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MSG Networks Inc.  (NYSE:MSGN)

Q2 2019 Earnings Conference Call

Feb. 05, 2019, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning. My name is Christie, and I'll be your conference operator today. At this time, I would like to welcome everyone to MSG Networks Fiscal 2019 Second Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions)

Thank you. I would now like to turn the call over to Ari Danes, Investor Relations. Please go ahead, sir.

Ari Danes -- Senior Vice President, Investor Relations

Thanks, Christie. Good morning, and welcome to MSG Networks fiscal 2019 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 operation. This will be followed by a review of financial results by 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 on 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 & 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 to free cash flow.

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

Andrea Greenberg -- President and Chief Executive Officer

Thank you, Ari, and good morning. We delivered strong results for our fiscal second quarter, fueled by increases in both our affiliate and advertising revenue. Second quarter revenues were approximately $193 million, up 6% year-over-year, and adjusted operating income was approximately $86 million, an increase of 4% as compared to the prior year quarter.

With the NBA and NHL regular seasons in full swing, MSG Networks continues to focus on providing sports fans a world-class programming lineup. This includes our exclusive live game telecast, in-depth behind the scenes teams coverage and other original and acquired programming combined to appeal to investing in new audiences.

We continue to focus on our MSG's Shorts programming block with innovative short-form series, which is an effective and attracting our viewers across our linear, digital and social platforms. Additional shows launched this past quarter includes Conference Room B, which features insightful and lighthearted conversation with sports and entertainment personalities unfiltered, which gives viewers a chance to watch their coaches and players in unfiltered discussion. And as part of our content partnership with Complex Networks, all new episodes of Hot Ones and Sneaker Shopping.

This quarter is also marked by impressive advertising results, driven in part by strong demand from the sports gaming industry, which we continue to believe will be an important contributor to advertising revenue moving forward. Sports gaming companies, such as William Hill, FanDuel and DraftKings have recognized the unique value of our live local sports content, the meaningful investment in our spot inventory.

And in the case of William Hill, we have an integrated sponsorship for our New Jersey Devils broadcast in addition to spot also includes branded content and other program integrations.

Branded content is an area where we continue to have success as companies look for impactful and unique ways to integrate their world-class brand with our exclusive live sports programming. During the quarter, we welcomed new branded content partners, Geico, Subway, Ford and Kia, among others, joining our already strong roster of sponsors, including Squarespace, Hospital for Special Surgery, and Anheuser-Busch and BMW.

In addition, our mobile app, MSG GO, continues to generate incremental non-rating space revenue from our sponsors. This past October, we launched a new version of the app with a redesigned layout and increased functionality; and, in December, added games, teams and player statistics and interactive gaming. These new features are designed not only to improve user engagement, but also to provide additional inventory for new and existing advertising partners.

With respect to affiliate revenue, so far this year, we've experienced solid growth, due to the strength of our relationships with our traditional MVPD distributors coupled with our digital distribution partners.

In terms of our viewing subscribers, we experienced a low single-digit percentage decrease in our second quarter as compared with the prior-year period. While this year-over-year percentage rate of decline increased as compared to the fiscal 2019 first quarter, we are pleased with our affiliate revenue results for the first half of this year.

In summary, we had a strong first half of fiscal 2019 as we continue to capitalize on the strength of our exclusive live sports content. Looking ahead, we are on track to deliver another year of significant revenue, adjusted operating income and free cash flow and believe we are well positioned to 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. For the fiscal 2019 second quarter, total revenues of $192.9 million, increased $11.7 million or approximately 6%. This increase was primarily driven by a $7.8 million increase in affiliate revenue, mainly a result of higher affiliate rates partially offset by the impact of a low single-digit percentage decline in subscribers.

In addition, advertising revenue increased $3.5 million, primarily due to higher ad sales from live professional sports programming. This reflects higher advertising on a per game basis in part due to increased demand from the sports gaming industry as well as the timing of telecast as compared with the prior-year period.

Direct operating expenses of $81.5 million, increased $2.6 million or 3% as compared with the prior year period, primarily due to higher rights fees expense, mainly result of contractual rate increases. SG&A expenses of $31.3 million increased approximately $7 million or 29% as compared with the prior year period. The increase was primarily due to higher advertising and marketing expenses, employee compensation and related benefits, including share-based compensation and ad sales commissions.

Adjusted operating income of $85.8 million increased 4% as compared with the prior year period, due to the increase in revenues partially offset by higher SG&A expenses and to a lesser extent higher direct operating expenses.

With respect to our balance sheet, as of December 31, 2018, total cash and cash equivalents were $174.6 million, total debt outstanding was $1.08 billion and our $250 million revolver remained undrawn at quarter's end. As of December 31, 2018, net debt was approximately $909 million and our net leverage ratio was 2.7 times trailing 12 months adjusted operating income. Our average interest rate for the quarter was approximately 3.8%. Reported free cash flow for the six months ending December 31, 2018, was $88.8 million.

During the fiscal second quarter, we made a mandatory principal payment of $18.75 million in accordance with the terms of our credit agreement. In addition, last month, we made a voluntary principal payment of $25 million.

Looking ahead, our credit facility provides for a total of $88 million in mandatory principal payments over the next 12 months. In terms of the company stock repurchase program, we did not repurchase shares during the quarter. We currently have $136 million remaining under our authorization and planned to remain disciplined and opportunistic with our share repurchases.

With regards to taxes, our financials reflected an effective tax rate of 35% for the second quarter, which includes additional tax expense of $3.5 million related to certain changes in state apportionment rates and tax return to accrual adjustments that we booked in conjunction with the recent filing of our state tax returns. The majority of the $3.5 million was non-cash tax expense. Excluding this amount, the effective tax rate would have been 30% for the quarter.

In addition, as we noted on our last quarter's earnings call, we changed our tax year to align with our fiscal year. This change does not impact our overall tax liabilities. However, it does impact the timing of cash tax payments and resulted in higher cash tax payments in our fiscal second quarter as compared with the prior-year period.

I will now turn the call back over to Ari.

Ari Danes -- Senior Vice President, Investor Relations

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

Questions and Answers:

Operator

(Operator Instructions) And your first question is from Bryan Goldberg, Bank of America Merrill Lynch.

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

Thanks. I've got two on affiliate fees. First, you reported, I think, $7.8 million in affiliate fee growth in the quarter and that's an acceleration sequentially versus the September quarter and I just heard your paid -- your subscriber commentary and I was wondering if you could just give us some more color on the drivers there, on the growth, the $7.8 million, is that a reasonable run rate for the business over the near term, or was there anything unusual going on that would have distorted the growth rate in the quarter? And then, secondly, somewhat related to it, it's that time of the year again, I was wondering if you could update us on whether or not you had any major affiliate renewals during or at the end of the quarter?

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

Thanks, Bryan. I'll take the first part and I'll hand it over to Adam. So, importantly, we're pleased with our affiliate revenue results for the quarter. And it fundamentally reflects our ongoing strength of our product in the marketplace. As we talked about the increasing revenue was driven by higher rates and offset by that sub-trend, but I'd also note that there were some noise in the quarters affiliate revenue, which enhanced what was an already solid underlying growth rate.

Adam Levine -- Executive Vice President, Business Affairs

And on renewals, we are pleased to report that we recently renewed affiliate agreements with several distributors, including one of our major affiliates. Without getting into the specifics, I'd say we're pleased with the renewal agreements and they reflect unique value of our live sports content and are consistent with our goal to drive continue to affiliate revenue growth. And, as you may recall, last fiscal year, we also had several successful affiliate renewals, including one with a major distributor.

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

Okay. Great. Thank you very much.

Operator

Thank you. Next question comes from Alexia Quadrani of JP Morgan.

Ari Danes -- Senior Vice President, Investor Relations

Alexia, you're on the call.

David Karnovsky -- JP Morgan -- Analyst

Hi. Sorry, I was on mute. This is David Karnovsky on for Alexia. I just wanted to clarify the prior comment. The major renewal you just referred to, is that in the current fiscal year?

Adam Levine -- Executive Vice President, Business Affairs

Yes.

David Karnovsky -- JP Morgan -- Analyst

Okay. And then just following up on the affiliate, can you just remind us when DirecTV Now started to roll onto your financials? And then, looking ahead, that service had reported a fairly significant amount of sub declines in Q4, do you think you are largely insulated from that just given that those were sales -- were promotional and other peer (ph)?

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

Yes. David, I'll take the first part. It launched in late December of last year, so December 2017 and Adam will pick up on the DirecTV.

Adam Levine -- Executive Vice President, Business Affairs

Yes. Just regarding DirecTV Now and the subscriber performance in the market, we're not going to get into specifics regarding individual affiliates, but we're pleased with the agreement we have. We're certainly mindful of what's been reported publicly by AT&T and I think we just take the opportunity to reinforce what we've said previously that the New York market is fairly unique and highly competitive market for pay television and what we see nationally and publicly reported may not always translate to our market and our region.

David Karnovsky -- JP Morgan -- Analyst

Okay. And then just on your SG&A expense, can you bucket out the increase you're seeing this quarter and maybe just provide some additional color on advertising and marketing costs? Is this sort of a one-time expense without the NBA and NHL seasons or is this more run rate? Thanks.

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

Sure. So as we talked about in our prepared remarks, the increase was primarily due to the advertising marketing expense you mentioned. It also included employee compensation, including share-based comp as well as higher ad sales commissions, which reflect the strength of the advertising revenue in the quarter. The increase in advertising and marketing expense was primarily related to our efforts to highlight the enhancements we recently made to MSG GO and I'm not going to comment on a go-forward basis, but it was certainly an activity we had in the quarter.

David Karnovsky -- JP Morgan -- Analyst

Okay. Thanks.

Operator

Thank you. Your next question is from Brandon Ross of BTIG.

Brandon Ross -- BTIG -- Analyst

Hi. A couple of questions. Today, you've announced agreements with two virtual MVPDs, which have been fubo and DirecTV Now. I assume that rate is holding you back from doing deals with YouTube TV and Hulu. However, those seem to be taking pretty decent market share among the virtual distributors. How do you think -- given that shift, how do you think about potentially budging on price to get deals done there? And, more broadly, how do you think about the trade-off between price and distribution? Then I have another. Thanks.

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

Okay. So really not -- I don't think we can get into specifics of negotiations or specific discussions we're having with operators or potential customers, but I think we say we've been successful in achieving broad distribution in affiliate revenue and rate growth. And price negotiation is obviously a key part of every negotiation that we have for distribution of our content. There are a variety of other important terms that need to be negotiated are also important. I think our focus always is whether it's for new distribution or renewal of an existing affiliate is to make sure that our content is properly valued. And we think we have a pretty good track record in that regard.

So with regard to the incremental distribution opportunities, we continue to focus on them and we believe in the power and popularity of our live sports content. And particularly our content with the volume of live games and a number of local teams that are representing on our networks, we think those are important for any operator that is looking to compete in this highly competitive market.

Brandon Ross -- BTIG -- Analyst

Great. And then your ratings have been pretty challenging season, obviously, due to team performance but the ad revenue was up nicely, is that predominantly sports betting related revenue or the branded contents that you called out in the prepared remarks? And can that tailwind allow you to grow ad revenue even if the mix don't get Kylie and Katie?

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

So, we're not going to comment on the go-forward element to tag on at the end there. But, as we said, gaming was a significant contributor to ad revenue this quarter, but it was not all gaming, we did have a few additional games as compared to last year, but importantly per game sales increased. And we also seen year-over-year contributions from other advertising sales, including branded content. Overall, I think the important message is, it was a very strong quarter for ad sales. And while ratings will continue to influence advertising revenue, the demand for our products been strong and we expect these non-ratings based products to be increasingly important in the future.

Andrea Greenberg -- President and Chief Executive Officer

Brandon, content is MSG GO and the new advertising opportunities that we've created, it's new categories not just sports gaming, tourism, film, all the things that we undertook to focus on two years ago that we've been talking about we see coming to fruition here.

Brandon Ross -- BTIG -- Analyst

Great. Thank you.

Operator

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

Vasily Karasyov -- Cannonball Research -- Analyst

Thank you. Good morning. I wanted to ask you this, how relevant in your view is the valuation of Fox RSMs to MSG and valuation? There have been multiple reports, some of the press report, some of them say that bids at this point are at valuation multiples below where your stock trades. What would you say is wrong within argument that MSG Networks should not trade above the valuation at which RSMs gets sold out in the play? I appreciate your commentary here. Thank you.

Andrea Greenberg -- President and Chief Executive Officer

Hi. Well, we're not going to comment on speculation or sort of engage in a hypothetical recommends about our valuation relative to others, but we will point out how we believe we're different, right, and we have done this over and over, and I think it -- our difference and our strengths is what we should look at when we're looking at the valuation of our business. And we're the home of a variety of marquee franchises. We're in the nation's largest television market. We operate in the nation's most competitive distribution market. We've talked about that. We have long-term rights agreements in place. That's a tremendous asset for us. And we have visibility into our expense base for many years to come. And as you can see from this quarter and previous quarter's results, advertising demand for our products is strong. So I would urge anyone who was thinking about that to look at those factors.

Vasily Karasyov -- Cannonball Research -- Analyst

That's helpful. Thank you very much.

Operator

Thank you. Next question is from Michael Morris with Guggenheim.

Michael Morris -- Guggenheim Securities -- Analyst

Thank you. Good morning. I want to go back to the major renewal that you referenced, my questions are, did that renewal impact your affiliate revenue in the fiscal second quarter in any way? And if not, should we expect it to have an impact on the rate of change in the third quarter? And then I have a second question.

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

Yes. Mike, I'll just -- we did want to highlight that renewals and event, but we're not going to breakdown the impact on the financials or even make a go-forward statement.

Michael Morris -- Guggenheim Securities -- Analyst

I want to go back to the major renewal that you referenced. My questions are, did that renewable impact your affiliate revenue in the fiscal second quarter in any way? And if not should we expect it to have an impact on a rate of change in the third quarter? And then I have a second question.

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

Mike, I just we did want to highlight that renewals and event but we're not going to break down the impact on the financials or even make a go-forward statement.

Michael Morris -- Guggenheim Securities -- Analyst

Okay. My other question had to do with sort of a pay-per-view model. NBA league pass offers full games at $7 a game. They have rolled out partial games at this point for a fee. Does MSGN have the rights or the ability to develop the products like that in market? And if so, how do you think about that? You haven't done it yet, just kind of what's the balance in your mind of maybe making a product like that available for your consumers? Thanks.

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

So I think we -- we're always looking at opportunities for new products with a content that for rights that we control, that makes strategic and financial sense for our business. So, obviously, we're monitoring what the leagues that are out there and what other companies have. That being said, I think, we're very comfortable with the current business model on the strong revenue, AOI and free cash flow that we generate as a result of the current business model. But we're always looking at incremental opportunities and we believe we do have those rights and if it makes sense for us to pursue those opportunities, that's something we would do.

Michael Morris -- Guggenheim Securities -- Analyst

Okay. Thank you.

Operator

Thank you. Next question is from David Joyce of Evercore ISI.

David Joyce -- Evercore ISI -- Analyst

Thank you. On the topic of your strong advertising growth, is there any contribution there from enhanced measurements on the multiple platforms of viewing? I was just wondering where you are on getting that rolled out or agreeing to those kind of terms of the advertisers? And, also, I was wondering where you are in terms of addressable advertising? Thank you.

Andrea Greenberg -- President and Chief Executive Officer

We're not going to comment on how we sell our advertising. I mean, clearly, we use every metric available to us. And, as we've said, we're really looking to non-ratings based advertising integrating with our very, very strong brands and multi-element sponsorship deals, which we've talked about it in the past. In terms of addressable advertising, we certainly are intrigued by it and we're monitoring what the industry is doing at this point.

David Joyce -- Evercore ISI -- Analyst

All right. Thank you.

Ari Danes -- Senior Vice President, Investor Relations

Christie, we have time for one last caller.

Operator

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

David Miller -- Imperial Capital -- Analyst

Yes. Hey, guys. Questions for Bret and also for Andrea. Bret your leverage ratio at 2.7 times, you guys have just done an absolutely spectacular job of getting that down since the split some time ago from the mothership company, what do you consider capital efficient in terms of that ratio? Is it sort of the low-2s or high-1s -- and -- just given the backup and rates over the last six months or so?

And then Andrea, as you know, your -- what's called a little sister company, MSG, is planning on splitting it half or they may split in half, they obviously haven't announced that formally yet, but if they do split in half and spin-off the sports side and the RemainCo is the entertainment side, how do you see working with the entertainment company in any way shape the form, if at all? Thanks very much.

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

So, I'll take the first one. We don't have a specific number that I'd point to as capital efficient. I think, even that approach assumes so many other aspects of the equation, the markets, the marketplace being sort of a constant. As we know, we're in a sort of an ever-changing world. What I would highlight is, we do put a premium on having a strong healthy and flexible balance sheet. We appreciate the complements. It's usually a much better challenge to delever than to relever and we think if there was an opportunity to use leverage in the future having that capacity in the balance sheet is a premium.

Andrea Greenberg -- President and Chief Executive Officer

And as to your second question, we're not going to speculate on any potential transaction across the street other than to say that we have wonderful working relationships with both the entertainment group and the sports group and continue and expect that to continue going forward.

David Miller -- Imperial Capital -- Analyst

Okay. Wonderful. Thank you.

Operator

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

Ari Danes -- Senior Vice President, Investor Relations

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

Operator

Thank you. This does concludes today's conference call. You may now disconnect.

Duration: 26 minutes

Call participants:

Ari Danes -- Senior Vice President, 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

David Karnovsky -- JP Morgan -- Analyst

Brandon Ross -- BTIG -- Analyst

Vasily Karasyov -- Cannonball Research -- Analyst

Michael Morris -- Guggenheim Securities -- Analyst

David Joyce -- Evercore ISI -- Analyst

David Miller -- Imperial Capital -- Analyst

More MSGN analysis

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Source : https://www.fool.com/earnings/call-transcripts/2019/02/05/msg-networks-inc-msgn-q2-2019-earnings-conference.aspx

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