National CineMedia, Inc. (NCMI) Q3 2014 Earnings Report, Transcript and Summary

Hello and thank you for standing by. Welcome to the National CineMedia Inc. Third Quarter 2014 Earnings Conference Call. As a reminder, all participants are in a listen-only mode and the conference is being recorded (Operator Instructions). At this time, I'd like to turn the conference over to David Oddo, Vice President of Finance for National CineMedia Inc. Please go ahead, sir.

Good afternoon. I'd like to remind our listeners that this conference call contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 as amended and Section 21E of the Securities Exchange Act of 1934 as amended. All statements, other than the statements of historical facts, communicated during this conference call may constitute forward-looking statements. These forward-looking statements involve risks and uncertainties. Important factors that can cause actual results to differ materially from the Company's expectations are disclosed in the risk factors contained in the Company's filings with the SEC. All forward-looking statements are expressly qualified in their entirety by such factors. Further, our discussion today includes some non-GAAP measures. In accordance with Regulation G, we have reconciled these amounts back to the closest GAAP-basis measurement. Now, I'll turn the call over to Kurt Hall, CEO of National CineMedia.

Thanks David. Good afternoon, everyone. Welcome and thanks for joining us for our 2014 Q3 earnings conference call, especially given the last-minute change in the timing. Given the DOJ announcement earlier today, we thought that it was the right thing to do. During this call I’ll provide you with a brief overview of our Q3 actual results and some color on our strong recovery in Q4 that was primarily driven by our record upfront for the media fiscal year that began on October 1st. We also had some good tailwinds from favorable media buyer response to the improved product that will be created once the merger with Screenvision is completed. I will talk more about the status of the merger and the DOJ complaint filed today and related benefits of the merger later in my discussion. David will then provide you with a more detailed discussion regarding our Q3 results and our Q4 guidance. And then, as always, we'll open the line for questions. While our Q3 adjusted OIBDA finished slightly higher than the midpoint of our guidance, it was clearly a disappointing quarter as significant declines in our national advertising CPMs were only partially offset by record Q3 local and regional revenue that was up almost 16% versus Q3 2013. Our adjusted EBITDA decreased approximately 30%. However, our margins only declined to 52% as the impact of the lower national advertising revenue was offset by higher local and regional revenue, the sale of the low-margin Fathom business, tight cost control, and the strength of our underlying business model that features a high percentage of variable operating costs. Our Q3 national revenue was negatively impacted by a very soft TV scatter and upfront marketplace during Q2 and Q3, as media buyers evaluated the impact on their marketing plans of declining…

Thanks, Kurt. For the third quarter our total revenue excluding the Fathom Events Division decreased 21% versus Q3, 2013 driven by a 29.9% decrease in national advertising revenue including beverage partially offset by a 15.6% increase in local advertising revenue. Total Q3 adjusted OIBDA excluding Fathom Events decreased 31% on an adjusted OIBDA margin of 51.8%. This margin decrease related to the lower high margin national advertising revenue. We recorded 600,000 of AMC and Cinemark integration payments for the third quarter versus $1 million for Q3, 2013. You should note that these integration payments are added to adjusted OIBDA for debt compliance purposes, but are not included in our reported revenue and adjusted OIBDA, as they are reported as a reduction to net intangible assets on our balance sheet. With the decrease in national and local and regional growth our Q3 2014 advertising revenue mix shifted to 52% national, 29% local and 9% beverage versus Q3 2013 which was 71%, 20% and 9% respectively. Q3 national ad revenue excluding beverage decreased 31% versus 2013, driven by a 27.2% decrease in CPMs and a 9.3% decrease in impressions sold. This decrease in utilized impressions was driven by a decrease in network attendance of 14.8% partially offset by an increase in utilization rate to a 125.3%, compared to a 117.6% in Q3 2013. The decreases in both CPM and impressions sold were impacted by $9 million decrease in Q3 content partner spending versus Q3 2013 primarily related to an increase in content partner spending in excess of their annual commitments in 2013 and a $6 million decrease in scatter spending by our previous cell phone PSA client versus Q3 2013. Our make-good was $1.8 million at the end of Q3 2014 versus $500,000 at the end of Q3 2013 due to the…

Thank you. (Operator Instructions) First question today is from Eric Handler of MKM Partners. Please go ahead. Eric Handler – MKM Partners: Yes. Thanks for taking my question. So, Kurt, just curious, you sound very confident that this deal can still go through. And, while I think a lot of people are surprised that it didn't get approved, what gives you great confidence that, on appeal, you can get the DOJ decision reversed? And secondly, can you walk us through the steps of the appeal process, how long this could take, and just some of the points along the way that need to happen?

Yes, Eric, it’s not technically an appeal, I mean we have been sued and we have to go through the process of defending ourselves in that lawsuit and we feel very confident that our arguments are continue to be strong I think clearly some of the claims at the DOJ has made, I think can be proven incorrect or misguided and that will be our job over the next several months. As far as the process itself as these things go, it’s reasonably quick, but you can count on somewhere in the neighborhood of four months or possibly more, does that answer all your questions, or…?

Well, yes. And as far as in the decision that came up or discussions that you had with the DOJ prior to this announcement, was there any type of concessions that they asked you to make that you weren't willing to make? Or what can be done to maybe remedy the situation?

No we didn’t talk about any concessions at all, and again, we weren’t asked to make any, we didn’t offer any, we have gone back to theater circuits over the last few months and offer them extensions to their contracts which I think a good thing for them, but that’s really the only thing that comes close to something that could be adjusted as part of this.

Okay. And then one last thing. In terms of the people that might have sent letters to the DOJ saying this was not a good idea, do you get a – was there a much pushback from advertiser or theatre partners to that end? I'm just trying to get a sense of.

Yes. We weren’t actually aware of any pushback and we saw several letters that came from advertising clients or agency in support of the deal we saw several letters from theater circuits that were support of the deal, so honestly it was a little bit of a surprise it came out this way. Eric Handler – MKM Partners, LLC: Okay, thank you.

Yes.

The next question is from James Dix of Wedbush Securities, please go ahead. James Dix – Wedbush Securities: Hey, good afternoon, guys. I guess the first question, just shifting to fundamentals. What appears to be your outlook now for CPMs next year given that it seems like you're upfront sales were kind of at a premium to where you think 2014 is finishing up and it sounds like things could be stabilizing. So, it seems like that might be a headwind that's finally lifting. But, I just wanted your perspective on that. Go ahead. I had two others.

Yes, that’s clearly the case, clearly we got a much lower benchmark, the comps are much easier for next year on a CPM basis and as we mentioned we’re starting to see the benefit of that in fourth quarter. But a lot of it is just supply-demand economics that we're benefitting from. As we said in my comments, we had a lot of demand for upfront. There were even a few clients that we cut off. They didn't make it in by the deadline that was at the end of September and we actually cut them off. Lot of it is just driven by the supply-demand economics. As we said before, we think cinema pricing should be sort of pegged by the market at the top end of the TV pricing, sort of where prime broadcast is or sports, in that neighborhood. I think that's where the proper clearing price is. James Dix – Wedbush Securities: And that's kind of where you're at now.

Yes, I think it's plus or minus a couple bucks either way, we are in that range, yeah. James Dix – Wedbush Securities: Okay, great. And then, second, what is the importance of being able to sell more by demo than you do now? I mean if you could just give a little bit of an outline as to how you're selling at the moment and then what the potential impact could be and what the timing of that impact could be as you move more to selling, I guess a little bit more like how other TV networks sell.

Yes. I mean one of the big benefits of the merger that clearly wasn't understood fully was the fact that we just don't have enough impressions right now to be able to provide all the demo targeting and related guarantees, because they kind of go hand in hand, that TV does. TV right now sells 78 different demo groups between male and female and all the different age groups, there's 78 of them. We've just barely started selling two or three or four in addition to total audience or two-plus. And so when you think about product definition, we're at a significant handicap on the definition of the product as it relates to targeting. So, with the 16%-plus increase in impressions that the Screenvision merger results in, it gave us the ability to increase the number of demo groups that we could actually provide an efficient guarantee against. The problem is – we can always target. The problem is there is so much waste that it makes it very inefficient for us to even offer that product because of that waste. I’ll just give you an example, 25 to 54 year old women demo, only about 20% to 22% of the theatre audience fits that demo. So, said another way, there's 78% waste. And the ability to be able to create film genres groups against that specific demo and pick films a little bit better and come up with a demo group at the end that has a big enough level of attendance to make it worth the while of the advertiser; that's what we’re really working on here. We could demo it now but, by the time you're done targeting the audience, you've got such a small buy the advertiser really doesn’t share. So for us it’s a combination of putting some new software in place that we’re in the process of developing and having a bigger audience to begin with to use that software against. James Dix – Wedbush Securities: So, I mean to some extent, if for some reason the merger did not go through, is that something which you're really kind of handicapped in pursuing?

We’re still going to do it, but we’re not going to be able to offer as many demo groups because there is going to be some demos that we just can’t offer because the waste is too high and the group of the audience size that we can offer just isn’t big enough. James Dix – Wedbush Securities: Okay.

Meaning 60% of – 60% increase is a fairly significant increase. James Dix – Wedbush Securities: Right. No, I understand. And then just one last one, I had this question from an investor so I figured I would just raise it. Any issue with the security of the dividend one way or the other? I know David gave kind of what's on the balance sheet now. But, anything that's going on that would affect, really, that in any way?

Nothing at all. James Dix – Wedbush Securities: Okay, thanks very much.

The next question is from Townsend Buckles of JPMorgan. Please go ahead. Townsend Buckles – JPMorgan: Thanks. Kurt, on your outlook for the strong rebound in national ad revenue, going from your toughest third quarter in five years to what looks like could be a record fourth quarter, you mentioned your upfront selling efforts and advertiser dissatisfaction with TV. So, would you say this is really a turn, this turn is about flipping to the new broadcast year to free up spending from TV? Or is there anything else unique going on that’s driving this sort of abrupt upturn in demand?

Well, we never know where the money is coming from, but the coincidence of timing where there was over $1 billion not committed to TV upfronts and then our upfronts ended a month and a half or so later, and we didn’t really see the pickup until people came back from Labor Day. And the bookings that we had between the second week of September and second week of October were some of the biggest weeks we’ve ever had in our history. So something was going on and what I’ve said for years now is that I think you know eventually people are going to start looking for other opportunities and we’re one of those other opportunities. Obviously, the big winner from all of this market share shift or whatever you want to call it has been the online and mobile guys as well. Townsend Buckles – JPMorgan: And keeping in mind the fourth quarter has been tough the last couple years with revenues sometimes not coming in quite as strong as expected originally, are you far enough along at this point in November that you feel this outlook is pretty well booked, given your commitments?

Yes, we’re pretty confident about it and we still got two months worth of booking time left and an extra week between Christmas and New Year’s. So we’re pretty confident with the numbers. Townsend Buckles – JPMorgan: How much of a lift do you expect from that from that extra week?

It’s hard to tell. The national business it will undoubtedly reduce your make-good because you’ve got one really big week that would have normally fall into January. So it obviously helps there. But it’s a little hard to tell, because, again it’s almost two months out right now. On the local business it should be a little bit more liner. As I mentioned the local business we’re not expecting the growth in the fourth quarter that we saw in the first three quarters of the year, especially third quarter. And it could be just a matter of timing. It could be that a lot of the uptick we saw in the third quarter was just people moving forward. But again that continue to pretty quickly as people start to loosen up their budgets for the Christmas holiday shopping season. Townsend Buckles – JPMorgan: Okay thank you.

Yes.

The next question is from Barton Crockett of FBR Capital Markets. Please go ahead. Barton Crockett – FBR Capital Markets & Co.: Okay, great. Thanks for taking the question. How much of the growth that you’re seeing in your upfront for next year and your trend for the fourth quarter is you think new people coming into theatre advertising versus share gain from Screenvision?

Well, I can't tell you about the share gain from Screenvision because I have no clue what their upfront bookings have been. But what I can tell you is there were a number of new clients that are spending with us for the first time and they're spending in the upfront. I'm just looking from my notes. I've got it here, just a sec. I think in my comments, I said there were 13 new clients that committed for $58 million, we know that's all incremental. And there were a bunch of clients that returned that both made commitments in 2013 and 2014 and the overall commitments for those nine clients were up 14%. So, we not only got new people to come in, we also got our existing people to spend more. And as I mentioned, our content partner commitments were up 16% as well. Barton Crockett – FBR Capital Markets & Co.: It's not really clear. Those new people, are they new to you or are they new to the theatre advertising? Or do you know?

Well, again, I can't tell you every single Screenvision client so I can't tell you it's new to – I can only tell you what's new to us. Barton Crockett – FBR Capital Markets & Co.: Okay.

So they may have bought Screenvision before. I can’t tell. Barton Crockett – FBR Capital Markets & Co.: But does your gut tell you that it's more kind of new money coming in or people kind of switching over?

Yes. I mean you don't go from $110 million of upfront to $250 million without there being money switching over from somewhere. So as I said before in one of the previous questions, the fact that the TV upfronts were down reasonably, significantly, $1 billion or more and ours are up pretty significantly. You draw your own conclusions from that, but it looks like some money shifted over. Barton Crockett – FBR Capital Markets & Co.: Okay. And can you remind us on your merger agreement, and what are the penalties if the deal doesn't go through if the government blocks it? What gets paid, if anything?

Well, we have to completely go through the whole process and if we and Screenvision collectively decide that it's not going to go through, then the merger agreement has a reverse breakup fee of $28.5 million that we would pay. But we're a long ways from that. Barton Crockett - FBR Capital Markets & Co.: Okay. And in terms of the process, you said about four months. This is a courtroom process, right? There's a judge, discovery.

Yes. Barton Crockett - FBR Capital Markets & Co.: Is there a jury?

There's a lot of work to be done before you'll ever be in a courtroom; a lot of discovery, as you point out, and a lot of other work to do. We just got the complaint today so we're still reviewing it. Barton Crockett - FBR Capital Markets & Co.: Okay. But the four months, is that just based on what you're seeing with other antitrust challenges or how did you come up with that?

Yes. I mean they try to move these processes along fairly quickly because they know there are two companies kind of hung up in the middle, if you will. And so, there's already been a judge put on the case. So these things move along reasonably quickly compare to other litigation situation. Barton Crockett - FBR Capital Markets & Co.: Okay. That's great. Thank you.

Yes.

The next question is from James Marsh of Piper Jaffray. Please go ahead. James Marsh – Piper Jaffray & Co.: Great, thanks. Two quick questions here. Just, first, to circle back on that breakup fee. Are there any conditions that would allow you guys to avoid paying it or any offsets or remedies, those types of things that might mitigate the out-of-pocket cost there? And then, secondly, I was wondering if you guys were aware of any examples of the Department of Justice suing to stop a merger and then eventually being unsuccessful? What's the template for you guys?

Yes. There's plenty of situations where suits are brought and they're settled in one form or another. There have actually been very few merger cases that have gone completely through the trial process. So, there's a long process of trying to work through this. So I'm hopeful that, as more in more fax come out, there’s an education process that ensues, that we'll get to the right answer. James Marsh – Piper Jaffray & Co.: Okay and then just the offsets and any remedies available that would help mitigate that?

Yes, the only way that would happen is if there was certain covenants that weren't followed by Screenvision. James Marsh – Piper Jaffray & Co.: Okay. Alright, thanks very much.

Yes, you’re welcome.

Next question is from Mike Hickey with Benchmark Company. Please go ahead. Michael Hickey – The Benchmark Company, LLC.: Hey guys. Thanks for taking my questions. Kurt, just curious if you have an impression at this point, sort of the crux of the DOJ's argument because it seems like they kind of have an issue or feel like everyone is sort of harmed by this deal. Do you see any sort of focus point beyond any of the others or…

No, I think they went after all the different parts of the marketplace that we operate in and even threw in theatre patrons, to boot. So, I can't tell you what the strategy there is. I can't speak for the Department of Justice so I really can’t comment on that. Michael Hickey – The Benchmark Company, LLC.: When is it that – I mean I mean obviously I'd imagine that you had a fair amount of evidence going in that this deal was constructive and positive and, obviously they saw it differently. I mean, is it about offering more evidence to support your case? Or is it just getting a different person to hear the same argument?

Look I think it's a review process. You've got to go through all the evidence and, obviously, they see it a different way than we do. I think at this point, Mike, it's probably best that I don't comment any further on the case. Again, we just got the complaint today so we've still got a lot of work to do. Michael Hickey – The Benchmark Company, LLC.: Alright, fair enough. I think you talked about your core business, but just curious sort of your perspective on 2015 and your confidence in growth there. And I don't know if I missed this or not, but if you can give us a look at your sort of bookings to date for 2015, maybe how that compares to prior year?

Well, the only thing we talked about today, Mike, is the upfront and, except for the money that's in Q4 which I talked about, the rest of it is all in 2015. So, we've got a heck of a good head start. We'll be a lot further ahead of making our budget for the year than we've ever been in our history. So, that was part of the whole upfront strategy was to get more money on the books. It gives us a lot more flexibility in the scatter market and we don't have to rely as much on the healthiness of the scatter market. So, I think, it's good news for us all the way around. Mike Hickey – The Benchmark Company: I think the Screenvision had some affiliate contracts coming up for renewal. I'm not sure of the timing of those, but is that sort of any conflict with the review process that you have with the DOJ at this point?

No, I don't think so. Mike Hickey – The Benchmark Company: Okay. Last one. Obviously, there's some enthusiasm for the box office in 2015 and 2016. Do you think that offers any sort of tailwind from a media buyers perspective about wanting to put money in that space or to work in the vertical?

Yes, I don’t think there is any question that it provides a tailwind for our national product. Our local and regional products are a little more sensitive to the film release schedule. So I suspect once we get closer to the actual films being released that that will have some positive impact on our local business. It always seems to be very good. Clearly, one of the issues that is affecting the TV business right now are rating declines. And one of the things that I think has been good for progress and it’s over the last two or three years our ratings have been, the increase in 2012 and 2013 because the film business was very good, 2014 is going to be down a bit, but we’re strong attendance projections for 2015 and 2016 I think that’s clearly good news, because stability of impressions and rating points and all that, I think it’s something that advertisers really value and so, that is something I think that will benefit us next year. Mike Hickey – The Benchmark Company: All right guys, thanks. Best of luck.

Yeah, thank you.

Next question is from Ben Mogil with Stifel, please go ahead. Ben Mogil – Stifel Nicolaus & Co: Hi, guys. Good afternoon. Thanks for taking my questions. So, Kurt, over the last couple calls you've talked a lot about how Screenvision was being very price disruptive in the market and that was obviously impacting you given the guidances you were giving as the quarters went on. So, now you look at 4Q, which I know has a much bigger upfront contribution awaiting than normal, so that sort of insulates a little bit the Screenvision disruption. Are you still seeing them be disruptive state, from the last time that we talked?

I don’t think I’d ever actually characterize their activities has been disruptive, I think there was clearly a need for cinema we get much more creative and flexible around pricing, we have been doing that in various forms for the last couple of years, we have always known in order to attract QSRs and a number of other, big, big client spending category we had to be more flexible and we had to also start providing demo guaranteed, because that was something that advisors valued and it is something TV guys obviously did and if we are going to compete in that market place we had to start doing it, and as I mentioned before unfortunately we can’t do as much of it as we would want. And so, that was one of the clear benefits of the merger, so what we’re seeing I think in Q4 that was clearly from supply demand economic benefits that helped us we also moving into now quarters that have got easier CPM comps and all I can tell you is what I said before, as I think cinema pricing has come down into the top range of broadcast TV sort of event sports and other event programming pricing and that probably appropriate for us and we’re hopeful from that sort of stable base if you will, we will be able to price up from there based on supply and demand and to the extent that we need to go down from there to attract QSRs and other companies that need more pricing flexibility will be able to do it. Ben Mogil – Stifel Nicolaus & Co: Okay, that's great. Thanks, Kurt.

Next question is from Jim Goss of Barrington Research, please go ahead. Jim Goss – Barrington Research: Thanks. First, I was wondering if you could remind me of the initial targeted date of closing versus what might be sort of an earliest opportunity at this stage?

Yes. What we’d hope for Jim is sometime in the middle of the fourth quarter give or take around where we are now, maybe a little bit later. So this is obviously going to push us into 2015 unless something really great happens. But so like I said before, you know, it’s a four to six months process, so we’re clearly into early next year. Jim Goss – Barrington Research: Okay. And if it turned out that there was no deal closing, is there some timeframe over which you feel you can achieve your targets without Screenvision? Because I'm expecting that you think you could, but I bet this would have accelerated the process.

When you say targets, Jim, what are you referring to? Jim Goss – Barrington Research: Well, in terms of getting into other ad categories. For example, are there ad categories that Screenvision might have served that you haven't and things that you might be able to exploit on your own or other financial targets? You talk about the $30 million of synergies you could create. But, aside from that, I would imagine there are goals that you think you could achieve on your own. This would just help things along more.

Look really what the Screenvision deal was all about is the product redefinition. It was actually us creating in many ways a different and more effective product in the new advertising marketplace that we’re all faced with. And that doesn’t mean that our product today is terrible, it obviously isn’t as we’ve talked about in the Q4 and the upfronts for next year. Clearly, versus all the other alternatives we compete against out there, it’s still a very attractive product. The question is how much more improvement could we have made in the product to increase the number of ads that we sell and then increased obviously the payments to our theatre circuits. And as I said in my comments, I think the biggest – the group that’s being hurt the most by the DOJ’s actions here are the theatre circuits themselves because there is lots and lots of upside. And if you look at our relationship with our theatre circuit, it’s a very much a partnership. If we win and we do better, they do better. And that’s the case really since the formation of this business and we really do need each other. There are certain things that it’s harder for them to do, sell national advertising for instance and there are certain things we can’t do at all. And one of the things I thought was interesting is that we’re completely out of business without their attendance and auto revenue is really only represents I don’t know 2% or 3% of their revenues. So I know there is a concern about the sort of balance of power, if you will there, but it’s really a symbiotic relationship that has worked very, very well in this revenue share world that we’ve dealt with. And I really think it’s unfortunate that we’re not going to be able to do as quickly as we otherwise would have likely to create a better product and bring more sales immediately to these theater circuits. Jim Goss – Barrington Research: One last thing. Were some of your ad sales agreements already envisioning the merger and are there adjustments that may be required in anticipation or with pushback…

Jim yes, nothing was contingent per se on the merger itself. There was no way for us to have access to any of the Screenvision inventory. So we could only tell the inventory that we have. Jim Goss – Barrington Research: Okay. I didn’t know if like some of the pricing metrics might have been more favorable because of that anticipation or not.

Look, clearly, as I said in my comments there was some very positive and enthusiastic tailwind created by the talk of the merger. As you may remember I don’t know if you went for our upfront presentation, but it was one of the centerpieces of our upfront presentation. And as I mentioned before, we have gotten many, many very positive letters from advertisers and advertising agencies about the benefits that it will create for them, because it creates a much better and easier product for them to buy and a much better targeted product for them to buy. So I think clearly, they were very enthusiastic about it. But none of the numbers that I talked about were necessarily contingent on the Screenvision merger. And so there was just no way for us to actually do that. Jim Goss – Barrington Research: All right. Thanks, Kurt.

Yes, thank you.

This concludes the time allocated for questions on today’s call. I’ll hand the call back over to Mr. Hall.

Yes. Thank you everyone for joining us on short notice. And I also apologize for the timing of the events today, obviously we couldn’t control when the government send their press release out. It was very unfortunate that it happened in the middle of the trading day. We did delay trading for several hours in order to make sure that we could get some information into the marketplace. So I do apologize with the way this came down, but again, there is nothing that I could really do about it, we did the best we can. And I think moving this call up to tonight at least tomorrow everybody will have all the positive information that we talked about on this call about how our core business is doing. And so, stay tuned. We will continue to keep you all updated on how the process goes with the DLG. And thanks so much for your patience and your support.

This concludes today’s conference call. You may disconnect your lines. Thank you for participating. Have a pleasant day.