TKO Group Holdings Inc (TKO) 2006 Q2 法說會逐字稿

Welcome to today's teleconference, at this time all participants are in a listen-only mode. Later, there will be an opportunity to ask questions during our Q&A session. I will now turn the program over to your moderator Mr. Michael Weitz.

Thank you. Welcome to World Wrestling Entertainment's second quarter conference call. My name is Michael Weitz, Vice President of Investor Relations and Financial Planning at WWE. Here with me today are Linda McMahon our CEO, and Michael Sileck our CFO. We issued our earnings release earlier this morning and will be referencing a presentation as part of our discussion. These are available on our corporate website at corporate.WWE.com.

We'll be making several forward-looking statements today as part of our discussion. These statements are based on management's estimates. Actual results may differ due to numerous factors as called out on page 1 of the presentation and in our earnings release. Today we will review our operating highlights and second quarter results followed by a Q&A session. As a reminder, in June, we announced our Board's decision to change the Company's fiscal year end to a calendar basis beginning with calendar year 2007. This change resulted in an 8-month period through December of which we refer to as our 2006 transition period. At this time, I would like to turn it over to Linda.

Thank you, good morning, everyone and we appreciate again your joining us. During the last earnings call we highlighted our objective of positioning the Company for long-term growth. We also underscored the importance of managing our business to achieve our transition period financial expectations. In the second quarter we continued to make important progress on these goals. First, we delivered impressive revenue growth versus a strong quarter last year. The current quarter drew strength from the favorable trends underlying our live events, home video, and e-Commerce businesses. Revenue growth in these areas more than offset the anticipated absence of domestic television ad sales. As a result in our new deal with USA Network, we longer sell advertising in our programs.

Consistent with our transition period, financial expectations we also increased investment in our television programming and key strategic initiatives before providing you with an update on the progress of our strategic initiatives. Before providing you with an update on the progress of our strategic initiatives, however, let me start by sharing some perspective on our current results. We posted earnings below what was an outstanding quarter last year, a quarter that also benefited from a $3.4 million legal settlement. As previously indicated we expected that the sunset of television advertising, increased investment, and the absence of last year's legal settlement would have a direct impact on our earnings growth. As a result of these factors, the year-over-year change in the Company's earnings does not reflect the underlying vitality and positive momentum of our businesses.

This positive momentum can be seen in the performance of our domestic live events business. Average attendance at our North American live events increased on a comparable year-over-year basis for the seventh consecutive quarter. Excluding ECW average attendance increased 21% to 5200 in the current quarter and mirrored a comparable increase for the year-to-date period. Moreover, this business contributed both revenue and profit growth to the quarter's results.

We believe that the performance of our domestic live events is an indicator of the overall positive trends developing across our businesses. Complementing the growth in live events, both our home video and e-Commerce operations realized their sixth consecutive quarter of year-over-year growth. Home video DVD shipments increased 67% in the quarter and online merchandise orders nearly doubled.

During the quarter, we accomplished several operational objectives that should help us take advantage of these trends. First, we successfully transitioned our SmackDown branded program to the CW Network. Since moving to the CW, SmackDown's U.S. coverage has increased by more than 3 million homes. In addition, while the coverage has grown, SmackDown's appeal to audiences has grown stronger. Drawing over a 5% increase in viewers in the first few months after the transition. We also completed a new home video distribution agreement with Genius Products, which became effective in November. We believe the partnership will enhance our revenue potential by leveraging Genius's best in class management and their strong relationships with retailers. In addition, we expect that the 3-year agreement will pose economic advantages to WWE by providing better terms than the deal with Sony that it replaced.

Now let's turn back to our long term growth initiatives. During the quarter our management sustained an ambitious campaign to relaunch ECW as a third brand. We secured television distribution on the Sci-Fi channel through December 2007 and held 34 nontelevised live events through the second quarter. These events were staged in smaller venues which provided our fans with a unique experience. We believe these venues do not provide an efficient avenue to expand ECWs audience. As such we are refining our touring strategy in order to find a more economical way to grow this brand. Going forward, ECW's live events will be coupled with SmackDown until ECW builds a large enough audience to tour independently. At that time ECW may tour in larger venues following the same business model as RAW and SmackDown. We continue to believe that we can develop strong consumer demand for this unique form of entertainment and that the venture will build value over the long-term.

Now let's turn to an update on our digital media initiatives. During the quarter as our e-Commerce business continued to surge, we focused on the development of our online advertising. Specifically, we made some key organizational changes. We brought in new talent to revamp our online advertising sales efforts and realigned these activities under an experienced senior executive. We believe the changes enacted in the quarter have already enhanced our selling efforts and our ability to attract new advertisers. While there is still more work ahead of us, we remain committed to realizing the value of this business.

Finally, regarding our film's initiative, we released our second feature film The Marine on October 13. To date, The Marine has garnered more than $18 million in domestic box office receipts and is pacing in line with our profit projections for the film. So from my perspective, our businesses remain strong. We continue to work hard to position the Company for the long-term. Now, I'm giving you a strategic overview and I would like to turn it over to Mike Sileck our CFO to take you more through the financial details.

Thank you, Linda. As Linda has mentioned we delivered an impressive 8% increase in revenue to $96 million in the second quarter. Exceeding a strong second quarter last year. Revenue growth in our live event, home video, and e-Commerce businesses more than offset the decline in our domestic TV advertising, which we had anticipated. As we've previously discussed, the quarter reflected a $4 million reduction to profit from the absence of domestic television ad sales. In addition, the second quarter last year reflected a $3.4 million benefit from a legal settlement. Excluding the impact of these factors gross profit and operating income increased slightly over the prior year.

During the quarter, our strong top line growth was mitigated by increases in our television production costs and by increased investment in our strategic initiative. Page 5 of our presentation lists the revenue and profit contribution by business unit as compared to the prior year. Revenues from live events including merchandise sales at these events increased by about $6 million or 36% led by the timing of our international tours. This quarter's results reflect 11 international events as compared to only 2 in last year's quarter. The 11 events in the current quarter were staged in both emerging markets, including Mexico and the Philippines as well as more established markets in Australia and Japan. With a 21% increase in average attendance, excluding ECW, our North American events also contributed to an increase in profits during the quarter. Overall, the profit contribution for live events increased by just over $1 million from last year. For the remainder of the year, our plan calls for 21 international events compared to 16 events in the comparable period last year.

Turning to our pay-per-view business, revenues for the quarter were essentially flat to the second quarter last year. Revenue reflected a 4% increase in buys for the 3 pay-per-view events that were in both quarters and a $5 domestic price increase that was initiated earlier in the year. These growth factors were offset by the recognition of over 300,000 prior period buys in last year's second quarter. International buys in the quarter comprised 36% of the current period total as compared to 40% in the prior year.

In our consumer product segment, our home video business continued to deliver strong revenue growth. Home video revenue increased 22% to nearly $15 million reflecting the shipment of 1.2 million DVD units, a 67% -- 67% above the prior year quarter. Sales were led by the release of our Hulk Hogan title which has shipped over 200,000 units to date. During the quarter home video revenue was impacted by sell through rates that while still on average better than the industry norm were below year ago levels. We believe the revenue and profit growth generated by this business over the past year is due in large part to the development of strong relationships with our retail partners. Looking forward, we expect our work with Genius Products will enhance our relationship with retailers and facilitate greater operating efficiencies. Revenues from our licensing activities increased 14% to $7.3 million primarily due to greater royalties earned from book publishing, novelty products, and music.

During the quarter, we saw an improvement in our international sales. Also of note, in November we released the 2007 version of our SmackDown versus RAW video game for the PS2, PSP, and Xbox 360 platforms. Sales of these games will be reported by our licensee partners in 2007. Our digital media segment comprised of online advertising, e-Commerce, and wireless businesses delivered revenue growth of 51% compared to the year ago quarter. Revenues from the sale of merchandise on our Internet based store front WWEShop increased about $2 million or 125% compared to the prior year with orders processed nearly doubling to 71,000. Along with the large volume increase, the average sales per order also increased by approximately $5 to $51.

Revenues for our other digital media businesses increased 17% to $2.7 million reflecting growth from both our online advertising and wireless businesses. We continue to build our online ad sales and content infrastructure in order to monetize our high level of Internet traffic. For the quarter, we averaged 16.6 million unique visitors and 44 million video streams per month, compared to approximately 9 million unique visitors and 25 million video streams per month in the second quarter last year. Our profit contribution margin for the quarter was 40% compared to 47% in the prior year. The 7 percentage point decrease versus last year primarily reflects the absence of high margin domestic TV ad sales.

As I mentioned earlier, our profit margin was also mitigated by increases in our television production costs, including a technical trial of high definition broadcasting as well as ongoing investment in our strategic initiatives. SG&A expenses were $24.6 million in the current quarter, up 24% from the second quarter last year, which benefited from a $3.4 million legal settlement. Excluding the settlement, SG&A expenses increased 6%, primarily reflecting increases in staff associated with our digital media initiative and increased stock compensation costs. Operating income for the quarter was about $11.7 million, excluding the impact of domestic television ad sales and legal settlements operating income exceeded last year's second quarter results. Page 14 of our presentation compares the year-over-year results and provides a summary of changes by business.

It should be noted that our effective tax rate decreased from the second quarter last year. The decrease reflects the settlement of a state and local tax audit that resulted in a lower 29% effective tax rate for the quarter compared to 42% in last year's quarter. Excluding the impact of the settlement, the current quarter's tax rate would have been 36%. In the future, we expect our effective tax rate will be approximately 36%.

Page 15 of the presentation contains our balance sheet, which remains strong. On October 27, we held $254 million in cash and short-term investments with virtually no debt. To date, we have recorded $53 million in feature film production assets. As we have stated in past calls,these assets will need amortized on a pro rata basis as revenues are recognized in accordance with GAAP.

Our first feature film, See No Evil was released on May 19, and generated approximately $15 million in domestic box office receipts. The film is currently being distributed on DVD by our partner, Lyon's Gate. Our second feature film The Marine was released on October 13, and has generated over $18 million in domestic box office receipts to date. We do not anticipate realizing any revenues from our feature films until calendar year 2007.

For the quarter, we generated free cash flow of $5 million compared to $14 million in the second quarter last year. The decline primarily reflects changes in working capital, partially offset by lower capital expenditures. We spent approximately $5 million in the second quarter last year to acquire land adjacent to our television facility. As we mentioned in our last earnings call, we are changing the Company's fiscal year-end to a calendar basis beginning with the 2007 calendar year. Regarding our business outlook for our 8 month transition period through December 31, 2006 we continued to expect modest revenue growth from the $248 million in the comparable period in 2005. In addition, we anticipate bottom line results approximately even with the $30 million of net income in the comparable period last year. That concludes this portion of our call, and I will now turn it back to Michael Weitz.

Thanks, Mike. Operator, we're ready now, please open the line for questions.

Thank you. [OPERATOR INSTRUCTIONS] We'll take our first question from Michael Kelman with Susquehanna. Go ahead, please.

Thanks. Hi, I wanted to dig a little bit more into the gross margins in the quarter. I think specifically gross margins in the consumer product segment were around 52% this quarter, which was more than 400 basis points lower than the fiscal first quarter and over 900 basis points lower than last year's fiscal Q2. Can you talk about some of the major drivers? What drove the margin contraction? And perhaps you can provide with some of the margin detail for licensing home video and the magazine business? And then more importantly maybe you can talk a little bit about where you see these margins trending over the next several quarters?

Sure, Mike. I'll take that one. Regarding the margins, primarily -- in consumer products, primarily if you look at the DVD business, that margin was down from the prior year. And much of that had to do with -- the sell through rates regarding the DVDs were lower in this quarter than they were in the prior year quarter. The prior year quarter was especially helped by certain titles that sold just exceptionally well with over 80% sell through rates and a few of the titles last year. In particular The Undertaker DVD. This year, this year's quarter, we've returned sort of a more normalized rate. And as a result of that, that compressed the margin in the quarter.

Looking ahead to that business, that's an important part of our business, obviously, we look for over time particularly with our new partnership with Genesis. As we look to get the model even ore efficient and as we just look at our titles over the next coming several years, we expect that margin to kind of settle in, in kind of the mid 50s where it has been historically. This quarter was dow slightly below 50, but we expect that to kind of moderate over time back to the mid 50s.

And then the only other piece of that, Mike, that I'll clarify is in the publishing. We had said a year ago or 9 months ago at -- as we were going to transition to a cleaner, we're consolidating our magazines to one edition of the magazine, WWE Magazine and that debuted July of this year. There are higher costs associated with that magazine, we think it's a much better product. The news stand reception has been very well. But there is an investment period for that that we're sort of working our way through now. Again, totally anticipated. I think those are the two things that I would point out relative to the margins. And we do think the publishing business over time as the strength of the advertiser pace solidifies for that product and as the subscriptions, which we think will increase over time. We think that will shore up that margin, as well.

I have one other question with regards to, maybe you can talk a little bit about your expectations for home video sales for See No Evil, as it was just released the other week? And maybe also talk about what type of sell through rates or units shipped you would need in order to meet your expectations or to hit the profit hurdle on that film.

Sure. Mike. The See No Evil DVD did go on sale on Tuesday. For those of you who have not purchased it yet, we'd appreciate you going out and buying it. We have in the model a little over a million units expected to be -- in fact, we did ship over a million units out to our retail partners. And we, in terms of our model we expect in the neighborhood of a million units to be sold through. The -- and the early returns on these things are -- the early indications are that we're right in line with our plan for that.

Great. Thanks very much.

You're welcome.

Thank you. We'll take our next question from James Clement with Sidoti, go ahead, please.

Mike, I know I ask this question every couple of quarters and I figure I'll ask it again now. Pay-per-view buys recognized from prior periods was certainly a lot lower than it's been over the last two quarters, is that just an -- is that just -- is that just an issue of the inherent lumpiness and just timing of how those are recognized? Or do you feel that the initial -- the initial information that you get from MSOs now from their reporting is more accurate than it's been historically and we shouldn't be looking for upward revisions of the same kind of magnitude we've seen over the last couple of years?

Yes, my sense on that, Jamie, is that the reporting is getting better and it's getting more timely. Now the counter to that is that the increase in the international piece of that business because of the nature of the international buys, the time, the reporting time lines are a bit slower. So there's a built in lag there. But I would say just on balance going forward, I would not expect to see the big sort of adjustments that we've seen in the past. I think the initial forecasts are better than they had been historically.

Okay. Because just looking at the information you provide on your website. I mean, it doesn't really look like -- even going back to this past year's WrestleMania, which obviously would have had a fair number of international buys, that's really been revised upward all that much.

Right.

Okay. Okay. All right. Moving on. With regard to digital media and specifically online advertising, do you guys have a dedicated sales force that's actually out there selling advertising? Can you explain to us a little bit how that's evolved over the last couple of quarters?

Jamie, yes, we do have a dedicated sales force and we are growing it. We sort of had a stutter step there for a bit with our sales force, but I think now that we have secured the services of an experienced online integrated salesperson and she is now in the process of adding to that, to that staff. We'll have -- currently we're -- have about 8 people in our New York office, we have about 2 in California, and we have about, we're scheduling about 3 for the Midwest, the Chicago or Detroit area. So that's significantly more than we've had in the past outselling this particular product. So with now the advertising looking not only to create banners et cetera on pages, but now have to monetize the streaming that we have. Are we packaging it? Are we going to have advertising in advance of each of the streams? Those would be sort of the strategic areas now that we're looking at since we have been adding to this dedicated sales force on the ground. I think that it bodes well for our continued growth in that area. In fact I expect big growth in that area over the next year.

Okay. Great. Thanks very much for your time.

Thank you.

We'll take our next question from Alan Gould with Bleichroeder. Go ahead, please.

Thank you. Few questions. First for Mike, there is 0.5 million to 600,000 of other income the quarter. Could you tell us what that was? And with the video games, was there revenue recognized in the quarter for the video games? Or is that recognized after you get the sales from the video game manufacturers?

I'll take them in reverse order. The video games is not -- the revenue from that has not yet been recognized. It will be recognized in 2007 as we get reports from our license partners. Early indications are that those gains are doing well, though. We're very pleased with both the product itself, got very good reviews, and we're also pleased with the selling activity of it since it was released.

Okay.

Relative to the $600,000 item, there was some investment income on kind of a mark to market of an investment that we have that generated some income for us.

Okay. And a couple more. Linda, you said this is the seventh consecutive quarter of North America attendance growth. If you go back to the peak there theoretically could be a lot of upsides. How much does this keep -- what's your crystal ball say? How much does this keep increasing? Or is it rate increasing et cetera?

Well, at the peak, I think our average live attendance was about, yes, it was 9,500 to 10,000. So at about 5,200 for domestic attendance now, as you said there's quite a bit of upside potential. We are -- there's more competition in the marketplace now, but I'm very encouraged by the growth that we've seen in our live events. We, I think we said on a prior call that we relooked at our touring schedule, we have grouped more of our tours, in particular marketplaces and we move on to the next market so that we really wanted to make sure we didn't have a burn out factor in the marketplace by going there too often. And I think that strategy has really worked. We have an aggressive marketing team that's out there and promoting team that's been fueled by a new leader in that group, as well. And then it's how we've looked at our international marketplace for, again, the touring and capitalizing on how many times to go to those markets. I think our focus is really on growing the marketplace, not burning it out, capitalizing on having the event at a less frequent rate in the larger markets. But it's a delicate balance of how many times are the right times to go. And I think our experimenting with that has proven that we're having success.

Okay. And the change of ECW into SmackDown, does that occur -- when does that occur? And I assume that should increase some of the SmackDown attendance.

I believe it's this week. That we've made the change to have ECW start touring with SmackDown, and really that was a logistics issue that we looked at the cost of travel, et cetera and the advertising and marketing in a particular marketplace it just made sense at this point to expose ECW to a larger live event audience and I think that will give us an opportunity to grow that brand, as well.

Last question. The international pay-per-view buys were a smaller percentage of total than they had been historically. Any reason why that occurred this quarter?

I think the one thing of note is as we had said previously, Italy has been a really hot market for us. And really, it's really performed, we had above natural growth as sort of we would characterize it historically. Leading up this kind of the trailing year. That the growth there has now moderated and so we've seen some pay-per-view sort of moderate at that level. That has caused kind of a shifting. And then also the -- several of the prior year buys were international events, as well. And that had an impact, but primarily we have seen some cooling down in Italy and, I think, that's been a big factor for us. But overall we are pleased with the balance. We had said all along that we didn't necessarily anticipate being at 40%. And what we're seeing is kind of a come back to sort of a normalization in the 30 to 35%.

Okay. Thank you very much.

Yes.

We'll take our next question from [Bob Jenkins] with [Schaeffer] Capital Management.. Go ahead, please.

Hello, good morning. Linda, just a question on brand management. Between the three wrestling brands, SmackDown, RAW, and ECW. Why not have them as three separate and distinct brands ran by three different people, set up their own budgets, and keep them independent? No mingling of wrestlers except for special occasions. Because right now it just seems like all three brands are just homegenized into one separate thing, one separate entity and there is no difference between the three. It gives the viewer no reason to check out any other, any other brand over one.

Well, clearly, our goal with the three brands is to have them be stand alone brands. However, the decision that we made when we first separated the RAW and the SmackDown brands was to provide us with the opportunity to reach different audiences on cable and on broadcast, also to give us different touring teams so that we could increase our international live events, all of which we have done. We've spent the last 4 to 5 years in the brand separation and now we found that you can still create more rivalry, sometimes by crossing over the brands no different than if you had a different league competing with another. Part of the crossover effect has been to increase that competitive factor. So that is part of what we're doing.

We also look at ECW as a development brand and also gives us the opportunity to launch more in a newer talent through there. So I think we're accomplishing the goals we set out to -- when we first started, which was to give us the opportunity to create more stars by having the two brands. And now adding ECW, providing the opportunity for greater international growth, more licensing product off of the two brands and now the three brands and ECW's growing slowly. So your question really is why not make them even more distinct? I think that we have created the distinct brands and since they are now created distinctively, we have the opportunity to cross promote and have some of the talent migrate back and forth across the different brands so that we can increase the story lines and continue to grow all of the brands in our total business.

Thank you very much.

Thank you. [OPERATOR INSTRUCTIONS] We'll take our next question from Robert Routh with Jefferies. Go ahead, please.

Hi, yes. Thank you very much. Few quick questions. With respect to the Genius Products deal. I was wondering if you can go into a little more detail about the cofinancing and coproduction aspects of that particular transaction. And in terms of the economics, obviously they're better than the Sony economics and they can focus more on your product and Sony because that of MGM and Columbia TriStar. I'm wondering for you can give us a sense as to how many basis points in terms of distribution fee, WWE will be saving as a result of that particular deal. Also, I was wondering if you could talk a little bit about how you feel about the International Fight League going public. What your feelings are about that. I know they backed into a shell last Wednesday. And a little bit on 24/7 in terms of how the progress with that is going, obviously with more VOD being rolled out, I would think that that could be a big opportunity going forward.

That was a lot, Robert.

Robert, I'll start and then if we miss a few of them we apologize. The way I would characterize the Genius deal is that there's several hundred basis points that we are advantaged by going forward. I don't want to get any more granular than that, I'm sure you can understand why. So overall, and that's kind of the deal. Now while we've had a lot of strategic conversations and I think there's a lot of -- there's the McMahons, and the Weinsteins, I think there's a lot of common ground there. And we really do anticipate over time that we hope to develop a more broad reaching business arrangement. The reality is as we sit here today the economic -- the Genius distribution deal is the only thing that is formalized at this point.

And then, I think your other question was regarding 24/7. Just regarding that, we have announced that CableVision is, we are going to be carried on CableVision. That was one of the last big MSOs that we were looking to get. So we'll see that kind of, that will help the expansion of the distribution. We are still are waiting on Time Warner Cable, that's one of the large ones that we have left to go. But that product, I think, just continues to evolve, the distribution is evolving, and I think the quality of the product is evolving, as well. And your other question, I think I missed, Robert. I apologize.

As far as the International Fight League, they kind of stealthily went public through a shell last Wednesday. I was just curious, it's obviously not the same as WWE, but it's similar. Kind of like the Ultimate Fighting Championship, whether or not you have any feelings about that or not? And then just kind of one adjunct question is whether or not you care about HD, DVD, or Blu Ray given the size of your library, whether you're kind of deciding one way or the other, or it really doesn't matter to you?

At this particular time, relative to IFL, and UFC, I think they are good competitors in the marketplace for sporting programs, it's a good demo reach for them, and it's clearly , a growing sports theater, one that we're taking a look at too and even announced last week that we had the folks from Pride in to meet with us. We're having an opportunity to take a closer look at the development of that particular business, as well. In terms of HD and DVD, we're ready when the marketplace is ready , for what our product needs to be. And I think as the demand for those high quality products roll out, then our distributors will let us know. I think that's what the partnership with Genius will help us focus on as well, the need to produce that kind of product. For now, we have not entered into that.

Great. Thank you very much.

Thank you. We'll take our next question from Michael Kelman with Susquehanna. Go ahead, please.

Thanks. I just had a quick question on the TV rights revenue. It looked like it was down sequential this quarter from 22.2 million to 21.8 million. Just want to get an understanding of why we saw that sequential down tick. And also with regards to your change in touring strategy for ECW, does that have any impact on your TV rights deal?

No, Mike, the only thing I think you'd notice in the TV rights deal is if you're looking at it consecutively is that in the prior quarter, I guess that would have been the first quarter, first fiscal quarter, there was some TV -- we had some specials that we were paid above and beyond for. There was a diva special in there and one other, one other -- an additional hour of one of our shows, which we get paid incrementally for. And the only other change relative to -- in that line item to last year is, of course, we are getting paid for ECW programming. And that is up from what it was a few months ago. Because when there was a pickup for an additional 15 months, the rate went up fairly significantly on a percentage basis. So that's been the only kind of movement around in that area -- in that line item.

And just to answer the other question, the change in tourings, doesn't have anything to do with our television rights fees. We are producing our television show just as we've been doing since the inception of ECW.

Perfect. Thank you.

Thank you.

Operator, was that the last question?

Yes, it appears we have no further questions at this time, sir.

Thanks, everyone. We appreciate you listening to the call today. My name is Michael Weitz, if you have any questions, please do not hesitate to contact me. My number is 203-352-8642. Thanks again, have a great day.

This concludes today's teleconference, thank you for your participation and have a wonderful day. You may disconnect at any time.