MSG Networks (MSGN) Q2 2020 Earnings Call Transcript

MSG Networks (NYSE: MSGN)
Q2 2020 Earnings Call
Feb 04, 2020, 10:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good morning. My name is Christie, and I will be your conference operator today. At this time, I would like to welcome everyone to the MSG Networks fiscal 2020 second-quarter earnings conference call. [Operator instructions] I would now like to turn the call over to Ari Danes, investor relations.

Please go ahead, sir.

Ari Danes -- Investor Relations

Thanks, Christie. Good morning, and welcome to MSG Networks fiscal 2020 second-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 from 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 -- President and Chief Executive Officer

Thank you, Ari, and good morning. We had an eventful fiscal second quarter as we took a number of important steps that we believe well positions our company for the future. As we've previously discussed, in early October, we repurchased approximately $250 million of stock, representing 24% of Class A shares outstanding, and a transaction that reflects our confidence and our long-term outlook. This was followed later in the month with the refinancing of our outstanding debt, which provides us with enhanced financial flexibility.

And in December, we successfully renewed affiliate agreements with two of our largest distributors. We have now completed renewals with four of our top 5 affiliates over the past two years. This demonstrates our track record of working with distribution partners to reach mutually beneficial deals that for us are consistent with our goal of generating robust revenue, adjusted operating income, and free cash flow. We believe there are a number of factors helping to drive these renewals, including the increasing importance of live content in today's changing media landscape; the sheer number of live games we telecast, more than any other RSN in the country, the strength of our relationships, many of which span decades, and our presence in the New York DMA, one of the most competitive markets in the country.

Looking ahead, we believe our desirable position will continue to serve us well, as we not only work to renew future agreements, but also explore incremental distribution opportunities. Another area of focus is our commitment to providing compelling content, which begins with our exclusive live game coverage of five local NBA and NHL teams. For the 2019-'20 regular seasons, we will broadcast approximately 400 games, complemented by our pre and post-game shows and behind the scenes team coverage. We continue to pursue original programming that increases fan engagement and broadens our appeal, including popular theme week programming and the return of a condensed version of our MSG 150 show, which initially debuted last summer.

And we will soon be airing a new 30-minute program produced for us by DraftKings, designed to meet the growing interest of our audience in sports gaming. This collaboration with DraftKings is part of our recently renewed marketing partnership and highlights the unique value we receive by being part of MSG's integrated sports, entertainment, and media sponsorship deals. Sports gaming continues to be a strong overall category for us with a variety of content, advertising, and sponsorship arrangements with some of the nation's top sports betting brands. This past quarter, we also benefited from our pursuit of non-ratings reliant advertising opportunities, expanding many of our branded content partnerships and further improving the user experience of MSG Go, designed to increase customer engagement, and ultimately, enhance the value of the platform sponsorship inventory.

Finally, while we experienced a higher year-over-year rate of subscriber decline, as compared to our fiscal first quarter, we are confident that the strength of our relationships, coupled with our compelling content and attractive offerings for advertisers, positions us well to generate substantial free cash flow and create 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, and Treasurer

Thank you, Andrea, and good morning, everyone. Let's start with a discussion of our financial results for the fiscal 2020 second quarter. Total revenues of $187.7 million decreased $5.2 million or approximately 3% as compared with the prior-year period. This was driven by a $3.1 million decrease in affiliate revenue, primarily reflecting the impact of the decline in subscribers, partially offset, by higher affiliate rates, and to a lesser extent a $2.3 million favorable adjustment recorded in the quarter.

Advertising revenue decreased approximately $1.4 million year over year. This was primarily due to a lower net decrease in deferred revenue related to ratings guarantees and the timing of professional sports telecasts as compared with the prior-year quarter. This decline was partially offset by an increase in per-game sales for our live game telecast and other net advertising increases, primarily from our non-ratings based initiatives, which include branded content, MSG Go, and our outdoor digital billboards. I would note that we currently anticipate that fiscal third-quarter advertising results will reflect the impact of additional professional sports telecasts as compared with the prior-year quarter.

Other revenues were lower, primarily due to the absence of $800,000 in Fuse media fees. Our fiscal 2019 second quarter was the last quarter we recognized revenue from Fuse media. Direct operating expenses of $84.1 million increased $2.6 million or 3% as compared with the prior-year quarter, primarily due to higher rights fees expense, mainly results of contractual rate increases. SG&A expenses of $32 million increased $700,000 or 2% as compared with the prior-year period.

This was primarily due to higher advertising and marketing costs, professional fees, and other cost increases, partially offset by lower employee compensation and related benefits. I would note that the increase in SG&A expense includes $600,000 in expenses in the current year quarter that are not indicative of the company's core expense base. Adjusted operating income of $77.1 million decreased 10% as compared with the prior-year period, primarily due to the decrease in revenues and higher direct operating expenses. Reported free cash flow from continuing operations for the six months ending December 31st, 2019, was approximately $72 million.

Turning to our balance sheet. As of December 31st, 2019, total cash and cash equivalents were approximately $116 million, our total debt outstanding was $1.1 billion, and our $250 million revolver was undrawn. Our average interest rate for the quarter was approximately 3.3%. Net debt at quarter-end increased by approximately $240 million to $984 million and our net leverage ratio increased to 3.1 times trailing 12 months adjusted operating income as compared with 2.3 times at the end of our fiscal first quarter.

As a reminder, the increase in our net debt position and our net leverage ratio was primarily the result of our repurchase of approximately 15 million shares or 24% of our Class A common stock for approximately $250 million in early October. This was partially offset by incremental cash flow generated from operations during our fiscal second quarter. As we discussed on our last quarter's earnings call, subsequent to the repurchase, we amended and extended our credit facilities for a five-year term from October 2019, and as part of this refinancing, increased our term loan by $100 million to $1.1 billion. Looking forward, our new credit facility provides for a total of $27.5 million in mandatory principal payments during the next 12 months.

Lastly, the company has $186 million remaining on its share buyback authorization. And looking ahead, we will continue to maintain an opportunistic and disciplined approach to capital allocation. I will now turn the call back over to Ari.

Ari Danes -- Investor Relations

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

Questions & Answers:

Operator

[Operator instructions] And your first question is from Bryan Goldberg of Bank of America.

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

Thanks. I had a question on the new carriage agreements you called out today. As we think about your long-term outlook, are there any changes in these new deals we should be taking into account? And I'm really focused on a few areas, like, did rates go backwards or forwards on you? Are you going to be packaged any differently by these new distributors -- well, by these existing distributors? Have minimum guarantees changed? Or are there any shifts to add inventory sharing agreements with the distributors? And then, I have a follow-up.

Andrea Greenberg -- President and Chief Executive Officer

Hi, Brian. Well, let me say that we're not going to get into the specifics of the agreement. But generally, we are wholly comfortable with renewal terms. They include rate increases, packaging, and other protections that are consistent with our goals of creating continued robust revenue, AOI, and cash flow.

On your positioning question, I'll say that the -- generally, the packaging and other protections in our deals ensure continued expanded basic carriage.

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

OK, great. And then, on the subscriber results in the quarter, I was just wondering if you could share your views on the drivers of the accelerated sub losses versus the September quarter? And I guess, somewhat related to this if you could update us on your efforts to secure new carriage on streaming platforms like YouTube. Any color you could share would be great.

Andrea Greenberg -- President and Chief Executive Officer

Sure, sure. On the subscriber decline, as has been the case in our prior quarters, the -- virtually all of the acceleration came from the same two distributors that we referenced in previous calls. And just some additional color, one of these distributors, has again, publicly disclosed that it continues to be impacted by the roll-off of professional subscribers. So, we believe that the same dynamic impacted our subscriber results this quarter.

On OTT, Adam, you want to?

Adam Levine -- Executive Vice President, Business Affairs

Yeah. So, on new distribution with respect to operators like YouTube or Hulu, we continue to have discussions with those operators in that evolving, but still, fairly small segment of the pay-TV universe. This past quarter, we were pleased to have been included in AT&T's new product for the AT&T TV service in New York, which you probably know is currently only available in select markets, but including New York, and we look forward to that being rolled out in the rest of our regional footprint. Of course, we remain focused on exploring and pursuing all incremental distribution opportunities going forward.

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

Great. Thanks a lot.

Operator

Our next question is from Brandon Ross of LightShed Partners.

Brandon Ross -- Lightshed Partners -- Analyst

Hey. Good morning, guys. Verizon recently made some changes to its packaging or shall I say, merchandising with mix and match, and they're now offering YouTube TV as a video alternative. Maybe, if you could give us some color on how this is impacting your business? And what protections you have in place in your Verizon carriage agreement to potentially offset some of the weakness that this would theoretically cause? And then maybe, how this move by Verizon may have impacted your recent negotiations and/or the protections that you look for in those deals? Thanks.

Andrea Greenberg -- President and Chief Executive Officer

That's Adam.

Adam Levine -- Executive Vice President, Business Affairs

Yeah. I'll jump in on it. So, Verizon is a long-standing partner of ours. They also happen to be a significant advertiser on the network as well.

As you probably know, this just launched in January. So, it's all really fairly new. We're still discussing it with Verizon, but we're very comfortable with the terms of our Verizon agreement. For the Fios TV branded packages, our networks were not negatively impacted.

As a matter of fact, we're actually available to subscribers in more packages now than we were before. What we see is simplified pricing, elimination of certain fees on the Fios TV branded side. On YouTube TV side, what we see is a price point that's comparable to the base price of the -- your Fios TV package, one of the new packages with substantially fewer channels. And we think consumers will look at that, and decide ultimately, how that price-value equation falls.

Ultimately, we're comfortable with our contract and the protections that we have. We remain confident in the value of our networks. As far as the recent renewals, I think, as Andrea said, just to reinforce, we're pleased to have concluded those renewals, and we're comfortable with the protections that we have in there. And I would say, there was no impact of this on those discussions.

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

Thanks so much.

Operator

Your next question is from Alexia Quadrani of J.P. Morgan.

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

Hi, this is David Karnovsky on for Alexia. Just looking at the rate of affiliate revenue decline in Q2, factoring in adjustments would seem to imply an acceleration greater than we would have expected with subs moving from down 7% to down 8%. So, just wondering if there's other factors such as price or anything from your recent renewals that might have impacted results in the quarter?

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

Yeah, David, I'll take that. You know, the primary impact on our affiliate revenue this quarter and the comparison to a prior period was the rate of subscriber change. We've talked consistently that there's a lot of complexity in these agreements. And in any given quarter, there can be some adjustments.

When they're large enough, we call them out. We called out a large positive this quarter. But there's -- the relationship isn't wholly linear to just rate and sub, and of course, the renewals were at the end of the year.

Andrea Greenberg -- President and Chief Executive Officer

Yeah.

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

OK. And then, just -- your stock is now approaching levels where you had announced the tender offer over the summer, assuming the recent renewals you did provide some level of visibility and stability. How are you kind of thinking about capital allocation here? Any update would be great.

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

Yeah. Our plans for capital allocation haven't changed. We're going to continue to be very thoughtful about it and balance the need for a strong balance sheet with allocating capital to efforts that we believe would enhance shareholder value. I think our actions earlier this fiscal year were wholly consistent with that, both the tender and the refinancing of our balance sheet.

Looking forward, we'll make that determination on a dynamic basis, but I think it's important that we do have additional authorization, and that was put in place at the time of our tender, but we will allocate capital as we see fit.

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

Great. Thank you.

Operator

Thank you. Your next question is from David Miller of Imperial Capital.

David Miller -- Imperial Capital, LLC -- Analyst

Hey, guys. I have one for Bret and one for Andrea. Bret, as you know, through our written research product, we've sort of continued to propagate the theme that the public markets are not really recognizing the intrinsic value of the company. And so with that, you've gone over additional terms of the term loan, you've talked about additional buybacks, which we appreciate.

What other levers do you think you can pull going forward to engineer additional tender offers at these prices? Because it feels like you guys are slowly going private, which you probably should just given the overall landscape. And then, Andrea, could you give us an update? And maybe, I'm asking this question out of naivety over here on the West Coast in Los Angeles. But could you give -- could you just give me an update on where the legalization of sports, mobile sports betting rather, stands in the state of New York? Is that the real juice in the story as we see it? Obviously, it's legal in New Jersey, but we'd like to understand what the process is for legalization in New York. Thanks very much.

Andrea Greenberg -- President and Chief Executive Officer

OK. Brett, do you want to --

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

Yeah, I'll take the first one. So, I think with regards to engineering future tenders, I think what's important is that we have a lot of flexibility. We have $186 million maintaining on our buyback. We've put in place five-year terms of our credit facility, which in the near term, significantly reduced the mandatory prepayment obligations.

We continue to generate free cash flow and we'll continue to evaluate what's right for the company in the pursuit of shareholder value on a go-forward basis.

Andrea Greenberg -- President and Chief Executive Officer

And on the mobile sports betting question. As you indicated, mobile sports betting is legal in New Jersey and we've capitalized on that. We're seeing strong demand for the product. Tied to the New Jersey legalization as to New York, it's really an evolving landscape in New York.

It is not legal in New York yet. We are closely following developments and we believe that there is a significant upside when and if legalized or if gaming becomes legal, not just in New York, but we also serve portions of Connecticut. It's -- we're seeing strong demand from the category now. So, we expect to see continued strong demand.

David Miller -- Imperial Capital, LLC -- Analyst

OK. Thank you.

Operator

Thank you. Your next question is from Vasily Karasyov of Cannonball Research.

Vasily Karasyov -- Cannonball Research -- Analyst

Good morning. I wanted to ask about the cost side of the equation. So, what do the current pressures on your top-line mean for your relationships with the teams in the midterm? Because historically, teams often pushed for a step-up in rights fees when renewing contracts? And do you think that's still their mindset now given where -- how your business model is evolving? Or are they more understanding of what's going on? So essentially, my question is, do you see a more or less stable margins going forward? Or there will be pressures from TV rights costs on the margin, assuming the current revenue trends continue?

Andrea Greenberg -- President and Chief Executive Officer

Well, we have said that we have long-term rights agreements for our professional NBA and NHL product. We've also disclosed that for the Knicks and the Rangers, specifically, our deals are in excess of 15 years. We have more than 15 years left on our remaining term. Those deals all have fixed step-ups in rights fees.

So, we have significant visibility into our expense base on the right fee side for many years to come.

Vasily Karasyov -- Cannonball Research -- Analyst

All right. Thank you.

Ari Danes -- Investor Relations

Christie, we have time for one last caller.

Operator

Certainly, your final question comes from Bernie McTernan of Rosenblatt Securities.

Bernie McTernan -- Rosenblatt Securities -- Analyst

Great. Thanks for taking my questions. Just a follow-up on the carriage agreement. I was wondering if you could provide any color on how long these renewals were for? And then also, mentioned in the prepared remarks, if four of the top 5 renewals have been done over the past two years, should we expect a hiatus over the next year or two? And then lastly, just on free cash flow.

It was lower year over year. There was some seasonality in free cash flow last year with 2Q being the trough. Should we expect free cash flow to pick back up in the second half of the year? And if you can just detail the seasonality and why it snapped back?

Andrea Greenberg -- President and Chief Executive Officer

Adam, do you want to --

Adam Levine -- Executive Vice President, Business Affairs

Yeah. Just to start with the renewals. I think that's all we could really say is that our deals are generally multi-year in nature. They come up from time to time in a generally staggered manner, but we're not prepared to disclose more than that.

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

And, Bernie, with regards to free cash flow. Obviously, it starts with our operational performance. There were some expenses this quarter that related to the financial activity in Q2 with the bank refinancing, the tender. In terms of seasonality, this is a high use of working capital quarter for us.

Advertising revenues ramped up in Q2, the timing of receipts trails. So, you see some of that. That's not new to the business. The one thing you might be noticing, and as a reminder, is last year, we aligned our tax year with our fiscal year, moving to a June 30 tax year, which changed the timing of our estimated tax payments.

We used to do higher estimated tax payments in Q4, and now, we do higher estimated tax payments in Q2, but I think we're beginning to lap that change.

Bernie McTernan -- Rosenblatt Securities -- Analyst

Great. Thank you very much.

Operator

Thank you. I would now like to turn the call back over to Ari Danes for any additional or closing remarks.

Ari Danes -- 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

[Operator sign-off]

Duration: 26 minutes

Call participants:

Ari Danes -- Investor Relations

Andrea Greenberg -- President and 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 -- Lightshed Partners -- Analyst

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

David Miller -- Imperial Capital, LLC -- Analyst

Vasily Karasyov -- Cannonball Research -- Analyst

Bernie McTernan -- Rosenblatt Securities -- Analyst

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