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MSG Networks (NYSE:MSGN)
Q3 2019 Earnings Call
May. 02, 2019, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Good morning. My name is Tina, and I will be your conference operator today. At this time, I would like to welcome everyone to the MSG Networks fiscal 2019 third-quarter earnings conference call. [Operator instructions] It is now my pleasure to turn today's call over to Mr.

Ari Danes. Sir, the floor is yours.

Ari Danes -- Vice President, Investor Relations

Thanks, Tina. Good morning, and welcome to MSG Networks fiscal 2019 third-quarter 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 of 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 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 5 and 6 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 8 of the earnings release, we provide a reconciliation of net cash provided by operating activities to free cash flow. With that, I'll now turn the call over to Andrea.

Andrea Greenberg -- Chief Executive Officer

Thank you, Ari, and good morning. For the fiscal third quarter, our company generated revenue of approximately $195 million, up 5% year over year; and adjusted operating income of approximately $89 million, an increase of 3% as compared to the prior-year quarter. We continue to execute against our core objectives and are pleased with our accomplishments so far this year. As we've previously discussed, we renewed several affiliate agreements earlier in fiscal 2019, including one with a major distributor, and we are pleased with the terms of those renewals.

At the same time, we have delivered solid revenue, AOI and free cash flow results, a reflection of the unique value of our live local sports content for both our partners and dealers. The strength of our content, along with our ongoing commitment to programming excellence, not only continues to drive our financial performance but has also been recognized once again by our industry, with MSG Networks receiving 39 New York Emmy nomination across a wide range of categories. Turning to our recent programming highlights. Last month, the NBA and NHL regular seasons concluded, with the New York Islanders qualifying for the Stanley Cup Playoffs.

MSG Networks served as the exclusive regional home for the Islanders' first-round sweep of the Pittsburgh Penguins. And we are continuing our postgame coverage throughout round two where the Islanders take on the Carolina Hurricanes. We recently welcomed back Major League Soccer's New York Red Bulls for their 24th season on MSG Networks. Last year, the team finished with the best regular season record in the league, advancing to the Eastern Conference Finals.

We look forward to its another exciting campaign this season with games continuing into the fall. And next week, we will debut a special edition of MSG 150, presented by Chase. 150 minutes of content surrounding our teams in New York sports airing for 10 weeks, Monday through Thursday, during what we expect will be an exciting spring and summer. The show will feature analysis and commentary from our army of talents, as well as a rotating group of special guests and cover important events, such as the NBA Lottery, the NBA and NHL drafts and free agency and the start of Giants Mini Camp.

We've also continued to introduce new content that broadens our appeal especially with younger audiences. Last year, we launched our MSG Shorts programming block, which provides us with a vehicle to feature compelling short-form content focused on the worlds of sports, entertainment and pop culture. This past quarter, we added to this lineup themed content specials: Food Week, Wellness Week and most recently Sneaker Week, providing viewers with a look into the lives of athletes and celebrities around these popular interests, on air and across our social platforms. And in another special programming presentation geared to the younger viewer, on March 17, we partnered with Overtime, a digital sports media start-up in which we recently made a small equity investment to debut a first-of-its-kind simulcast of an NBA game.

This alternative broadcast, featuring the Knicks and the Los Angeles Lakers, appeared on MSG Plus, MSG Go, msgnetworks.com and, for the first time ever in the NBA, Facebook Live. Another partnerships that has proven valuable to us is ESPN Radio. And we are pleased to have extended our long-standing relationship with the station, which has served as the radio home of the New York Knicks and Rangers since 2004. Turning to advertising, this past quarter, we again generated strong growth driven in part by robust demand from sports gaming companies for our spot and sponsorship inventory.

We remain confident there are significant advertising upsides in this category should additional markets in our territories join New Jersey in legalizing sports gaming. We also continue to benefit from our pursuit of incremental non-ratings-based advertising opportunities. The success of our branded content initiative, along with our mobile app, MSG Go, demonstrates the value proposition we deliver for companies that are seeking unique way to integrate their offerings with exclusive live sports programming. In terms of viewing subscribers, our year-over-year percentage rate of decline increased in the third quarter as compared to the fiscal 2019 second quarter.

While we, of course, remain focused on this dynamic, we believe in the strength of our business and our ability to create long-term value for our shareholders. I will now turn the call over to Bret who'll take you through our financial results.

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

Thank you, Andrea, and good morning, everyone. For the fiscal 2019 third quarter, total revenues of $195.1 million increased $8.5 million or approximately 5%. Advertising revenue increased $6.1 million, primarily due to a lower net increase in deferred revenue related to ratings guarantees, higher per-game sales from the telecast of our live professional sports programming and increased sales from the company's branded content initiatives. This was partially offset by the impact of fewer live professional sports telecasts as compared with the prior-year period.

Affiliate revenue increased $3.2 million, primarily reflecting higher affiliate rates, partially offset by the decline in subscribers. Direct operating expenses of $82.1 million increased $1.8 million or 2% as compared with the prior-year period, reflecting higher rights fees expense, which was primarily the result of contractual rate increases. This increase was partially offset by a decline in other programming-related costs. SG&A expenses of $28.7 million increased $5.4 million or 23% as compared with the prior-year period.

This was primarily due to higher employee compensation-related benefits, including stock-based compensation expense and increased advertising and marketing costs, as well as a higher provision for doubtful accounts related to other revenue. Adjusted operating income of $88.7 million increased 3% as compared with the prior-year period, reflecting the increase in revenues, partially offset by higher SG&A expenses and, to a lesser extent, higher direct operating expenses. With respect to taxes. Our income statement reflects an effective tax rate of 25% for the fiscal third quarter, which includes a $3.9 million benefit related to a tax return to book provision adjustment in connection with the filing of last year's income tax returns.

Excluding this amount, the effective tax rate would have been approximately 30% for the quarter. In terms of our balance sheet, as of March 31, 2019, total cash and cash equivalents were $182.3 million. Total debt outstanding was $1.04 billion, and our $250 million revolver remained undrawn at quarter's end. As of March 31, 2019, net debt was approximately $858 million, and our net leverage ratio was 2.5x trailing 12 months adjusted operating income.

Our average interest rate for the quarter was 4%. Reported free cash flow for the nine months ending March 31, 2019 was $140.2 million. During the fiscal third quarter, we made principal payments of $43.75 million, which was comprised of a mandatory $18.75 million payment in accordance with the terms of our credit agreement and a voluntary prepayment of $25 million. Looking ahead, our credit facility provides for a total of $101 million in mandatory principal payments over the next 12 months.

Lastly, in terms of the company stock repurchase program, we did not repurchase shares during the quarter. I will now turn the call back over to Ari.

Ari Danes -- Vice President, Investor Relations

Thanks, Bret. Tina, can we open up the call for questions?

Questions & Answers:


Operator

[Operator instructions] And your first question comes from the line of Bryan Goldberg with Bank of America.

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

I've got two questions on affiliate trends. First, I was wondering if you could frame for us how much of the deceleration in your affiliate growth came from subscriber declines as opposed to a possible stepdown in minimum guarantees commitments from you distributors? And I think you disclosed you'd completed a renewal with a major distributor at the end of fiscal 2Q. I was just wondering if that was at all a driver of the deceleration or if this quarter's result is more a symptom of the macro environment. And then my second question is on growth potential.

Was just wondering if you could update us on your latest perspective on the opportunity for -- or progress in securing incremental distribution on MVP platforms that you're not currently on?

Andrea Greenberg -- Chief Executive Officer

OK. Bryan, I'll take the first one. As to the deceleration in growth, first, let me point out that we did grow affiliate revenue. And the increase was driven by higher rates, offset by the decrease in subscribers.

None of that was attributable to changes in renewal terms. So the deceleration related to the decline in subscribers, which, as we said, increased as a percentage over last quarter, but it's still less than 4%.

Adam Levine -- Executive Vice President, Business Affairs

Yes.

Andrea Greenberg -- Chief Executive Officer

As far as --

Adam Levine -- Executive Vice President, Business Affairs

And -- yes. On the second question, it's Adam. I'll jump in. Nothing new to report in terms of an update.

We continue to explore all opportunities for new distribution with entities that properly value our content. It's in the ordinary course of our business to have those discussions that are ongoing, but we don't have anything specific to report.

Operator

And your next question comes from Brandon Ross with BTIG.

Brandon Ross -- BTIG -- Analyst

My first one is, recently, Verizon announced they were going to start marketing YouTube TV alongside their own Fios video packages. Since you guys aren't in the YouTube TV offering, I was wondering if there were any protections you had in your contractual agreements with Fios to protect you there?

Adam Levine -- Executive Vice President, Business Affairs

Sure. I'll take that one. It's Adam. So obviously, we can't get into specifics of our agreement with Verizon, but I'd say we're comfortable with the terms.

We have a long-standing positive relationship with them. It's a very strong one. I think it's premature to comment on this partnership based on the limited information that's out there at this time. From what I saw, this seems largely focused on their wireless 5G offering, but we -- obviously, we stay focused on it and keep track.

But I can't -- I'm not going to get into the details of our agreement with Verizon.

Brandon Ross -- BTIG -- Analyst

OK. And then is there any more color you guys could give us on the higher provision for doubtful accounts that you called out, both in the press release and in prepared remarks?

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

Yes. Sure, Brandon. I think first and foremost, this relates to our other revenue line, which you might notice from the release and was -- reflected a decline year over year for the quarter. This relates to services that we provide to our former subsidiary, Fuse.

The decrease reflects the fact that there's no recognition of that revenue in this quarter, and the provision relates to a provision against revenue we booked in the prior quarter as a result of them recently filing for Chapter 11 protection. I'd also highlight growth -- yes. And I'd just highlight the growth in revenue for the quarter is -- includes this decline.

Operator

And your next question comes from Ben Swinburne with Morgan Stanley.

Ben Swinburne -- Morgan Stanley -- Analyst

I wanted to ask either -- for any of you, maybe Andrea, starting with you on MSG Go. Any update you can give us or trends on engagement on that product, any plans in terms of product pipeline or distribution expansion of that service? Now that you've had it in the market for a while, and we're seeing such rapid growth in streaming usage, I'm just wondering if you could help sort of fill in some color on how that product is evolving. And then I had a follow-up.

Andrea Greenberg -- Chief Executive Officer

Sure, sure. Well, let me first say that we are very pleased with the utilization of the product. But as you would expect, this season, team performance does have some impact on the take rate. So there is a bit of a correlation between ratings and utilization of MSG Go.

Having said that, you'll see that we had strong advertising growth this quarter, and MSG Go was a part of that. We found that customers and advertisers really liked the product. We've talked about the enhancements that we continue to make to the product. This past season, we added stats, we added interactive gaming, we redesigned the features to make it easier to find additional content once you're in the app environment.

We have more interactive features on the product pipeline going into next season. So we'll talk about those as they get closer to launch, which will be before the beginning of next season, working on them now. So we're really, really pleased with the development of the app. We're pleased with the demand for the app.

And we see it as a real growth opportunity for us coming in the future. We are carried by every major distributor in the market, so I think you'll see distribution is fairly ubiquitous here.

Ben Swinburne -- Morgan Stanley -- Analyst

How about on device distribution? I may be wrong, but I don't believe it's on Apple TVs yet. Are there opportunities on the device side to push it further?

Andrea Greenberg -- Chief Executive Officer

Yes, yes, absolutely.

Ben Swinburne -- Morgan Stanley -- Analyst

OK. Got it. And then just the second, as we think about the June quarter subscriber trends, obviously, the universe is sort of the universe. But for MSG Networks, I believe you are lapping the pickup of Fubo and DIRECTV NOW now last year around that time.

I just want to confirm from a timing perspective that the June quarter is the quarter where you start anniversarying those distribution gains.

Adam Levine -- Executive Vice President, Business Affairs

Yes. We've lapped those already. Those were the end of 2017.

Ben Swinburne -- Morgan Stanley -- Analyst

Calendar 2017.

Adam Levine -- Executive Vice President, Business Affairs

Yes, calendar 2017.

Andrea Greenberg -- Chief Executive Officer

Right.

Operator

Your next question comes from David Miller with Imperial Capital.

David Miller -- Imperial Capital -- Analyst

Question for Andrea. Andrea, the advertising numbers are just simply outstanding. They really stand out. You guys are clearly being very creative there.

What other categories would you say are coming into the platform other than the sports betting entities that you mentioned last quarter? I believe the $6.1 million growth kicker is the highest we've seen in a long time on a year-over-year basis. And congratulations on that.

Andrea Greenberg -- Chief Executive Officer

Thank you. Thank you. Yes. Well, we've been talking a lot about growing non-ratings-based advertising categories, and we're seeing the fruits of our efforts there.

MSG Go is one of the products on which we've been focused, our outdoor signage and digital boards and integrating our sponsors into those, obviously non-ratings-based. We have made great progress growing our branded content initiatives. We talk a lot about that. In fact, you'll see in our upcoming MSG 150 program, there will be a lot of branded content and sponsor integrations that have nothing to do with spot inventory.

So spot inventory continues to present an opportunity for us in growing revenue for that show. Sports gaming, we've talked a lot about that. We saw very, very strong demand this past season from William Hill, FanDuel, Draftkings, not just for spot inventory but for integrated sponsorships. And I know we spoke a little bit about our Devils sponsorship last season with William Hill.

We have to do more of that. So going forward, I mean we're very focused on growing this category of revenue. Also, let me just say that clearly, as team performance improves, I think there'll be significant growth opportunity for us.

Operator

And your next question comes from Alexia Quadrani with J.P. Morgan.

David Karnovsky -- J.P. Morgan -- Analyst

This is David Karnovsky on for Alexia. The Sabres, I think, had an over eight rating in Buffalo this past season. It seems like their games would be a real draw for any virtual MVPD operating in that market. Just wondering, can you or would you negotiate with a distributor just for Buffalo? Or do you generally negotiate New York City and Buffalo at the same time?

Adam Levine -- Executive Vice President, Business Affairs

Sure. Yes, I'll take it. So we're really pleased with the ratings and the demand for the Sabres product in Western New York. Sabres are consistently the No.

1 or No. 2 rated -- local rated team in the National Hockey League. So nothing really new there, but there was a spike even despite a challenging season for them. I don't think we'd rule anything out and just say we will explore all opportunities for distribution that makes sense.

We have the flexibility to do it. But I'd also point out that in Western New York, the Knicks, which is our other professional team that we distribute in that market, is -- has significant value.

Operator

And your next question comes from David Joyce with Evercore ISI.

David Joyce -- Evercore ISI -- Analyst

Could you please help us think about the relative ad revenue size and given your strength there for your different property types, the buckets of the professional programming versus the collegiate programming versus your original new talk shows and what have you? And then related to that, what kind of incremental investments should we be thinking about for these advertising opportunities that you're working on?

Andrea Greenberg -- Chief Executive Officer

On your first question, David, we're not going to get into specific categories of advertising. Let me say generally, as you might expect, right now the Knicks and the Rangers do represent a significant portion of our advertising revenue. But all categories have been increasing for original programming, for branded content, for non-rating-based, for Islanders, Devils, as we become more creative. And I think we're an incredibly flexible organizations, so we're good partners for major brands.

I'm sorry, what was the second question? Oh, investment, yes. And we said this in the past, our investment is virtually always accretive to the bottom line. So I would not expect you to see any investment that doesn't result in offsetting advertising revenue.

Operator

And your next question comes from Brett Harriss of G. Research.

Brett Harriss -- G. Research -- Analyst

It seems that the sale process for Fox's RSNs is perhaps less robust than originally thought. If you could just remind us why you really originally chose not to participate in that process. Was it a valuation or a strategic consideration? And the second thing, it was maybe -- could this be an opportunity for MSGN to potentially pick up some attractively valued RSNs?

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

Yes. We'd love to help. We actually haven't commented a lot in the past, and we generally don't comment on speculative work, layout, that type of thought process. So no updates or comments.

I don't think we've really made any.

Operator

Your next question comes from Vasily Karasyov with Cannonball Research.

Vasily Karasyov -- Cannonball Research -- Analyst

Bret, I wanted to ask you about your Plan B and how confident you are in the financial metrics going forward, assuming the headwind on the distribution side continues. Would you be able to maintain margins by cutting costs? Do you have any cushion there? If you could outline that for us. Then do you think you will be rethinking your leverage targets? And how confident are you in your free cash flow generation going forward, assuming the top line trends continue into the next several quarters?

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

Sure. So just I think a couple of points. One is we don't provide that kind of guidance, but I think first and foremost, we should focus on the top-line trends. We had a strong revenue growth quarter.

If you look back, I think it compares favorably to many of the other quarters that we've spoken about on this call. And again, that was net of the absence of the revenue in the other revenue line that we spoke about that related to Fuse. I think the quarter highlights the advertising opportunity that we believe and have believed and have spoken about on these calls that is inherent in the business. And we were able to achieve a lot of that this quarter.

With regards to the cost structure, I think we operate very efficiently, that we're -- all of our comments are consistent with making smart investments that are rate of return positive. The business has high margin. We have very low capital needs. And then with regards to our ability on a go-forward basis, we think this management team has the experience and ability to look at the business objectively.

And that's -- we'll figure out what's needed for the business over time. I don't think there's much more to speculate with regards to that.

Vasily Karasyov -- Cannonball Research -- Analyst

And the leverage targets?

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

With regards to leverage -- yes, with regards to leverage, as you know, we've never set a formal target. We've obviously prioritized deleveraging over the last several years. We took the business from a much higher level of leverage down to approximately 2.5 times. That is on the back of our robust free cash flow, and our ability to generate throughput from our AOI to free cash flow, I think, compares with almost any company.

So we'll continue to evaluate what's right for the business, but given that we haven't provided a leverage target, there's no update to it.

Operator

We have no further questions at this time.

Ari Danes -- Vice President, Investor Relations

Thanks, Tina. And thank you to all for joining us on the call. We look forward to speaking with you on our next earnings call. Have a good day.

Andrea Greenberg -- Chief Executive Officer

Thanks, everyone.

Operator

[Operator signoff]

Duration: 29 minutes

Call participants:

Ari Danes -- Vice President, Investor Relations

Andrea Greenberg -- Chief Executive Officer

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

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

Adam Levine -- Executive Vice President, Business Affairs

Brandon Ross -- BTIG -- Analyst

Ben Swinburne -- Morgan Stanley -- Analyst

David Miller -- Imperial Capital -- Analyst

David Karnovsky -- J.P. Morgan -- Analyst

David Joyce -- Evercore ISI -- Analyst

Brett Harriss -- G. Research -- Analyst

Vasily Karasyov -- Cannonball Research -- Analyst

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