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MSG Networks, Inc. (NYSE:MSGN)
Q4 2018 Earnings Conference Call
August 15, 2018, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning. My name is Summer, and I will be your conference operator today. At this time, I would like to welcome everyone to the MSG Networks Fiscal 2018 Fourth Quarter Call. All lines have been placed on mute to prevent any background noise. After the speaker remarks, there will be a question-and-answer session. [Operator Instructions]

Thank you. I will now turn the call over to Ari Danes. You may begin.

Ari Danes -- Senior Vice President of Investor Relations

Thanks, Summer. Good morning, and welcome to MSG Networks' Fiscal 2018 Fourth Quarter and Year End Conference Call. The company's President and CEO, Andrea Greenberg, will begin this morning's call with a discussion of the company's operations. This will be followed by a review of financial results with Bret Richter, the company's EVP, Chief Financial Officer, and Treasurer.

After their prepared remarks, we will open up the call for questions. If you do not have a copy of today's earnings release, it is available in the Investors section of the company's corporate website.

Please take a note of the following. Today's discussion may contain statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that any such forward-looking statements are not guarantees of future performance or results and involve risks and uncertainties, and that actual results, developments, and events may differ materially from those in the forward-looking statements as a result of various factors.

These include financial community perceptions of the company and its business, operations, financial condition, and the industry in which it operates as well as the factors described in the company's filings with the Securities and Exchange Commission, including the sections entitled Risk Factors and Management's Discussion and Analysis of Financial Condition and Results of Operations contained therein. The company disclaims any obligation to update any forward-looking statements that may be discussed during this call.

Lastly, we will discuss certain non-GAAP financial measures on today's call. On pages five and six of today's earnings release, we provide consolidated statements of operations and a reconciliation of operating income to adjusted operating income. In addition, on page eight of the earnings release, we provide a reconciliation of net cash provided by operating activities from continuing operations to free cash flow.

With that, I will now turn the call over to Andrea.

Andrea Greenberg -- President & Chief Executive Officer

Thank you, Ari, and good morning. Fiscal 2018 represented a year of meaningful progress as we successfully executed against the financial and strategic priorities we set at the beginning of the year. These included delivering strong revenue with adjusted operating income and free cash flow, enhancing our content through new and innovative programming with the goal of broadening our viewership, and driving increased distribution of our networks, particularly on digital platforms. In addition to these priorities, this past year, we strengthened our traditional distribution with several affiliate renewals and initiated our first share repurchase program as a stand-alone media company.

I would now like to walk you through some of the year's highlights. For Fiscal 2018, we delivered revenue of approximately $697 million, a 3% increase compared to last year, and adjusted operating income of $336 million. Our results continue to underscore the unique position we hold thanks to our exclusive rights local content and a well-earned reputation for programming excellence.

This past year, our networks once again showcased approximately 500 live games featuring professional teams, including the New York Knicks, Rangers, Highlanders, Liberty, Red Bulls, the New Jersey Devils, and the Buffalo Sabres, providing fans of those teams with in-depth coverage, including expert pre- and post-game shows and other team related content. We took steps to broaden our appeal, particularly among younger viewers by experimenting with new content, formats, and talent. Highlights include people talking sports and other stuff, with a variety of sports guests and celebrities, Knicks gaming, which continues to follow he official New York team of the NBA 2K eSports League during the inaugural season and MSG Short, our short form content block focused on unique and interesting stories in and around the world of sports.

We are pleased with what we've accomplished on the programming front this past year, and look forward to building on these efforts in Fiscal 2019. We also believe that our valuable content, along with ongoing growth opportunities, positions us well to increase advertising revenue over the long-term. These opportunities include our branded content initiative, where we worked with a number of our partners, including Anheuser-Busch, the Hospital for Special Surgery, BMA, and Squarespace to integrate their brands with our assets. We look forward to building on these efforts in the upcoming season.

We created another growth opportunity this past year, with our street front digital boards on Seventh Avenue, which established a high impact vehicle to showcase our brands, contents, and partners. In addition, we continue to see MSG grow as a compelling sponsorship platform and ahead of the 2017-18 NBA and NHL season, strengthened our livestreaming and video on the demand offering by achieving full distribution among our major distributors. This year, we also made our content more broadly available through digital platforms by reaching multiyear distribution agreements with two OTT providers while continuing to explore other distribution opportunities that appropriately value and package our networks.

At the same time, we've successfully renewed several affiliate agreements with our traditional distributors, including a major partner, which we believe highlights the importance of our content in the marketplace and the strength of our long-standing relationship.

Turning to subscribers for our fiscal fourth quarter, we had a very small year-over-year decrease in viewing subscribers. This represents a substantial improvement, compared to our fiscal third quarter, which had a low single-digit percentage rate of decline. We have also now experienced an improvement in our annual rate of decline for three consecutive fiscal years.

In summary, Fiscal 2018 marked a year of meaningful accomplishment. We delivered another year of strong financial results and further enhanced our programing while strengthening both our linear distribution and digital presence. As we look ahead to Fiscal 2019, we believe that our unparalleled live sports presence in the nation's largest media market will enable us to continue to generate significant long-term value for our shareholders.

I will now turn the call over to Bret, who will take you through our financial results.

Bret Richter -- Executive Vice President, Chief Financial Officer, &Treasurer

Thank you, Andrea, and good morning, everyone. I would like to start today by touch on our full year Fiscal 2018 financial results before turning to our results for the fourth quarter. For Fiscal 2018, total revenues were $696.7 million, an increase of 3% as compared with the prior year. This growth was primarily driven by an increase in affiliate revenue, partially offset by a decrease in advertising revenue.

Fiscal 2018 adjusted operating income was $336.5 million, which represents a slight increase as compared with Fiscal 2017. We are pleased with these financial results, particularly in light of the fact that Fiscal 2018 AOI was impacted by a step-up in expense related to the renewal of our rights agreement with the Buffalo Sabres and by a decline in advertising revenue, which we primarily attribute to the performance of certain of our teams this past season.

Turning to our results for the Fiscal 2018 fourth quarter, total revenues of $171.4 million increased $8.5 million, or approximately 5%. This included a $9.2 million increase in affiliate revenue and a $1.2 million decline in advertising revenue. The year-over-year increase in affiliate revenue was primarily due to higher affiliate rates and, to a lesser extent, the favorable impact of a $1.2 million affiliate adjustment recorded in the current year period, and the absence of a $1.1 million unfavorable adjustment recorded in the prior year period. The decline in advertising revenue was primarily due to lower playoff related advertising sales, partially offset by a higher net decrease in deferred revenue related to ratings guarantees as well as other net advertising revenue increases.

Direct operating expenses of $68.8 million increased 6%, or $3.9 million, as compared with the prior year quarter, due primarily to higher rights fees expense. The increase in rights fees expense mainly reflects annual contractual rate increases, the step-up in expense related to the renewal of our rights agreement with the Buffalo Sabres, and league fees relating to streaming rights. Please note that Fiscal 2019 first quarter direct operating expense will include a full quarter's impact from this step-up in rights fees expense related to the Sabres, as compared to a partial quarter's impact for the Fiscal 2018 first quarter.

SG&A expenses of $19.8 million increased approximately $700,000, or 4%, as compared with the prior year quarter. This was primarily due to higher employee compensation related benefits, partially offset by lower advertising and marketing costs and advertising sales commissions. Excluding share-based compensation, SG&A expenses were down slightly versus the prior year quarter.

Adjusted operating income of $86.2 million increased $4.8 million, or 6%, as compared with the prior year period. This increase was primarily due to higher affiliate and other revenue, partially offset by higher direct operating expenses and lower advertising revenues. Excluding the favorable impact of affiliate adjustments recorded in the current and prior year periods, fourth quarter adjusted operating income would've been $85 million, and increase of $2.4 million, or 3% as compared with the prior year quarter.

Turning to taxes, our 35% GAAP tax rate for the quarter primarily reflects a blended federal corporate tax rate of 28%, state and local income taxes, and the impact of certain adjustments, some of which were necessary to reflect the impact of tax reform becoming effective at the midpoint of our fiscal year. Our fiscal 2019 GAAP tax rate will fully reflect a new federal tax rate of 21%. Reported free cash flow from continuing operations for the fiscal year ending June 30, 2018 was $206.9 million.

With respect to our balance sheet, as of June 30, 2018, total cash and cash equivalents were $205.3 million. Total debt outstanding was $1.2 billion, and our $250 million revolver remained undrawn at quarter's end. As of June 30, 2018, net debt was $991 million, and our net leverage ratio declined to 2.9 times trailing 12 months' adjusted operating income. Our average interest rate for the quarter was approximately 3.4%.

During the fiscal fourth quarter we made a mandatory principal payment of $18.75 million in accordance with the terms of our credit agreement. Our credit facility provides for a total of $75 million in mandatory principal payments over the next 12 months. In terms of the company's stock repurchase program, during the fourth quarter we repurchased approximately 713,000 shares for $13.8 million at an average price of $19.39. This amount represented approximately 1% of Class A shares outstanding. We currently have $136 million remaining under our authorization and plan to remain disciplined and opportunistic with our share repurchases. We will continue to update you on our progress on a quarterly basis.

I'll now turn the call back over to Ari.

Ari Danes

Thanks, Bret.

...

Summer, can we open up the call for questions?

Questions and Answers:

Operator

Thank you. [Operator Instructions] And your first question comes from Bryan Goldberg of Bank of America.

Bryan Goldberg -- Bank of America Merrill Lynch -- Analyst

Thanks. On subscriber trends, it sounds like you had a nice improvement there relative to the low single-digit loss rate you've been reporting over the last handful of years or so. I was hoping maybe you could provide a little color as to what the drivers of the improvement were -- how much is coming from new distribution relationships versus any notable shifts in activity at your traditional distributors. And then, if it's possible, would you be able to provide us with your year end viewing sub number? I believe that's usually in the 10-K. Thank you.

Andrea Greenberg -- President & Chief Executive Officer

Sure. Hi, Bryan. While there were a variety of factors that drove the year-over-year improvement, we still had a very small decline in viewing subs in our fiscal fourth quarter. The factors included both of the items you mentioned, the impact of our new OTT agreement, and stronger performance by some of our traditional affiliates. So, both factors contributed to the improvement. That said, there are ebbs and flows with respect to our viewing subscribers. To this point, I would note that for our most recent available month of data, we saw an uptick in the percentage rate of decline from the fourth quarter, resulting in a combined average of MSG and MSG Flex subscribers of about 7 million, which is down about 1.2% versus the day and month of the prior year.

Even given that, we've still seen an improvement in the rate of subscriber decline now for three consecutive years. If you go back to the subs that we reported in our Fiscal 2015 10-K, we have seen a minus 3.5% decline, in the subsequent year a minus 3.2% decline, then a minus 2.5% decline. And for the same period this year, we've seen a minus 1.2% decline. I hope that gives you some additional color.

Bryan Goldberg -- Bank of America Merrill Lynch -- Analyst

That's very helpful. Thank you.

Operator

Your next question comes from Brandon Ross of BTIG.

Brandon Ross -- BTIG, LLC -- Analyst

Good morning. Thanks for taking the questions. I have two. First, the FOX RSNs are now in the marketplace. If something piecemeal became available, especially the YES network, would you guys be interested in taking a look at that? In general, do you think it makes sense for somebody to consolidate the RSNs in the New York Market? And then, I have a follow-up. Thanks.

Andrea Greenberg -- President & Chief Executive Officer

Well, first let me say that we're quite pleased with what we've been able to accomplish in the last three years as a stand-alone company, and we feel that we're positioned for long-term success here as a stand-alone company. That said, we're closely monitoring the changes in the RSN landscape, and we would always consider opportunities if we feel they make strategic and financial sense for us beyond that --

Brandon Ross -- BTIG, LLC -- Analyst

[Crosstalk] As buyers and sellers?

Andrea Greenberg -- President & Chief Executive Officer

We're not going to comment on hypotheticals, but we certainly look at all opportunities that make sense for our business and our shareholders.

Brandon Ross -- BTIG, LLC -- Analyst

Okay. Just to confirm, the sub trends you report are viewing subscribers, so there is no help for minimum guarantees at wired MVPDs or DirecTV Now, correct?

Adam Levine -- Executive Vice President of Business Affairs

This is Adam. I'm not sure what you mean by no help, but we said the OTT deals that we had contributed and that the protections that we have in our contracts are a part of what contributed to the viewing numbers that we report in general. The viewing subs are the viewing subs and they reflect the sub numbers as reported to us by our affiliates.

Brandon Ross -- BTIG, LLC -- Analyst

Got it. Thank you.

Operator

Your next question comes from John Janedis of Jefferies.

John Janedis -- Jefferies Group LLC -- Analyst

Thanks. I just had one. Have you begun to see any incremental advertising by either eSports or gambling houses ahead of the upcoming NBA and NHL seasons? How significant of a bucket could this be, or is it too early to tell until sports betting is legalized in New York?

Andrea Greenberg -- President & Chief Executive Officer

Well, it is still very early, but we are already seeing strong demand from this segment of the marketplace -- not just for traditional media buys, but also for more creative integrations. So, there is lots of activity in this space. We're pretty excited about it. We believe that it'll serve as the catalyst to drive increased ad revenue from both casinos and sportsbooks. Those two categories have historically represented a fairly small percentage of our advertising on our networks. So, more to come. We do operate in New Jersey, so that, I think, makes us appealing to sportsbooks in advance of legalizing in New York or Connecticut.

John Janedis -- Jefferies Group LLC -- Analyst

Helpful. Thank you.

Operator

Your next question comes from Michael Morris of Guggenheim Securities.

Curry Baker -- Guggenheim Partners, LLC -- Analyst

Thanks for the question. This is Curry Baker on for Mike. On the OTT front, you're currently on DirecTV Now and fuboTV. There is obviously additional opportunity if you can get other large OTT platform carriage on YouTube, Hulu, Sling, etc. What's the biggest obstacle that you're encountering on getting additional carriage on the other OTT platforms that price MFNs tiering? Can you say if you're in active conversations with any of the other players? Thanks.

Adam Levine -- Executive Vice President of Business Affairs

So, I would say we're pleased with the progress we've made in digital distribution this past fiscal year, the first full year where we've had digital rights to all of our professional games. We're pleased to launch on the two platforms that you mentioned. Andrea noted they contributed to the year-over-year improvement of our subscribers for the fourth quarter. As far as incremental opportunities, we're focused on all of those opportunities to increase distribution for our networks and our content.

In the ordinary course of business, we're talking to everyone. I'm not going to get into details about where those conversations are. I think, on the last call, somebody asked about whether there are obstacles. I wouldn't describe anything in particular as an obstacle. These are conversations we're having and exploring and we're always open to new distributions that properly value our networks.

Curry Baker -- Guggenheim Partners, LLC -- Analyst

Okay, thanks.

Operator

Your next question comes from Vasily Karasyov of Cannonball Research.

Vasily Karasyov -- Cannonball Research -- Analyst

Good morning. My question is about the capital structure going forward now that you are sort of done deleveraging from when you became a stand-alone company, given the business model and steady growth, not a ton of volatility, where the tax rate is. Can you tell us the puts and takes that go into your thinking about free cash flow generation going forward, the use of that free cash flow, and the comfort level with net gross leverage, whichever is more convenient for you. Thank you.

Bret Richter -- Executive Vice President, Chief Financial Officer, &Treasurer

Sure, Vasily. Even the nature of your question highlights the fact that this is a complex equation that we're constantly evaluating as a management team on an ongoing basis. The last part of your question is probably the easiest to answer. We're comfortable with the level of leverage that we have. It doesn't mean that at any point in time we might not take a view to ratchet that up or down based on the liquidity of the business and the needs and the market -- and almost innumerable other factors.

This is a constant evaluation process for us and we look at all the elements that you spoke to, particularly the free cash flow and the expectation of that free cash flow from the business and external factors like interest rates and the tax rate. The free cash flow of the business is really strong, producing over $200 million of cash this year. I think that's notable and it's only been two quarters since we put in place the additional tool in our toolbox, with the ability to buy stock back in the marketplace. We executed on that program in the fourth quarter.

So, I think we take a broad view. We're going to be opportunistic over time with regards to the use of our authorization. We intend to use it. There will be additional capital dedicated to paying down our debt. We have $75 million of mandatory prepayments due in the next 12 months, so -- I'm not sure how much more detail I can lay out the equation other than the fact that we're actively managing it.

Vasily Karasyov -- Cannonball Research -- Analyst

Alright. Thank you very much.

Ari Danes -- Senior Vice President of Investor Relations

Summer, we have time for one last question.

Operator

Okay. Your final question comes from Alexia Quadrani of JP Morgan.

Alexia S. Quadrani -- J.P. Morgan Securities -- Analyst

Thank you. This is David on for Alexia. With regards to distribution on virtual MVPDs, can you talk about any impact of churn you're seeing on those platforms now that the NBA and NHL season have ended. With DirecTV Now specifically, are you seeing any subs move to lower tiers given we're in the off season?

Adam Levine -- Executive Vice President of Business Affairs

It's early with regard to our OTT distribution, but it's not something I can really get into too specifically. It's not something I'd say we have a lot of visibility into with our OTT distributors. But, we're pleased with the agreements we have in the OTT space. They contributed to our year-over-year improvement in subscribers for the quarter and we look forward to participating in the expected growth in the sector.

Alexia S. Quadrani -- J.P. Morgan Securities -- Analyst

Okay. Thank you.

Operator

Okay. I'll now turn the call back to Ari Danes.

Ari Danes -- Senior Vice President of Investor Relations

Thank you all for joining us. We look forward to speaking with you on our next earnings call. Have a great day.

...

Operator

This concludes today's conference. You may now disconnect.

Duration: 26 minutes

Call participants:

Ari Danes -- Senior Vice President of Investor Relations

Andrea Greenberg -- President & Chief Executive Officer

Bret Richter -- Executive Vice President, Chief Financial Officer, &Treasurer

Adam Levine -- Executive Vice President of Business Affairs

Bryan Goldberg -- Bank of America Merrill Lynch -- Analyst

Brandon Ross -- BTIG, LLC -- Analyst

Curry Baker -- Guggenheim Partners, LLC -- Analyst

John Janedis -- Jefferies Group LLC -- Analyst

Alexia S. Quadrani -- J.P. Morgan Securities -- Analyst

Vasily Karasyov -- Cannonball Research -- Analyst

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