platforms, and we are seeing superb and very encouraging momentum and acceleration in trends in this space. The key to these over-the-top products is that they’re local, local, local. In addition, we have our best-in-class aggregated GO streaming apps in the U.S., which continue to grow quickly and show meaningful scale growth. And as we’ve mentioned previously, we are focusing hard at aggregating our brands into an OTT service here in the U.S., a major focus for our management team and me as we look to reach all passionate fans across all platforms and methods of distribution with our great IP, our great characters and our great stories. The second key pillar is our growing affinity view-and-do products focused on our passion verticals like food, sports and lifestyle. Much of the content on our view-and-do platforms have largely been amortized and afford us an incremental monetization opportunity, a second bite at the apple, and also encompasses our short-form strategy with our Group Nine investment and their strong affinity brands like NowThis, The Dodo and PopSugar. We like our hand in this rapidly evolving ecosystem, and I have total conviction on the simple but valuable principle: Audiences love our content. They now just want to see it on all platforms. The landscape that is emerging plays to our strengths and to our strategic advantage. We generated over $700 million of next-gen and direct-to-consumer revenue in 2019 and are well on our way to exceed $1 billion in 2020, representing a major milestone for us. And it underscores the solid traction we are seeing across all components of our strategy. Our organization is more aligned than ever around this priority. Starting in 2020, a significant percentage of our employee incentive compensation across all levels and rank will be measured by how well we perform against our next-gen and direct-to-consumer goals. Whether measured by our vast library, 60,000 hours, nearly two times the size of Netflix, our current pipeline of 8,000 new hours we produce a year, with the milestone we crossed and held for more than half of last year as the number one most watched portfolio in the United States for women across all of television. We have a very strong portfolio of brands that are consistently ranked at the top of consumer preferences for brand strength and loyalty. We have passionate superfans, authentic talent and characters that are loved in America and around the world: Oprah, Chip and Jo, the Property Brothers, Guy Fieri, Bobby Flay, we could go on and on. And we are not a renter. We own and control almost all of our IP globally. We will continue to serve viewers within the traditional linear ecosystem, much like we’ve done for decades. And we now serve them better than anyone within the virtual MVPD landscape, where we are more widely distributed than any of our peers. And we serve them within our authenticated GO apps, where the average age of our users is below 30. We also believe our aggregate content is very strong on a stand-alone basis and in addition would be a great complement to the many other scripted and AVOD/SVOD platforms that are already in the marketplace. We’re differentiated, and we fit well with all of them. And of course, while being mindful of the balance and importance of the linear pay TV business, we are positioned to create dual revenue stream direct-to-consumer platforms. And we continue to evaluate the possibility of offering an aggregated platform of all of our channels, brands and personalities, quite possibly with the help of any number of distribution partners in the U.S. and around the world. We believe there are a number of direct-to-consumer business models that are scalable, sustainable economically and rational from a cost perspective as we expand and complement the linear ecosystem. And evaluating this opportunity set is a strategic imperative for our leadership team. As we sift through the analysis, we are confident that we are playing a different game than everyone else. The efficiency of our content is unparalleled. Our content costs are under control. And for our affinity fan bases, we are delivering them truly coveted appointment viewing. But the key variable that I keep coming back to that distinguishes us from our peers is not only the good storytelling and brands and characters we bring to our fans, storytelling and brands that drove more female viewers to our portfolio than any other for more than half of 2019, but the economics of our model. Our content is a small fraction of what’s taking place on the other side of the ledger. The overbid, competitive, spiraling out-of-control costs for scripted, new and repeat is astounding. That is not who we are. We aren’t paying hundreds of millions of dollars for content, original or repeats, that we can’t even own. And accordingly, as we begin to scale our products to millions of subscribers, we’ll see profitability very early on. Take TLC’s 90 Day Fiance that is a great example of what I’ve discussed. It is the most watched program on Sunday nights in all of television among all key demos and consistently outdelivers each and every single broadcast network in women 25 to 54 in prime. And we now have 90 Day and spin-offs dominating TV on Sunday and Monday nights almost all year at a cost per episode that is 1/10 of the cost of a scripted series. In addition, the 90 Day Fiance franchise now airs across 170 countries, making it one of our top-rated shows globally. The power of fully owned global IP. Outside the U.S., we’re very excited about the success of our locally differentiated Hulu-like products, such as Dplay. These assets are becoming a meaningful part of our strategy in many key markets. Our JV in Germany, Joyn, crossed seven million monthly average users only six months after launch. And we recently added an SVOD tier, underpinned by ambitious plans for 12 new and exclusive series this year in German language, local. And we plan to combine and launch our TVN Player with Polsat to create the preeminent destination for Polish language content in this important and our largest European market. We are actively exploring additional opportunities to expand our model to other major markets in partnership with local programming leaders, perhaps in other JV-type models, where we believe we offer a winning solution for incumbent broadcasters to align and create compelling packages for consumers. You should expect that we will accelerate OTT services, such as our stand-alone aggregated app in Europe. 2020 is going to be a year where we really begin to fuel what’s working, where we believe we have a strong hand to play, and Dplay is one of those key areas for us. Expect us to play a bit more offense in select markets, particularly where consolidation in distributors means we have to push harder to get full value for our richer content portfolio. One such market where this is taking place is in Denmark, and we are pushing ahead far more aggressively with our OTT solution. In some countries like Sweden, for example, Dplay will be the only place fans can watch Allsvenskan, the local Swedish football league with 200-plus games. It’s a must-have and compelling content in the marketplace and in part, the reason why Dplay continues to be the fastest-growing SVOD service in the Nordics. Local entertainment, local sports, it’s a great combination. We intend to push Dplay expansion to nearly double the number of markets over the next year, up from 10 markets currently, supported by a robust technology platform and exclusive local content. And it’s likely we will see some near-term impact as we accelerate its push. The cadence of affiliate fee growth will become a bit lumpier during this process. However, we are confident of the longer-term financial and strategic payoff. And keep in mind, as I said earlier, our costs and margin profile will enable us to achieve our financial goals at much lower subscriber levels than many of our leading DTC player competitors. And our affinity view-and-do platforms are completely differentiated from the intensely expensive and competitive fight taking place on the scripted side of the industry. Food Network Kitchen continues to ramp up very nicely. We and our partners at Amazon are pleased with the very strong engagement, product ratings and functionality of the service. We recently announced a great distribution arrangement with Sur La Table here in the U.S., opening up Food Network Kitchen to an incredibly targeted audience base. And stay tuned for additional distribution and marketing pushes that we have in the works. For Eurosport, we are within six months of broadcasting our second Olympics across Europe and across all screens. This is our first Summer Games, and we’ll have three times as many events as the Winter. Our teams have been hard at work preparing for the challenge. We are excited to outdeliver the amazing set of games we delivered in 2018, supported by vast improvements in our technology, programming expertise and the delivery platforms. To finish, it is an unprecedented time in our industry. Not only is it measured by the magnitude of change, but also by the speed of that change. We feel confident that our strategic agenda, the fact we are one of the few media companies that own almost all of our content globally, combined with the strength of our brands in connection with passionate audiences, all position us for long-term, sustainable growth. We are singularly focused on strong execution and operational discipline and are always guided by an entrepreneurial zeal that got us to where we are today. This work continues to fuel our strides in building the next generation of growth for Discovery as we position our business within an industry undergoing generational transformation.

Thank you, David. I am very pleased to present our financial results for 2019, and I am confident in our financial position as we tackle a very exciting global agenda in 2020. Indeed, generating over $3.1 billion in free cash flow during 2019 after funding approximately $300 million of growth investments and nearly 67% conversion of AOIBDA is emblematic of both the cash generative capability of our business model and truly differentiated level of efficiency with which we are operating following our Scripps merger. And we will maintain that laser-like focus on cash and efficiency. Perhaps most importantly, our free cash flow underpins our ability to address the exciting opportunity set that David outlined and to continue investments to support our traditional linear networks while, at the same time, return capital to our shareholders, particularly given that our leverage is comfortably within our target range. To that end, I am pleased to report that we have already bought back $1 billion of stock, and we take our Board’s new $2 billion authorization as a strong sign of support for the initial momentum we are seeing as we lay the groundwork for our future growth plans. And we are excited about what we are seeing across our portfolio of next-generation businesses, which include our direct-to-consumer businesses and the digital element of our traditional business, like our Go products. With this portfolio having already generated over $700 million in revenue in 2019 and being on track for at least 40% growth to over $1 billion in revenue in 2020, approaching 10% of total company revenues, we are very pleased with the early traction. Over the course of this year, we plan to supercharge our expansion of Dplay in Europe, position additional direct-to-consumer initiatives, such as Magnolia ready for launch, start lighting up our BBC natural history content in multiple formats across the globe, significantly broaden the rollout of FNK and drive improvements and expansions across our entire portfolio. To that end, we do anticipate spending more against these initiatives in 2020, which should lead to a roughly $600 million annual investment in the sense of short-term P&L losses from these growth initiatives, representing an incremental $300 million over 2019. It is worth noting that we currently expect these investments to peak towards the end of 2020 or early 2021 at the latest. The year-over-year ramp-up for these growth initiatives is primarily driven by original content and marketing costs to drive subscriber growth, a healthy portion of which is success-based spending. We will also largely complete the initial investment in our own technology stack as well as further round out our management team under Peter, all of which should scale nicely as the business grows. Also, it is important to note that excluding the step-up in expenses from our next-generation and D2C initiatives and the Olympics, our core expense base is planned to continue to decline, which again speaks to our resilience on expense management and high level of operating efficiency. The contribution from next-gen and direct-to-consumer will certainly help drive an acceleration in our overall global revenue in 2020, where we currently expect solid mid-single-digit revenue growth on a constant currency basis over 2019.

Now this is our outlook as of what we see today and would expect in any business-as-usual environment. Clearly, given the news flow around coronavirus, being a consumer-facing company, we’ll have to carefully monitor these trends. The other key item I’d like to review in more detail is the Olympics in Q3. We will produce our first Summer Games from Tokyo, scheduled to take place from July 24 to August 9. Let me take a minute to provide some color around the games, which like the Winter Olympics that we produced in the first quarter of 2018, is something about which we’re very excited. We continue to expect the Olympics to break even over the life of the deal with monetization and exploitation of rights occurring before, during and after the games. Key revenue drivers will again be: sublicensing, which will be reported in other revenues and comprise the vast majority of Olympics revenues in the third quarter; advertising, which is tracking well with significant uplift versus the 2018 Winter Games; and distribution, which includes both traditional affiliate revenues as well as D2C revenues generated on Dplay and the Eurosport player. Recall, we saw a healthy uplift in the Eurosport player subscriber base during the 2018 Winter Olympics. With the transition to our owned and more effective tech stack, we expect to fare even better through these games. And as a reminder, we expense the entire set of rights fees and production costs during the period in which the games are aired despite the fact that some Olympics-related revenue will be generated post the games. Accordingly, like with the Winter Games in Q1 of 2018, we expect to incur an Olympics-driven AOIBDA loss in Q3 that will normalize in future quarters. We expect the Q3 loss to be in the $175 million to $200 million range.

I’d like to shift to providing some commentary about the outlook for the year as we look across our key operating segments. Like last year, we are not providing full year AOIBDA and free cash flow guidance, though I will describe a number of key factors, quantification of the one-off items, headwinds, tailwinds, building blocks, et cetera, to help you understand the cadence around the moving pieces this year. Turning to segment drivers. On the domestic side, advertising will continue to be impacted by underlying trends within the pay TV ecosystem. We continue to fight the uphill battle with cord cutting and cord shaving as well as declining PUT levels, which ultimately lead to lower audience delivery. And while our very strong yield and the strongly growing contributions from our GO business have more than offset these trends, rating headwinds at some of our key networks have put additional pressure on recent results. All of which, though, is fortunately taking place in what continues to be a healthy marketplace for TV advertising. Two months in, we’re forecasting slightly up. And as always, ratings trends will determine where we land. With respect to domestic affiliate, we’re coming off a very strong year, and we feel optimistic heading into 2020. We remain the most widely distributed network group in the industry, though as you all know, we began to lap inclusion in Hulu and Sling in the fourth quarter and will lap YouTube TV in the second quarter of 2020, which places us more in line with the broader industry trends, as we have noted previously. Visibility across this revenue line is also very much subject to shifting consumer patterns in and across different bundles and services as well as the pickup of D2C subscription revenues. Near term, we would expect at least low single-digit revenue growth from domestic affiliate. Turning to international, current operating trends and the outlook within advertising remains similar to what we have seen over the last few quarters on a constant currency basis. Our continuing commercial share growth across many countries, in part from broader distribution of Scripps content internationally, continues to support a positive international ad revenue story. Moreover, traction from the advertising side of our next-gen and direct-to-consumer products continues to provide additional tailwind. Also, please recall, we will lap the consolidation of UKTV in the second quarter of 2020. And on the international affiliate side, as David discussed, there are, as always, a number of moving pieces, chief among them is our desire to accelerate the penetration of Dplay, which is finding very solid footing across its growing number of markets. At the same time, we are, in some cases, pivoting to a hybrid model with some of our distributors selling on both a wholesale B2B basis as well as a B2B2C retail basis, while at the same time, driving direct-to-consumer. As David noted, in instances where we had to push harder to get paid full value for our content, we have held firm, much like we did in 2017 in a number of countries, leading up to the 2018 Winter Games. We now can and will take a more aggressive stance with a far faster pivot to a direct-to-consumer model, which we believe is ultimately the stronger move strategically. This, however, will naturally create some near-term impact on our segment revenue growth. And as a reminder, Q4 2018 provided a slightly easier comp, benefiting our 10% growth in fourth quarter of 2019. To that end, we expect that near-term and annual international affiliate revenue will grow modestly slower in 2020 compared with the constant currency revenue growth of 5% in 2019. As many of our growth initiatives evolve and become a bigger part of our overall revenue and as we prioritize investments between the individual initiatives, the balance of advertising and subscription revenue will evolve as well the cadence of expenses and the mix of domestic and international. Against this backdrop, you will have noticed that we are providing slightly less precise and detailed quarterly guidance on revenue line items, where I have come to the conclusion that they would be much less helpful at this point than in the past. Turning to free cash flow, which continues to be a top priority for us in 2020. We expect another year characterized by a very strong AOIBDA to free cash flow conversion rate in the 60% range, give or take. As discussed before, the Olympics are a cash outflow in 2020. We expect cash taxes to return to more normalized levels this year and will be up year-over-year to the low 20% range, excluding PPA amortization. CapEx is expected to be more or less in the same ballpark as last year as we continue to invest in, number one, our growth initiatives; number two, global software and infrastructure spend geared to productivity and cost efficiency; and number three, the final build-out of our global headquarters. FX is again expected to be a headwind both on revenue and AOIBDA in 2020, roughly a negative $120 million impact on revenue and a negative $60 million impact on AOIBDA. On the balance sheet, we will remain comfortably within our target range of three to 3.5 times net debt over AOIBDA. While we’re currently at the very low end of that range, with some of the lumpiness to our AOIBDA, particularly around the third quarter impact of the Olympics and continued share repurchases, our leverage multiple should increase modestly to around the middle of the range this year. And keep in mind that given our normal seasonality and with the Olympics in the third quarter of this year, our free cash flow generation will be somewhat lumpy and skewing toward Q4.

Thank you very much. I think we’ll wrap it up there. Thank you very much, and we’ll speak to you next quarter.