National CineMedia, Inc. (NCMI) Q3 2016 Earnings Report, Transcript and Summary

Greetings and welcome to the National CineMedia Third Quarter 2016 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Katie Scherping, Chief Financial Officer of National CineMedia. Thank you, Ms. Scherping. You may begin.

Thanks, Devin. Good afternoon and thank you everyone for joining the call. I would 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 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. These reconciliations can be found at the end of today’s earnings release, which maybe found on the investor page of our website at www.ncm.com. With that, I will turn the call over to Andy England, CEO of National CineMedia.

Thanks, Katie. Good afternoon, everyone. Welcome and thank you for joining us for our third quarter 2016 earnings call. During this call, I will spend a few minutes highlighting the company’s third quarter results in progress against our 2016 business plan. Katie will then provide a more detailed discussion of financial performance for Q3 and provide guidance for Q4 and full year 2016. And then as always we will open the line for questions. I am pleased that we were able to deliver third quarter revenue and adjusted OIBDA results that exceeded both the midpoint of guidance ranges and last year’s Q3 2015 numbers. On the positive side, our national, beverage and digital businesses saw healthy growth this quarter. However, these gains were somewhat offset by disappointing local and regional sales. Our Q3 national revenue increased nearly 4% due primarily to 2% higher CPMs versus Q3 2015 as both upfront and scatter CPMs increased over the prior year. Our impressions sold remained approximately flat quarter-over-quarter on a 9% increase in network attendance, which resulted in lower utilization. Beverage also benefited from a CPM increase in the first quarter in which we lapped the reduced beverage appetizing from one of our founding members. As you know, our national pre-show inventory is sold in three ways through content partnerships, other upfront commitments and the scatter market. While we don’t plan to share numbers around our upfront commitments, I do want to give a sense of how that process has been playing out this season. The 2016-2017 upfront market has been unusual and that the large broadcast companies have reportedly seen low double-digit CPM increases despite TV ratings weaknesses leading into the negotiating period. It’s widely speculated that this is as a result of tight inventory driving very high scatter prices in the first half of the year leading advertisers to determine that committing greater dollars to the upfront was a more prudent strategy. This, in turn, was taking substantial dollars out of the overall marketplace. However, NCM is benefiting from higher audiences and more sellable impressions resulting from increased 2016 attendance and a strongly perceived 2017 movie slate. I am pleased with the content and upfront commitments we have secured to-date and I am confident that we will enter 2017 in a good position to grow the business. I am also pleased that we continue to expand and diversify our national client base during the third quarter, adding four new national clients in three different categories bringing our total of new national clients to 25 so far in 2016. The three categories added during the third quarter included videogames, prepared foods and personal care products. These new additions to our client roster and changes in our category mix mean greater diversification of our national client base, which is good for the long-term health of our business. Our local and regional advertising business was not as robust as we had hoped driven by the absence of two large contracts greater than $1 million that we had in Q3 2015 where the customers’ programs did not recur this year. Nonetheless, we continue to see new local and regional clients coming on board here as well as we are beginning to benefit from competing the national spot budgets by the recent inclusion of NCM into the STRATA planning and buying system. This has resulted in 7 new clients with $0.5 million of revenue in third quarter bringing it to a total of 11 customers and $1.5 million of revenue through the first nine months of 2016 and positive momentum heading into Q4 and the 2017 national spot planning cycle. As the part of our strategy to grow our overall client base, we are continuing to creatively seek out new ways to acquaint brands with our media. As discussed on prior calls, National CineMedia is now the official United States representative of the Cannes Lions Festivals, which provides us with a unique opportunity to build relationships with the creative community and potential clients. We have used this role to take highlights of the 2016 Cannes International Festival of Creativity on the road with presentations to groups of advertising creatives in movie theaters in key national and local regional markets across the country. The intent is, of course, to introduce creatives to NCM as the official U.S. representative of Cannes, but also to inspire them with the very best advertising shown in the very best place on the big screen. I was there for our inaugural Cannes event in Chicago and I can tell you that the experience is powerful. Also during the third quarter, we expanded our client spend in our digital business, consistent with the growth of the overall online and mobile advertising marketplace we experienced strong Q3 online and mobile revenue growth of 83% versus Q3 of 2015. While it still remains a small part of our total advertising revenue as strategy of packaging our in-theater inventory with our online and mobile inventory through our cinema accelerator product continues to be important as it gives marketers a unique way to create a more cohesive cinema and digital marketing plan. Our NCM theater networks’ ongoing expansion and improvement continued to enhance that competitive positioning as the remaining Texas-based Santikos theaters affiliate screens joined our network during the second quarter of 2016. At the end of Q3, we had nearly 20,500 network screens, an increase of 2% versus Q3 of 2015 and coverage in 187 of the 210 TV DMAs. All of our network screens utilize digital projectors and our first look pre-show is delivered to approximately 98% of our network attendance over our digital distribution network. It’s also important to remember that when our founding members acquired U.S. theater circuits, the acquired theaters immediately become part of the higher margin founding member fee structure and related long-term contracts unless the acquired theater circuit is under contract with another advertising provider. As such, there are 223 additional screens with approximately 8 million annual attendees acquired by our founding members in 2013 that will join our network in November 2018 once their contract with another advertising provider expires. Until then, the founding members will continue to make integration payments to NCM LLC for these screens. If the proposed merger between AMC and Carmike Cinemas closes and the contract between Carmike and an alternative cinema advertising provider remains in effect, AMC could elect to receive NCM LLC membership units and make integration payments to us. We believe the effect on the NCM Inc.’s cash position would be relatively neutral in the near-term as the integration payments would increase available cash distributions from NCM LLC and approximately offset the impact of lower NCM Inc. ownership in NCM LLC. Further, we believe it would have the effect of reducing NCM Inc.’s net income and earnings per share without consideration of any tax expense implications due to the higher income attributable to non-controlling interests. As this merger is subject to customary closing conditions including regulatory approval and approval by Carmike shareholders, there is no certainty that the merger will close or what the ultimate outcome and impact on the NCM LLC or NCM Inc. will be. And last but certainly not least, as you know, we began increasing capital investment spending in 2015 to accelerate the timeline to complete the upgrade of our sales proposal and inventory management systems as well as the development of new audience targeting systems and data management platforms. The integration of these improved systems with our digital distribution network will allow for the further shortening of campaign lead times and provide more targeted and efficient campaigns with detailed reporting to clients. We are especially excited about the rollout of our new data management platform to our national advertisers, which will allow us to provide marketers with the expanded audience targeting and data analytics capabilities that are a necessity in today’s competitive video advertising marketplace. Before I turn the call over to Katie, I want to thank our National CineMedia employees along with our stockholders for their continued support. While our advertising business continues to be more volatile than I would like a month-to-month basis, I continue to believe that given the ongoing fragmentation in the overall video advertising marketplace and building skepticism about the efficacy of many online and mobile platforms, NCM is in a unique position. I believe that our combination of broad national reach reliable and high impact viewable impressions and engaged millennial audience and high quality event programming positions us very well for the future. Now, I will turn the call over to Katie to give you some more details concerning our Q3 operating performance and more specific color that supports our Q4 and full year 2016 guidance.

Thanks Andy. For the third quarter, our total revenue increased 1.6% versus Q3 2015 driven by a 3.8% increase in national advertising revenue and a 17.2% or $1.1 million increase in beverage revenue, partially offset by 8.8% decrease in local and regional advertising revenue. Total Q3 adjusted OIBDA increased 2.2% and adjusted OIBDA margin increased to 53.7% from 53.4% versus Q3 2015. For the first nine months of 2016, total revenue decreased 1.6%, adjusted OIBDA decreased was 6.7% and adjusted OIBDA margins decreased to 47.3% from 49.9% versus the first nine months of 2015. The Q3 increase in adjusted OIBDA was primarily driven by the increase in high margin national advertising revenue. The year-to-date decline in adjusted OIBDA was primarily driven by the lower national advertising and beverage revenue and increases in selling and marketing expense versus 2015 year-to-date. We recorded $700,000 of AMC Rave and Cinemark Rave integration payments for the third quarter of 2016 and the third quarter 2015. You should note that these integration payments are added to adjusted OIBDA for debt compliance and partnership cash distribution purposes, but are not included in reported revenue and adjusted OIBDA as they are recorded as a reduction to net intangible assets on the balance sheet. We now expect to record approximately $2.4 million of these integration payments from our founding members in 2016. Our Q3 2016 advertising revenue mix shifted slightly towards national and beverage and was 72% national, 20% local and regional and 7% beverage versus Q3 2015 that was 71%, 23%, and 6% respectively. Q3 national ad revenue increased 3.8% versus Q3 2015 and was driven by a 2.1% increase in CPMs versus Q3 2015 and an increase in online and other revenue partially offset by a 0.2% decrease in impressions sold. Q3 CPMs benefited from higher upfront pricing and scatter market pricing versus Q3 2015. The decrease in impressions sold was driven by a decrease in inventory utilization to 132.5% from 145.8% in Q3 2015 on a 9.4% increase in network attendance. Q3 impressions sold were impacted by lower must spend content partner allocations to the third quarter and client churn versus Q3 2015. For the first nine months of 2016, national advertising revenue decreased 1.2%, driven primarily by a decrease in utilization to 112.9% from 127% on network attendance that increased 1.3%, partially offset by a 5.4% increase in CPMs versus the first nine months of 2015. And lastly, our quarter-to-date make good balance was $2.4 million. Q3 local and regional ad revenue decreased 8.8% versus third quarter in 2015 and was driven by a decrease in revenue from contracts greater than $100,000, whereby contract volume decreased 27.3% and average contract value decreased 18.6%, largely due to the absence of two large contracts greater than $1 million where the customers’ programs did not recur in 2016. For the first nine months of 2016, local and regional ad revenue decreased 1.6%, also due to fewer contracts greater than $100,000. The new members of our sales team that were added late in 2015 are beginning to ramp up, which is reflected in the increase in the number of under $100,000 contracts, which are up 7% during the first nine months of 2016 from the same period last year, yet the higher value contracts have been inconsistent and spread unevenly throughout the year. Q3 beverage revenue increased 17.2% or $1.1 million versus Q3 2015 from a 9.8% increase in founding member attendance versus Q3 2015 and by the 5.7% increase in beverage CPMs for 2016. For the first nine months of 2016, beverage revenue declined 5.2% or $1.2 million versus the first nine months of 2015 and was driven by a decrease of $3 million related to the 32nd reduction in time by one of our founding members that began July 1, 2015, partially offset by the 5.7% increase in beverage CPMs for 2016 and a 2.2% increase in founding member attendance versus the first nine months of 2015. Looking briefly at diluted earnings per share, for the third quarter we reported a GAAP diluted EPS of $0.13, consistent with the $0.13 in Q3 2015. For the first nine months of 2016, we reported GAAP diluted EPS of $0.18 per share versus $0.15 for the first nine months of 2015. Excluding a loss on the early retirement of debt related to the redemption of some of our senior notes, terminated merger costs and certain other non-recurring items noted in our earnings release, diluted EPS for the first nine months of 2016 would have been $0.20 versus EPS of $0.32 for the first nine months of 2015. Our capital expenditures were $2.4 million for the third quarter compared to $3.3 million for Q3 2015. As Andy mentioned, we continued to accelerate the development of our inventory management system and audience targeting platforms to more efficiently compete in the video advertising marketplace. And we continue to estimate that our full year 2016 capital expenditures will be approximately $14 million or about 3% of our total revenue guidance for the full year. Now moving onto our balance sheet, our total debt outstanding at NCM LLC at the end of Q3 2016 was $923 million versus $936 million at the end of Q3 2015. During the third quarter of 2016, we issued $250 million of 10-year senior notes at an interest rate of 5.75% and redeemed our $200 million notes that were due in 2021 upon [ph] an interest rate of 7.875%. The net proceeds of $37 million after the payment of fees and a redemption premium were used to pay down our revolver balance. As we have discussed in prior calls, the negative available cash balance generated in Q1 2015 as a result of the payment of merger related costs was recaptured by reducing the Q2 2016 cash distributions by this amount. The reduced cash distributions were paid in August and in turn allowed NCM LLC to further decrease the revolver balance. Our average interest rate on all debt was approximately 5.1% at the end of Q3 including our $270 million floating rate term loan bank debt and revolver credit facility that had an average rate of approximately 3.8% and 70% of our total debt outstanding at the end of Q3 2016 had a fixed interest rate. Our interest expense increased $1.3 million during Q3 2016, because we paid interest on both our $200 million note and the $250 million note for one month between the issuance of the $250 million notes in mid-August and the redemption of the $200 million in notes in mid-September. Our consolidated cash and investment balances at the end of Q3 2016 were $54 million, a decrease of $27 million from the end of Q3 2015 with $53 million of this balance at NCM Inc. and $1 million at NCM LLC. Our total NCM LLC liquidity, including our NMC LLC cash balance and availability on NMC LLC’s revolver was $173 million at the end of Q3 2016. We announced today that the Board of Directors has authorized the company’s regular quarterly cash dividend of $0.22 per share of common stock. The dividend will be paid on December 2, 2016 to stockholders of record on November 18, 2016. We intend to pay our regular quarterly dividend for the foreseeable future at the discretion of the Board of Directors consistent with our intention to distribute over time a substantial portion of our free cash flow. The declaration, payment, timing and amount of any future dividends payable will be at the sole discretion of the Board of Directors who will take into account general economic and advertising market business conditions, the company’s financial condition, available cash, current and anticipated cash needs and any other factors that the Board of Directors considers relevant. Our annual dividend yield is currently 6.3% based on today’s closing share price of $13.95. Our net senior secured leverage at NCM LLC as of the end of Q3 2016 was approximately 3.1 times trailing four quarter adjusted OIBDA, which is well below our senior secured leverage maintenance covenant of 6.5 times. You should also note that while we have no NCM LLC total leverage covenant, our total leverage at NCM LLC, net of NCM LLC cash balance, was approximately 4.3 times at the end of Q3 2016 versus 4.4 times at the end of Q2 2016 and 4.1 times at the end of Q3 2015. Before I discuss our Q4 and full year 2016 guidance, I want to let you know that we will be reviewing our current guidance policy and we will update you regarding any changes to our policy during our February earnings call. Now moving onto fourth quarter and full year 2016 guidance, for the fourth quarter, we expect total revenue to be in the range of $135 million to $145 million and adjusted OIBDA to be in the range of $76 million to $86 million. This implies a total revenue change of down 1.1% to up 6% and adjusted OIBDA increase of 1% to 14% versus Q4 2015. These Q4 guidance ranges at the midpoint imply a national advertising revenue increase of 2%, local and regional advertising revenue increase of approximately 3% and an approximate 6% in beverage revenue versus Q4 2015. For the full year 2016, as we previously guided, we continue to expect total revenue to be in the range of $440 million to $450 million or a decrease of 1% to an increase of 1% versus 2015 and adjusted OIBDA to be in the range of $220 million to $230 million or a decrease of 4% to approximately flat versus a record 2015 for both advertising revenue and adjusted OIBDA. That concludes our prepared remarks. Now, we will open up the line for questions.

Thank you. [Operator Instructions] Our first question comes from the line of Alexia Quadrani with JPMorgan. Please proceed with your question.

Hi, thank you. This is Julia Yue on for Alexia. If your box office for two quarters this year outperform expectations, can you talk about how much of this is a benefit to your business both in the quarter itself in terms of being able to sell extra inventory and maybe longer term such as the changes to advertiser demand in the next couple of quarters or perceptions for the overall health of the industry?

Yes, thank you, Julie. That’s a good question. The way I’d characterize it is I think it’s difficult for us to react particularly when it comes to national. It’s difficult to react to a specific success. So put another way, if there is expectation that a movie is going to do very well and then the movie does very well that’s very helpful to us. If people don’t know whether a movie is going to do well and it actually does well, that’s significantly less useful to us, because it’s harder to sell into. So to your point, the fact that Q3 box office was so strong was not as helpful as we would like it to be. On the other hand, we think that the fact that the 2016 box office has been stronger in general than perhaps the pundits expected and the fact that people are feeling good about the 2017 film slate, I think is generally helpful to us. The one caveat I will put on that is I think it is a little easier for our local team to react to a movie doing very well. They seem to, in general, not demonstrate it in this third quarter, but they do seem to be able to react more swiftly. But it’s a good question.

Thanks. And then just on the point that you made about linear TV CPMs continuing to increase and ratings declining, have you seen the effect of this more recently, I guess, in your conversations with advertisers on their interest in cinema or maybe a benefit to your CPMs?

I think it’s a benefit to the overall conversation. And I think the way I think about it is that advertisers – there is a lot of advertisers who are deep believers in TV broadly in terms of its overall impact. And importantly, I think advertisers have a history of being able to quantify whether or not they received an ROI from advertising on television. So, their systems are setup to reevaluate that. So, there is a lot of stickiness, if you like, in TV. With that said, obviously there is huge number of dollars moving straight to digital and that’s something that is an ongoing, as you are well aware, reality of the broader media marketplace. I will say that, that broader industry situation enables conversations. It’s certainly a good time for us to be having conversations about frankly the stability and appeal of our network, particularly as it relates to millennials where we are so strong.

Got it. Thank you so much.

Thank you.

Thank you. Our next question comes from the line of Barton Crockett with FBR Capital Markets. Please proceed with your questions.

Hey, great. Thanks for taking the question. I was curious about your characterization of the upfront, which was the level kind of inscrutable and I think deliberately so, because you don’t want to talk too much about what you are seeing. But I just wanted to make sure I understood one of the point that I think you were trying to make. You talked about how the broadcast kind of upfront has taken some money out of the market. So to be clear, are you saying that the success of the broadcast networks in the upfront is a headwind for your business in 2017? And when you say you expect to be positioned for success, are you saying you expect to be able to do things that overcome that headwind? Is that the point you are trying to convey?

We are not necessarily saying it was a headwind. It’s more of an observation of, I think the unusual circumstances in which we operate today. I think we, like all of you, are really observers of what happens with the larger broadcast TV companies and look to understand why that’s happening and its implications for us. I think, for whatever reason, advertisers have chosen. We speculated, but for whatever reason, advertisers have chosen to commit more dollars to the upfront at higher CPMs and with expectations of lower ratings, which on the face of it seems irrational and I think the apparent reason is because of concern about scatter prices that really sort of did get out of control. So obviously, we worry that dollars get too locked up. I think the reality is that we continue to have a good opportunity to compete in the marketplace. We just don’t tend to be the first at the trough, if you like.

Okay. But just to follow-up a little bit more on your upfront, I mean, I understand you don’t want to go into the specifics, but in general terms, can you say whether your upfront process and what’s emerged from that is something that is going to be helpful in your ambition to grow in 2017 or is it something that you would need to overcome in order to grow in 2017?

So, let me say this, Barton. I think these are fair questions, but let me characterize it this way. I believe National CineMedia has operated in the upfront marketplace since 2012. I think it’s a good strategy for us. It’s a good strategy for us, because firstly, it positions us in the broader premium television marketplace or premium video marketplace. So, it establishes that those are the broader bucket of dollars that we are going after. And to our earlier discussion with ratings where they are that leads to I think good discussion. So, I think it helps position us as a business for one. The second thing it does is essentially give us more predictability of our business or at least in theory. It gives us a predictability of the large chunk of that business, let me put it that way. And so I think it is a very healthy process and a way of going about business for us. And it’s one that I am supportive of. As I look at the upfront that we have just gone through, I think I am going to – as we talked about in the past, I am going to resist giving you a percentage just because frankly, I don’t think it’s constructive or helpful. I will just say that I think our upfront is encouraging.

Okay, that’s helpful. Thank you.

Thank you, Barton.

Thank you. Our next question comes from the line of James Dix with Wedbush Securities. Please proceed with your question.

Thanks very much. Just one more follow-up if you can take it on the upfront, did it complete roughly the same time as last year or was there a material lengthening of the process? And then I had two others.

Thanks for the question, James. That is a difficult one for me to answer and I don’t think Katie is going to be helpful to me either for the obvious reason that neither of us were here last year. So I don’t know. My sense of it is from discussions we have had with our sales team that the upfront process has happened on a similar timeline to what happened last year, so there was an understanding that we don’t tend to be as I said, first to the trough when it comes to the upfront. We tend to spread significantly and our conversations spread significantly into the fall. And I think that’s good and appropriate, but nonetheless we are pretty much at the end of that process, I have a pretty good sense of it.

Great. And then second, you mentioned a little bit about the volatility of the business being maybe a little bit higher than you would like, I mean is it changing at all this year, anything in particular which you think is contributing to that volatility, I mean has there been times talking to the sales team when the business has been less volatile, when anything that’s changed make it more so and then anything which you were – any initiatives you are taking to reduce that volatility. And then my final one is just in terms of audience measurements, any changes that you are planning in terms of measurement of your audience, it’s obviously a hot button topic in the TV video market generally, but just wondering if there is anything there that you are anticipating and perhaps in connection with the move to theaters to doing a little bit more pre-assigned seating over time? Thanks.

Thank you. When it comes to volatility, volatility is obviously a double edged sword. When advertisers don’t return, that’s bad volatility. When advertisers appear out of nowhere and want to spend large amounts of money, that’s good volatility. And so volatility is not necessarily a bad thing. It’s just obviously would always – I think everyone would prefer a more predictable business. And I know people would, if you look at what’s happening tomorrow in our country, obviously people prefer to understand what’s happening in the future. But nonetheless, volatility I think is just a part of our business. And I think there is relatively little that we can do to change that other than get more advertisers onboard. I think more advertisers is a healthy thing, because you are – advertisers essentially hedge each other. But at the end of the day, when advertisers decide to advertise, it’s very much up to them and it’s up to the quirks and peccadilloes of their business, not of ours. And we have to be sensitive to that, so when people have something important happening and they want to communicate it to our audience and come to us to spend money, obviously we welcome them with open arms. And that’s at the core of the volatility of our business, I think. When it comes to audience measurement, I think there is a couple things I would say. I think one of which was perhaps, what you intended and then the other perhaps isn’t. When it comes to audience measurement, we constantly seek to better understand our audience. I mean this is where data comes in. The extent that we can better understand who our audience are, that essentially fuels our DMP. It enables CATO, which enables people for much better target against our audience. So when it comes to data that helps us measure exactly who our audience are, that’s extremely valuable and something we are very focused on. When it comes to what I think was more your intention, the impact of reserve seating, what Nielsen would tell us and obviously Nielsen is the third-party provider who we rely on for such information. Nielsen would tell us that the reserve seating is not having an impact when you look at what Nielsen shows us to be the audience build over the last 3 years, it’s remained stable, so that’s where we are.

Great. Thanks very much.

Thank you, James.

Thank you. [Operator Instructions] There appear to be no further questions at this time. I would like to turn the floor back over to management for closing comments.

Thank you, Devin. So again, I think we were pleased with the quarter. We are pleased to be able to reiterate the guidance we provided earlier and we are busy making sure that we prepare for 2017 and the years beyond. So thank you for taking the time to listen in and have good evening.

This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.