華納兄弟探索 (WBD) 2016 Q4 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the Discovery Communications full-year and fourth-quarter 2016 earnings conference call.

(Operator Instructions)

As a reminder, today's conference is being recorded. I would now like to introduce your host for today's conference, Jackie Burka, Vice President, Investor Relations.

Good morning, everyone. Thank you for joining us for Discovery Communications 2016 fourth-quarter and year-end earnings call. Joining me today are David Zaslav, our President and Chief Executive Officer, and Andy Warren, our Chief Financial Officer.

You should have received our earnings release, but if not, feel free to access it on our website at www.DiscoveryCommunications.com. On today's call we will begin with some opening comments from David and Andy, and then we will open up the call for your questions. Please keep to one question so we can accommodate as many people as possible.

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 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 annual report for the year ended December 31, 2015, and our subsequent filings made with the US Securities and Exchange Commission. And with that, I will turn the call over to David.

Good morning, everyone. Thanks for joining us today. 2016 was a pivotal year for Discovery Communications. We reported record revenues, profit, and free cash flow, and took a number of important steps to ensure our continued success and growth in today's rapidly evolving media and technology landscape.

I'll spend a few minutes detailing some of the year's most important highlights and how they position us for the future before turning it over to Andy for a detailed review of our financials. First, let me start with an update on Eurosport and the Olympic Games, which, as you know, are a key pillar of our international growth strategy.

Starting January 1, and as we ramp up for the 2018 Winter Games in PyeongChang, South Korea, Eurosport is now the official home to the Olympics in Europe for the next four games. We will have an opportunity to reach over 740 million people.

We will also be the exclusive home for the Olympic Games in Sweden and Norway, where winter sports are hugely important, and in Germany, the continent's largest market. In all three markets, we will deliver the Olympic Games across all of our owned platforms and services, including free-to-air, pay TV, digital, and OTT.

Many of you have had questions about our investment in the Olympics and other sports rights in Europe. Our strategy has been first, to assure that Eurosport will always be profitable. Second, to selectively increase investments, including around locally important sports rights, leverage these must-have popular sports to drive significant affiliate growth, and as affiliate growth continues to accelerate, ultimately realize profit expansion. And I am pleased to say our strategy is showing strong progress.

And as you look at the aggregate we spend on sports rights, it's important to note that over the last few years, we have paid only low- to mid-single-digit inflation on our sports rights as a whole. We have stayed clear, in most cases, of in-market football, where increases can be between 50% and 100%. In fact, I believe the high price of football across Europe has made all of our other sports rights more affordable for us.

Eurosport helped us grow international affiliate revenues in 2016 by 10%. Our local premium and exclusive sports rights drove Eurosport viewership up 23% in the fourth quarter, and we recently had record ratings across all of Europe during the Australian Open, where we have exclusivity in the majority of our markets.

With Eurosport leading the charge for our diversified and differentiated offering of about 10 channels per country, we expect our international affiliate growth to accelerate by at least 200 basis points in 2017, adding over $215 million in affiliate revenues, ex-FX, building off successful renewals with TDC, Telenor, and Liberty Global, and most recently, Sky.

While we never look forward to a potential carriage standoff, the negotiation with Sky reaffirmed the strong value of our brand portfolio and the passion and engagement of our super fan communities. Our new agreement with Sky in the key UK and German markets includes new opportunities to launch new channels and services, so we will be helped with more growth in the two biggest media markets in Europe in the years ahead. We will have more news to share in the coming weeks as we will be launching new services, including a second free-to-air channel in the UK, leveraging our strong existing IP to reach more viewers in the UK market, and the new free-to-air channel will make money for us this year.

Another large potential growth opportunity for us is the Eurosport Player. The team is making great progress on our sports Netflix strategy, which will use BAMTech's best-in-class streaming video technology, allowing for enhanced feature functionality, variable pricing, and gives us tremendous scale across the European continent. Our new team, under the leadership of Paul Guyardo, who built DIRECTV's NFL Sunday Ticket and sports packages business to an over $2 billion business, is currently pivoting the business away from a one-size-fits all model.

The team is building bottoms up, country-by-country business plans with custom pricing and packages, tailored to the rights we have in each market. Early results in testing various consumer packages are promising, including in the UK, where we have seen 150% increase in subscribers in the market.

Of course, our world-class content is only as good as viewers' ability to see it, and in 2016, we continued to enhance our distribution reach to reach more viewers across more screens. Following our successful renewal with AT&T in July, we have no deals up in the near term. As we look ahead, our strong affiliate deals in the US and abroad, which represent half of our total revenues, provides a valuable, growing foundation for our revenue base at a time when global advertising markets remain very difficult to predict.

Paul is also leading our pivot to mobile and the drive to monetize our content across all platforms. We've been very pleased with the progress of our recently launched TV Everywhere GO family of Apps. Today, GO is available in more than 80% of US pay TV households, so to over 150 million people, and we have expanded our content portfolio to now showcase over 5,000 episodes.

We are finding that GO is a great vehicle for reaching younger viewers, with about 40% of our viewers ages 18 to 34, averaging one hour length of tune in. With GO now super serving super fans and gaining momentum with viewers and younger viewers, we are undoubtedly directly connecting to our viewers and fortifying the pay TV ecosystem, while achieving premium CPMs.

In the first quarter, our GO apps will contribute over 1 point of US advertising growth to the bottom line, and its contribution is trending to increase to 2% by the end of the year. I am very confident in our ability to continue monetizing this important and growing platform.

Second, our original non-linear brands took an important step forward with our recent joint venture and commercial partnership with Group 9, home to leading short-form and mobile first brands, including NowThis, the number-one news publisher on Facebook, Thrillist, and The Dodo, with over four million monthly streams across Facebook and all platforms in January. While our partnership is still in its early days, we are already working together to sell our Group 9 brands in conjunction with our GO apps and our linear brands to deliver a true 360-degree solution that targets a younger audience to our advertisers. We're excited for the opportunity to further attract and monetize younger audiences across social media and short-form video.

Third, in niche categories, where we have a dominant consumer and brand advantage, such as ID and Turbo Velocity, we see huge potential to expand these genres on and off the traditional TV screen, such as through dedicated digital-only content verticals, SVOD channels, and through partnerships such as our recent agreement with Amazon.

In mid November, we launched our first dedicated Amazon SVOD channel. True Crime Files by ID is already seeing strong success. In just two and a half months, we are already seeing 10,000 new net subscribers per month, paying $4 a month. This is just the first of several niche verticals we plan to introduce as we continue to monetize our library content on a direct-to-consumer basis.

Lastly, we are making real strides internationally with Discovery Kids Play, our TV Everywhere product in Latin America, which is now running with 24 providers in 12 countries.

More broadly, our international business showed strong momentum with viewers during 2016. Our international portfolio recorded its highest international delivery yet, with year-over-year audience increase of 3%. ID and Turbo saw strong double-digit viewership gains in the fourth quarter, and Discovery Kids reported its highest audience delivery ever across the Latin America region.

Additionally, in the Nordics, where we have noted challenges before due to rapidly changing viewer habits and tastes, we now have a new Management Team in place that is rethinking the way we operate in that region. They are laser focused on right sizing the cost structure and restructuring the content portfolio.

In the fourth quarter, we wrote down over $20 million of content that wasn't working, and as the Team looks to pivot away from an overreliance on US studio content to more cost-efficient local programming, a model that has worked well in other international markets, where we have big free-to-air general entertainment services. I will note that looking beyond SBS's income statement impact, our initial $1.7-billion investment four years ago has already delivered over $0.5 billion in free cash flow, and we expect it to continue to be a strong free cash flow asset for us.

Now, while we've talked to all of you a lot lately about our international story, we're also able to report strong and steady growth in key areas in the United States, and that all starts with our commitment to compelling, quality content. In the US, our biggest momentum story right now is TLC. TLC showed a very encouraging return to growth in the US in the fourth quarter that continues into the current quarter. TLC ended January with its highest ratings in three years, with ratings up double digits in the US and also in many key international markets, including Germany, Chile, and Mexico.

Our growth in market share for women also includes our partnership with Oprah Winfrey, which continues to be a tremendous success with OWN posting its best year ever in 2016. With popular hits like The Haves and the Have Nots and Greenleaf, OWN was once again the number-one cable network for African American women.

Our third female flagship, Investigation Discovery, continues to have strong and steady growth. ID is now the number-two pay TV network in all-day delivery in the US, with a strong and balanced delivery across daytime, prime, and late night. ID also shattered audience records in multiple markets internationally in the fourth quarter, including Brazil, Chile, and the Netherlands. The female audience growth at TLC ID and OWN serves as a great complement to our strong male brands and the packaging we can offer to advertisers and clients looking to find any demo and audience segment.

The Discovery Channel finished 2016 as the number-one non-sports cable network for men, and while we remain by and large focused on unscripted content and had strong performance across many franchises, we are having initial success around the world with our scripted tent-pole strategy. Rich Ross and the Team's first big scripted project, Harley and the Davidsons, was the number-one rated cable mini series in more than three and a half years in the US, and was a top premier in many international markets, reaching more than 43 million viewers globally. And we're excited about a new scripted series to debut later this year, titled Manhunt, about the pursuit of Unabomber, Ted Kaczynski, that has an all-star cast attached.

As we look ahead, supported by brands and IP that truly matter to our super fans, we are simultaneously driving as much value as possible from our linear businesses while making smart digital and mobile investments. From Group 9 to BAMTech Europe, to Discovery GO, we are excited about expanding our content across numerous platforms around the world.

Lastly, as you well know, this is Andy Warren's final call as CFO. A public thanks can't do justice to Andy's contribution over the last five years, but it's a start. A big thank you to you, Andy, for being an essential part of the Discovery family all these years and for all the success you've helped us to achieve.

Our new CFO, Gunnar Wiedenfels, will be joining us April 1 from Germany's ProSieben. Gunner brings to Discovery expertise across multiple businesses, including digital and direct-to-consumer, where he was able to either build or enhance the ProSieben businesses in both those areas, as well as extensive knowledge of the European and international TV markets. Before joining ProSieben, Gunner worked at McKinsey and was very instrumental in evaluating all of the European media markets.

So we're looking forward to seeing Gunner. We bid a fond farewell to Andy. The transition has been terrific. And so for the last time, here is Andy with more details on our financials.

Thanks, David. And thank you, everyone, for joining us today. 2016 marks a great end to my five-year tenure with Discovery. I'm very pleased with our 2016 performance and our continued execution on our stated strategic and financial goals.

On our 2015 year-end call a year ago, we issued full-year 2016 guidance of constant currency adjusted EPS and free cash flow, both up low double digits to low teens. We also said that our 2016 effective tax rate would be below 30% and that we would have full-year constant currency margin expansion.

Throughout last year, we raised our financial commitments for constant currency adjusted EPS and free cash flow both for 2016 and our three-year 2015 through 2018 growth CAGR guidance. We also exceeded our effective and cash tax rate forecasts and met our margin growth commitment. I really am extremely pleased that in this constantly evolving and challenging global media and economic landscape, we have been able to deliver upon or exceed all of our financial guidance commitments.

For full year 2016, reported revenues were up 2% and adjusted OIBDA was up 1%. Excluding currency, revenues were up 4% and adjusted OIBDA was up 5%, and total Company margins expanded to 37%. On an organic basis, so excluding the impact of foreign currency and last year's SBS Radio sale, total Company revenues and adjusted OIBDA both grew 5%. I am proud that we were again able to deliver robust financial results, while at the same time continuing to thoughtfully invest and strengthen our global IP platforms and brands.

Full-year net income available to Discovery Communications of $1.194 billion was up 15% versus last year, driven by the strong operating results, below-the-line currency effects, gains from dispositions, and lower taxes. Our full-year effective tax rate was reduced by 600 basis points, to 27%, as we remained highly focused on maximizing the construct of our portfolio of global businesses to lower both our effective and cash tax rates. We've obviously been very successful in achieving both objectives, with additional tax rate reductions expected in 2017.

Full-year reported EPS was up 24%, to $1.96, and adjusted EPS, which adjusts for the impact from acquisition-related non-cash amortization of intangible assets, was up 21%, to $2.13, driven by our solid operating results and a reduction in our effective tax rate. Adjusted EPS excluding FX, the third-quarter landscape write-down, and the fourth-quarter Group 9 gain was up 20%. For the full year, free cash flow increased 9%, to $1.29 billion, primarily driven by improved operating results and lower cash taxes. Excluding the impact of currency, our full-year free cash flow was up fully 21%.

Focusing now on only our fourth-quarter results, reported total Company revenues were up 2% and reported adjusted OIBDA was at 1%. Excluding the impact of currency, revenues were up 4% and adjusted OIBDA was up 3%.

Looking at our individual operating units, our US Networks had another solid quarter. Fourth-quarter US affiliate revenues were up 6%, as we continued to benefit from higher contracted affiliate rate, partially offset by declining subscribers. Excluding a few small one-time items, Q4 growth would have been 7%.

Total portfolio subs in the fourth quarter declined by just under 3% year over year, a slight acceleration from the third quarter, driven by subscriber losses at our smaller networks due to package mix, as distribution platforms with these smaller nets on their basic tiers lost subs, while platforms without these networks on lower tiers gained subs. Subscriber trends for the Discovery Network and our other fully distributed nets were stable with prior quarters.

As you look ahead to 2017, given our high-single-digit pricing CAGR and assuming universe declines stay relatively consistent, we expect our US affiliate revenue to grow at least mid single digits given we now have lapped the significant year-one step-up rate increase in one of our largest distribution partners. Fourth-quarter US advertising revenues were at 1%, primarily due to strong pricing, as well as proactively managing inventory at certain networks to take advantage of the robust scatter market, partially offset by ratings declines.

As we look ahead to the first quarter of 2017, we are seeing similar positive ad market trends. While delivery is down, pricing is strong and cancellations are low. After 100 basis point negative impact from deconsolidating Seeker and SourceFed post the December Group 9 transaction, our first-quarter domestic ad revenues are expected to be at least flat year over year. Fourth-quarter adjusted OIBDA was up an impressive 9%, as operating expenses were actually down 3% due to our aggressively reducing expenses.

For the full year 2016, total US revenues increased 5%, led by 7% distribution growth and 2% advertising growth. Full-year costs were flat, leading to an 8% adjusted OIBDA growth. Our relentless focus on controlling costs drove domestic margins to 59%, 200 basis points higher than 2015.

Turning now to the International segment. All of my following comments we refer to our organic results, which exclude the impact of foreign currency as well as the 2015 sale of the SBS Radio business. International ended the year with a solid quarter of double-digit organic distribution growth and improved organic advertising growth, leading to 5% total revenue growth for the fourth quarter.

Fourth-quarter advertising growth of 8% was driven by growth in all regions, excluding Asia-Pac, our smallest region, which declined partially due to demonetization in India. Northern Europe returned to growth, led by increased demand in the Nordics, while SEMEA and Southern Europe both grew strong double digits. Our 10% affiliate growth was driven by another quarter of solid price growth in Europe as we continue to benefit from successfully leveraging our expanded content portfolio, that now includes sports, to drive higher contracted pricing step-ups.

Turning to the cost side, operating costs were 12% in the fourth quarter, leading to a 9% decline in adjusted OIBDA. Cost growth was driven by increased sports content and production costs as we continue to add new rights to our sports portfolio, as well as the significantly higher content impairment charges in the Nordics that David discussed. Excluding these impairments, adjusted OIBDA would have been down low single digits.

For the full year, revenues were up 6%, with 3% advertising growth and 10% distribution growth. Costs were up 9%, with a 12% increase in cost of revenues, primarily due to increased sports content and production costs, as well as the higher fourth-quarter impairment charges, while SG&A was up 4%, leading to a 3% decline in adjusted OIBDA. Excluding both the year's impairment charges, adjusted OIBDA for the full year was down 1%.

Looking ahead, as David noted, we expect our 2017 distribution revenue growth to grow at least $215 million pre-FX, or 12% to13%, as we continue to benefit from stronger price escalators. While advertising growth is obviously harder to predict, it is dependent upon macro factors as well as Company-specific performance, such as audience share and ratings. We currently expect first quarter's advertising growth to accelerate and be up low to mid single digits. Net-net International's OIBDA in 2017 will definitely grow.

Moving on to our Education and Other segment. As expected, this division operated at a slight loss in the fourth quarter and for the full year as we continued to invest in Education's digital textbook to drive the long-term value of this industry-disrupting business.

Now, taking a look at our overall Company financial position. In the fourth quarter, we repurchased $250 million worth of common and preferred stock, after investing, as we highlighted on our Q3 call, $100 million in the Group 9 transaction. During 2016, we bought back a total of $1.37 billion worth of common and preferred shares. Since the inception of our buyback program in 2010, we have now repurchased over $8 billion of our stock, reducing our outstanding share count by 36%.

As we continue to carefully think about how best to allocate our capital and maximize returns on invested capital, in the fourth quarter 2016, we began investing in socially responsible, renewable solar energy projects that offer substantial financial and tax benefits to Discovery. As a result of our unique US tax base attributes and position, we realized a mid-teen IRR on these investments, primarily through tax incentives and improved operating cash flow. In the fourth quarter, our initial $63-million solar investment improved our book tax rate by 100 basis points, and we also recognized a $24-million book equity loss due to solar asset depreciation.

For 2017, we have already committed to invest an additional $240 million, and will likely invest another $100 million, for a total solar investment of $340 million in 2017. Assuming we invest this full $340 million in 2017, we would expect a book equity loss of approximately $200 million, which should be more than offset by the tax incentives received on these investments.

Given additional global operating tax rate improvements as well as the tax benefits from these solar investments, we expect our 2017 effective book tax rate to be at or below 20% and our cash tax rate to be in the high 20% range, so over 700 and 300 basis point improvements from our 2016 tax rates, respectively. These 2017 anticipated rates assume no revisions to current tax legislations.

For 2017, as we continue to invest in new areas of growth and best position our Company for the future, our top capital allocation priorities remain the same. Investing in driving organic growth, as well as strategic M&A and investments, like solar investments, that have a strong IRR in order to enhance shareholder returns.

In the first quarter 2017, we have already invested approximately $100 million in additional solar investments. While we do not have a specific target amount for share repurchases, we will continue to allocate excess capital towards repurchasing our stock as we continue to find the return on owning our shares highly attractive. As always, we stand by our unwavering commitment to our investment-grade debt rating and keeping our gross leverage below 3.4 times.

Now, let's focus on our additional financial expectation for 2017 and beyond. On the cost side, we expect our global organic cost of revenues to be up in the high-single to low-double-digit range, driven by sports and direct-to-consumer investments. We also expect our global organic SG&A to be flat to up only low single digits, resulting from predominantly completed 2016 proactive cost reduction actions. Importantly, this year we expect constant currency adjusted EPS to grow strongly in the low- to mid-teen range and constant currency free cash flow to grow at least low double digits.

We are again quantifying the expected foreign exchange impact on our 2017 results. While global currency rates continue to fluctuate, at current spot rates, our year-over-year FX headwinds have really moderated, partially due to our effective foreign exchange hedging strategies. At current spot rates, FX is expected to negatively impact 2017 versus 2016 revenues by $30 million to $40 million, adjusted OIBDA by only $0 million to $10 million, and adjusted EPS by $0.10 to $0.12 given the below-the-line FX gains in 2016.

Finally, as you will recall, we raised our three-year growth guidance last year and are confirming today that we still expect our constant currency adjusted EPS and constant currency free cash flow CAGRs for 2015 through 2018 to both grow at least low teens or better.

To wrap up, with this being my last earnings call with Discovery, I want to sincerely thank David, the Board, and the Global Executive and Finance Teams for a tremendous five years. I've thoroughly enjoyed my time at the Company and extremely proud of what we accomplished together. In particular, our achieving the highest free cash flow per share growth of our peer group since 2011. I believe in the strategic direction of Discovery and know it is in exceptionally strong financial position.

Yesterday, it was announced that I'll be joining STX Entertainment, a high-growth privately-held global media company. It will be a great next chapter in my career. Thanks again for your time this morning, and now, David and I will answer any questions you may have.

(Operator Instructions)

Our first question comes from the line of Ben Swinburne with Morgan Stanley.

Thank you. Good morning, guys. David, could you spend a few more minutes talking about, in particular, the Bundesliga contract and strategy around those rights in Germany, and particularly any specifics around Sky or Liberty in that market? And also, on the Olympics, give us an update on how far along you are at least broadly in Europe in terms of monetizing and positioning distribution of that content across the major markets that you have purchased.

And then I just wanted to quickly ask Andy, if it's okay, the sub 20% book tax rate and high 20%s cash tax in 2017, are those the go-forward rates beyond 2017, or are these investments creating a one-time tax shield and then 2018 moves back up to a more traditional range? Thank you both.

Thanks, Ben. Well first, we have a terrific set of IP in Germany, and we went after it with some purpose because it's the largest market in Germany. It's also a very competitive market with Vodafone, Deutsche Telekom, Liberty Global, Ziggo, Sky. There are a lot of platforms. It's quite aggressive in terms of offering content on all platforms.

And we own all of our IP in Europe on every platform, and so when we bought this IP, if it shows up on mobile, it isn't because [a league] sold it. It's because we sold it. So we did attack Germany in specifically, as having, we think, a lot of upside.

The Olympics in general is going much better than planned. We said when we bought the Olympics that we would make money, and we think now we'll make more money. We've done a number of deals, many deals. We just did Poland last week.

We were able to get in our BBC deal. There were two markets where we didn't have the Olympics in 2018 and 2020. We got back a lot of the Olympic IP, and a lot it digitally and in the UK through our BBC deal.

Every deal that we've done has been ahead of plan, and we haven't begun to attack some of the other platforms. And in every deal, we've retained all digital rights. So in some cases, we may have given some digital rights, but we still have -- we will be the only place that you can get all of the Olympics on any one platform. And so we feel very good about that.

And we've also, because of how well we've done, we feel confident in certain markets to take the Olympics ourselves. So for instance, in Germany, we have our free-to-air Eurosport. We have two other free-to-air channels. We also have eight pay TV channels We are the leader in sports.com with Eurosport.com, and we have our Player.

And so we are stepping up with the Olympics ourselves, which we're super excited about. We think we could do very well with it. We also think we're going to enhance all those assets. We've played this game before when I was at NBC. We now have the rings on Eurosport, and those rings belong to us for almost the next decade. And it was a big helper to NBC to have those rings in the Olympic games, and we think we could build asset value on top of making money.

Finally, on LGI and Sky, we like the fact that the market is competitive. We have some very good Bundesliga games, and with that, together with MotoGP, together with all of the tennis majors and all of the cycling, and owning most of that, taking it back so that it's exclusive, we think we can go at that market very aggressively. We already have a strong brand.

And finally, that's going to be a center point for us in terms of our Player because our IP is so strong. And so the Bundesliga is effectively the NFL or stronger in Germany, and two nights a week, if you want to see the Bundesliga, the only place to see it will be us.

Great.

Hey, Ben. There's no question that these mid-teen IRR solar investments obviously have a meaningful impact, positive impact on our tax rates, but if you exclude those, you're still looking at about 100-basis point reduction in our effective tax rate, and given our deferred tax rate structures, 200-basis point reduction in our cash tax rate.

So as we think about looking forward, very dependent upon what solar investment opportunities we have and some of the regulatory environment there. But think in terms of probably a sustainable 26% effective tax rate and a continuing decline in cash tax rate as again, we really focus on maximizing our deferred tax rate structures.

Thank you.

The only thing I would add, Ben, and we said this publicly, is that we did not -- we purposely did not have the Bundesliga and the Olympics be part of our Sky deal, and so we have that IP, which we could either do with Sky, do together with Sky and all others in the market, do ourselves. We have full optionality. And that (multiple speakers) Bundesliga starts.

Thank you both.

Thank you. And our next question comes from the line of Steven Cahall with Royal Bank of Canada.

Yes, thank you. First question on domestic distribution revenue. I think you said that you don't have any new deals in 2017, but I was wondering if you could give us an update on where you might be with new virtual platforms.

And then relatedly, you talked about a bit of an acceleration in subscriber loss. I was wondering if you could maybe give us -- it sounds like there was a bit of a mix shift where you lost some subs on some of your lower affiliate fee networks, but you gained subs on lower-tiered packages where you have bigger affiliate fees. So does that mix shift, is that neutral to revenue, is a headwind to revenue, or was that a positive revenue? And then I have a quick followup on the International side.

Well, just in terms of the distribution. We're on Sony. We have five channels on DIRECTV now. We got out in front of this idea of really focusing our channels.

Our deals provide that about 85% of the economics are against five of our channels. And we've really focused on making them stronger, so ID and TLC and OWN being female, ID being number two in America, OWN number one for African Americans, TLC right now number one in Middle America, and strengthening Discovery and Science and Animal Planet.

At the same time, there's a lot of talk now of focusing on just the bigger networks. We over the last four years have -- we've been way ahead of the curve on that, and our smaller networks, we've been really focused on making them super fan networks. So we have velocity that it isn't a large audience, but it's a very compelling audience.

Discovery Espanol, number one for men in the Hispanic space. Discovery Familia, a family Hispanic service. Really focused on the fact that if in the years ahead, there's a move to skinnier bundles, and I think that will happen over time, but over the next couple of years, the impact is going to be quite small, but if it does, we've been on every skinny bundle outside the US. And so as we redid all of our deals, we structured them this way because as we have taken five or six channels in Brazil, we had the same model. We got 85% of the money, but then we actually got more ad revenue because people spent more time with our channels and our brands got stronger.

In addition, we're talking to Hulu, we're talking to Google, we're talking to all of the players. And we have 12% to 13% viewership. We have top channels for men, for women, in different ethnic groups. And we're -- I'm not proud of this, but we're 12% or 13% of the viewership, and we're about 6% of the money. Most of the money is going to sports and [retrans]. And so to carry our channels is quite inexpensive, and so on a practical level, it should happen.

And from a pure financial perspective, Steven, it's so important to highlight what Dave said about the 85% and growing share of our five tent-pole networks. While yes, there's an acceleration of the digi nondistributed, fully distributed networks, that's declining more quickly. Our economics are not embedded in those networks. The high single pricing CAGRs, contracted pricing CAGRs are all on the five nets. And again, that percent of total US affiliated revenue will accrete even higher, and that's where you're seeing more stability on sub declines there.

Great, thank you. And then just quickly on the International side, I was wondering if you could just shed a little bit more light on the impairment that you took in the quarter. Should we just assume that this is snooker or curling, or is this something that's outside the sport network? And relatedly, does all this track back to your plan to drive big increase in OTT subscribership, and where are we on those numbers? Thanks.

Great. Well, I'll give you the general, and Andy can give you more of the detail. More than 20 was Sweden. And we've been working very hard on our Northern European SBS business. It's about 20 million people, but we were running it as -- it's run as four different countries, Norway, Denmark, Sweden, and Finland, and that's the way all media businesses are run up there.

And there's been some meaningful decline in that whole region, and part of it has to do with the fact that culturally, everybody speaks English, and there's a, unlike most of the other countries in Europe, there's a love for US entertainment content. And so when Netflix went into that market and HBO went into that market, it's a market that they've done very well in, and so there's been about 20% decline over the last two and a half years in viewership, which hit us. It's still a very strong free cash flow asset for us and pretty compelling, but it has had an impact on us in terms of subs and viewership.

It's leveling off to some extent, and I expect that it's probably going to continue to decline on a secular basis, but what we have done is we've begun to attack it from a cost perspective aggressively. We've got Mike Lang now running that business, who ran Miramax, and very strong operating guy.

And we're now starting to run it as one unit, so instead of four independent countries, we think there's a more cost we can take out of that business and not affect what we're putting on the screen and be more effective. And we're starting to see that a little bit this quarter as fourth quarter, our ad sales started to grow, and they are accelerating in this first quarter for the first time. It's too early to say that we've hit bottom and now it's getting a lot better, but it's certainly getting better in the first quarter.

And finally, we were getting a significant amount of nourishment, maybe 25% of the nourishment on those channels was coming from US entertainment stuff, so we were out there buying scripted series comedies and movies. And because that's so available now on HBO, and on Netflix in particular, the viewership of it was declining. And so we have now written off a lot of that stuff, and we're finding that our ratings are as good or better with the stuff that we own, and we're getting out of the business of that entertainment stuff, which we were getting quite leveraged on and we were paying a huge amount for.

So I'm pretty happy and pretty bullish about the fact that we're off that gravy train of having to compete between -- we're one of two or three of the big broadcasters there, and we're fighting in each case with all of the big US entertainment companies over whose going to get the movies and the comedy series and the scripted. We're getting out of that, and that's what you saw.

Just to provide more financial perspective on that, we have in the last couple years, Steven, averaged about $10 million to $15 million of content write-downs in some of our international content, purely in a notion of just staying extremely clean on the balance sheet as we go into the next year. 2016 was about $20 million higher, entirely driven by the one-time cleanup that David just discussed, as we really do de-emphasize some of the US content and continue to drive more of our--

US entertainment content.

US entertainment content.

Our stuff is doing fine.

Correct. And so it is a very much a one-time -- I would think in terms of a more consistent run rate of cleanup in the $10 million to $15 million range going forward.

Great. That's very helpful, thank you.

Thank you. Our next question comes from the line of Kannan Venkateshwar with Barclays.

Thank you. David, looking at Europe overall, the sports component of it will add more and more fixed cost in the income statement, but it looks like that market is moving more or less the same way the US market is moving, if not faster, into more of OTT consumption and so on. So just from an investment perspective, what gives you long-term confidence around locking yourself into more fixed cost when the viewership environment is changing more to OTT? Thanks.

Okay, thanks. Well first, let me just disagree with the premise of that, and if it turns out that you're right, which we're betting that's directionally where it's going to go, it's a home run for us. But viewership on Eurosport was up more than 20% in the fourth quarter, 23%. Viewership so far this year is up significantly.

The brand is stronger. We have more live content. We don't expect that we're going to spend a lot more year to year -- we don't need to spend more. We feel like the IP package that we have right now for Eurosport is about right, and it's actually paying off for us. It's strong enough that we can package it together with Discovery, which is number one in the market in factual and our female networks, and put it altogether and get very significant increases, which we talked about, where you're going to be seeing 12%, 13%, and a year from now, you'll see higher than that as we continue to grow our affiliate fees, which we said we were going to do, and we did it.

We do own all of these all of this IP direct-to-consumer, and if, in fact, there is a transition direct-to-consumer, there's only one player in Europe, which is more than twice the size of US, that's playing that game, and that's us. We've been out in the market now for a year and a half. We've been talking to consumers. We did our deal with BAM six months ago. We're going to begin to roll that out in three months. It will be fully rolled out in six months.

And we're the only pan-European player. We have the cycling. We have all of the olympic sports. We have the Olympics. We have the majors in tennis. And we even have a lot of these affinity sports, whether it's snooker or we can categorize it -- or squash.

So we're very strong in IP, and right now, we're making money on that IP. It's not the same margin, but we have always said that we are going to make sure Eurosport is profitable in itself. If, in fact, your point, that people are going to start watching more direct-to-consumer, which is our bet, that they are going to continue to watch on linear, your that they will also watch on their phone or their device, they're gong to be doing it through the Player.

And if that happens, if we come back, and of the 740 million people in Europe, we have 3 million or 4 million people for our sports Netflix in two years, that's going to be a massive asset appreciation for us. Our multiple is 9, and look at the multiple that you're giving to Netflix. And the difference between us and Netflix is Netflix is spending $6 billion a year on IP, and we're spending $0 because our direct-to-consumer product IP is already making money on Eurosport. And so when we now go direct-to-consumer, our cost of IP is $0.

And so that would be one hell of a business, and that's why we got Guyardo. That's why we have a whole team working in London. That's why we got Peter Hutton focused on this. And unlike Netflix, we have a platform with Eurosport, and we are the leader with 60 million people every month coming to Eurosport.com to be able to let people know that if you want to watch all of the Australian Open or Tour de France, or if you want to see the Olympics, there's where you go.

So we're head down on Eurosport that it's going to continue to make money, and we're not going to overindex on the IP and tip that over. And then we're full out with a -- over the next 24 months to really drive this sports Netflix strategy, which no one else has. It would take someone else a long time to build. We own the IP. Anybody else that can play this game can play it in a country, and mostly, they just have football.

And it's very important to highlight and walk through the economic model that we've developed here, and again, as David said, just to really highlight that we've done what we said we're going to do. If you look at what we highlighted a couple years ago, step one was investing in exclusive content, as David said, allowing ourselves to have more must-carry content and have a greater sense of affinity groups.

Step two was taking that content and having it drive an accelerating contracted affiliate revenue growth curve. And clearly, you're seeing that not only in 2016, but are highlighting the 12% to 13% growth and accelerating further in 2017 and 2018. So step one and step two are done.

Step three then is, as we're now invested in the content that we need, we don't see a further acceleration of sports content spend really in 2018 and 2019 and 2020. So what you're going to see the step three being is a real acceleration of profits as margin as you have the contracted affiliate growth, you have, then, a stable sports rights investment, and then you really get the margin accretion out of that model. So we've clearly had this plan now for three years, and it's developing and progressing, quite frankly, exactly as how we had modeled this and expected it.

Your discussion point about transition to direct-to-consumer, for the last four years, we've changed our view of not just how does our content work on linear, but how good is our IP for any device. And that's why we've focused Discovery to be more on brand, even if -- we're not going for ratings. We're going for a core super fan audience, on OWN, on Velocity, on all of our channels, and we're invested significantly in kids in Latin America where we beat Disney because we think owning that kids IP is going to be over the longer term very important to growth, and we're starting to see that now with our Everywhere product in Latin America.

Very helpful, thank you.

Thank you. And our next question comes from the line of Drew Borest with Goldman Sachs.

Thank you. I have two questions, one for David and one for Andy. David, wanted to ask about the US Networks business and your outlook for the operating expenses there over the next year or so. I think it was an interesting year for you guys in 2016 in the sense that operating expenses were flat, I think your EBITDA margins were either at peak or maybe above peak, but you also had ratings challenges over the course of the year. So I wanted you to talk a little bit about how you're thinking about reinvesting in programming on the US Networks.

Sure. Well I feel pretty good about where we ought to start the year. We've got Discovery at number one, and we have, for the first time, TLC, ID, and OWN all working. We've worked very hard on getting TLC turned around, and we spent a lot of time talking to the audience, so I think we have those four networks very strong.

We have Science and Animal Planet, I would say, as our blockers. You have National Geographic out there, and we have Science now with ratings that are exceeding Geographic and Animal Planet with ratings exceeding Geographic. And we think that's important that we keep those brands strong, more niche-y, but also as a blocker, as Discovery is that number-one channel for men.

And on the content costs, I would say focusing more on the bigger networks, but we've been doing that all ready. And the smaller networks, our cost of content is a lot lower. We're doing a lot more content on Velocity for a lot less dollars. Bob Scanlon is a great operator there. He worked at ESPN and Speed and is doing a great job of building that affinity group.

And the overall non-content cost, we think we can take that down even a little bit. And over next two years, I think you'll see flat to slightly down. So I think the US is a good story.

We've gotten our affiliate deals done. It would be better if universe decline was less than 2 and having it be in the high 2s, but our deals are pretty good. We're very well protected in terms of how we are versus everybody else, certainly in terms of the limits of how we're packaged and offered. So I think if we can continue to reduce our non-content costs and continue to invest in our channels that are working and building those super fans, that we could have a nice growth business, continue to have a nice sustainable growth business in the US.

Okay, thanks. And then just a housekeeping question for Andy. With respect to the 2017 adjusted EPS growth guidance, could you just clarify whether the base year of 2016 includes or excludes some of the gains and losses that you ended up booking, like the Lionsgate and Group 9?

One point that I just wanted to add that's important for why we're different than everybody else is when we invest in Discovery, Science, Animal Planet, ID, we're investing in channels that create IP that we take everywhere in the world. And so that investment -- and we tend to -- we're investing more in the channels that work globally, so when we see ID up 15% in most markets and we see Discovery growing around the world, we have this unique model where we invest in one piece of content, convert it into 52 languages, and take it around the world. And I think continuing that discipline of investing more in the global content, which gives us a much stronger return than investing in content that works only in the US. And Velocity falls in that category of global as well.

And Drew, the question about 2017 guidance, it is clearly off of simply the reported adjusted EPS of the $2.13, but we provided that ex Lionsgate, ex the gain on Group 9, only to provide some clarity on what we'd say is more of an organic operating view. But our guidance is clearly off of the very simple reported adjusted EPS actual for 2016.

Okay. Thank you both.

Thank you. And our next question comes from the line of Alexia Quadrani with JPMorgan.

Hi, thank you. Just one followup on some previous comments. I think you were talking about the content cost and the programming cost, and I wanted to ask you, given that you've always had this big -- one big positive drivers for Discovery has been the lower cost of programming, but we've seen a bit more of a switch toward more event programming or scripted shows by you and also some of your peers. Does that change the model at all or how we should think about the cost structure going forward?

Good question. For us, the answer is no because we're doing basically one scripted series a year, and we're focused on making sure that it's content that works globally.

So Harley and the Davidsons was very successful for us. It lifted the patina of the brand. It was a special treat for our audience, but it's expensive content. It worked out for us because it worked so well, but I think, at least for us, that's not the core of what we do. It's part of a tent pole.

We've also accelerated our content that's in the natural history, in animal extinction, science, more traditional areas, space for discovery, and that content is relatively inexpensive. And we don't do that for ratings. In most cases it under performs, but it over performs on the brand, and it over performs for that super center of people that love Discovery because we satisfy curiosity.

And so we've built a whole team. Rich built a whole team with a whole documentary unit where we are putting more of that content on. So net-net, we don't see cost being an issue, and we're not moving more into scripted, which is more expensive.

Thank you very much.

Thank you. Our next question comes from the line of Anthony DiClemente with Nomura Instinet.

Good morning, and thanks for taking my questions. David, as you know, Fox has really stepped up its investment in Nat Geo. Seems like they are really stepping into what's typically been your core genre.

You mentioned a minute ago Science and Animal Planet ratings. Are you concerned -- should we be concerned about increased competition from Nat Geo, either as it pertains to ratings share or carriage with the new virtual MVPDs where Nat Geo seems to be included in a lot or most of the skinny bundles?

And then Andy, first off, wish you all the best going forward. I wanted to just follow up on the questions earlier about trajectory of content spend at the US Networks in 2017. So specifically, what's in your outlook for program expense growth for the 2017 budget? I think you said globally, you're expecting high singles to low doubles, but just for the model, what should we expect for US Networks? Thanks guys.

Thanks, Anthony. Well, I have a special affection for National Geographic because I helped create it years ago and worked with Chase and the Murdoch family in partnership because we owned it when I was at NBC together. And I think it's a great brand, and it's one of the reasons why we've invested in Science and Animal Planet and really are very focused on what they're doing. They are spending a lot of money. I think they have a lot of ambition for it, and I think they are really good.

At this moment, we have some significant advantages. In the 220 countries we're in, we're on basic. We're the most distributed, and we're number one in every market against them, and in almost every market, we're number one for factual.

We did launch Science and Animal Planet in every market in the world really as a way of creating a flanker against Geo and History, which is also a great channel that does great non-fiction content. And I think they woke us -- History, at least, woke us up a few years ago.

History was beating Discovery at one point, and Discovery, six or seven years ago, we were cheating a little bit on the brand, and we got -- it forced us to get better. It forced us to get more focused on our audience. What do they love about Discovery? How do we create more content that satisfies curiosity?

And I think it made us better. Discovery now for two years has been the number one channel by a lot for men and number one around the world, and it's helped us with Science and Animal Planet. So I think competition is good, but they are both great services, and we're going to have to continue to really bring our A game because both of them have really good teams, and they got us in their sites.

Yes, I appreciate your comment about the next move. I'm excited. But look, it's always one of those that when you're leaving a Company that you truly do love -- one thing a lot of you commented on and I'll say which is unique here is, a CFO-CEO relationship is so important, and Dave and I are generally, genuinely very good friends, very constructive. We'll continue to be great friends and talk in the future. So look, it's hard to leave a place you love, but I'm excited about the future.

So look, to get into the US content spend, without giving too much detail, call it roughly mid single. The good news is we definitely see US SG&A being down just given the phenomenal work. We have a CFO there, Simon Robinson, who's done a tremendous job of driving cost productivity, utilizing technology, to really think about means of delivery. So we have sustained cost controls in our US business that we see for the next several years that gives us a lot of perspective on, even from these levels, continued margin growth out of our US business.

Thanks a lot.

Thank you. We have time for one final question. Our last question comes from the line of Todd Juenger with Sanford Bernstein.

Wow, the pressure is on here. Let me just keep it to one question if you don't mind. Turning back to Europe, David, I know you like to use the analogy of the sports for Netflix, and so one big difference between Netflix and a company like yours is they aren't also simultaneously trying to run linear network services. And just need reconcile maybe how you're thinking about the future distribution strategy and growth, especially in Europe, with the presence in sports.

Right now, you're getting double-digit increases from your traditional distributors. When you have this realized Netflix-like sports product available as well, is it your expectation that you can both get paid still strongly from linear and also have the direct-to-consumer product and also, by the way, launch an increasing number of free-to-air channels, which I know probably aren't sports, but they are discovery content? How does that all work together as opposed to eating each other? Thanks.

Sure. Thanks, Todd. The opportunity that we have is we have a massive amount of IP. So when we're showing -- if you're in Italy, and you're looking at the Australian Open, and we have three sports channels, we're showing three matches, but if you have the Player, we have 20 courts. And if we're showing you Australian Open for the whole weekend, then during that weekend is the World Speed Skating Championships, and we aren't showing that, or we are only showing two courts of tennis and one on speed skating, we're not showing the slalom, and so one, is we have a lot more IP.

Two is, there's a lot of IP we're not showing. We own all of the snooker; we're no showing most of it. We own all of the squash; we're not showing most of it. We own all of the speed skating; we're not showing it. And so the ability to go to super fan affinity groups and have them -- like they would go out and buy a magazine if they love golf or tennis, they can get a seasons pass for their sport -- we think is quite interesting.

The other piece is there's a lot of people in Europe. It's only about 50% penetrated on multi-channel television. And so 50% of Europe is doesn't have access to it, but there's a huge portion of that that has broadband, and so the ability to access them as well.

And so we will nourish the existing audience with the quality content that we have, and we don't -- we see a sustainable opportunity there. In fact, I think we're just getting started. If you look at what happened in the US, it started with double-digit and teen increases for sports, and then it just accelerated as they were able to aggregate that sports audience, and it became so powerful that it really almost -- it tilted the whole ecosystem here. None of that has happened there yet.

And so we think owning this IP, having the ability to go to super fans, and Todd, the final thing is that we find that when people are in their home, they want to watch it on TV, but when they leave, they want to see Tour de France or they want to see the hockey game or they want to see the tennis wherever they are. And so part of it is portability, which is a real utility to a lot of them, and part of it is being able to see all the matches in a particular sport that they love.

So we're quite optimistic about that, and in the same regard, we're optimistic about that same formula for kids or for crime or for animals with Animal Planet. We own all this IP. Or for science.

So we're going to start playing around with our IP direct-to-consumer until we get the right formula. We think we have it with sports and kids, and now, as we look at the rest of our portfolio, we think we have an opportunity there as well, and we'll be informing you over the next two to three years how successful we are in getting people to either pay for our content or elect the Discovery GO platform to get them to look at it for free.

But in that case, we have people watching a length of view of an hour, or a length of view of our cable channels is 14 minutes. There we get length of view of an hour, and they watch all of the commercials, and we get a higher CPM, and by mid to end of year, we think we can get 2 additional points of growth in the US out of that alone. And so that's where we are driving with our IP, and we're learning more and more from the audience about what they like and what they don't.

It'll be fascinating to watch it go. Thank you very much, David.

Thank you, and ladies and gentlemen, that does conclude today's question-and-answer session. Thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone have a great day.