National CineMedia, Inc. (NCMI) Earnings Call Transcript & Summary

We're going to go ahead and get started. We're very fortunate to have Tom Lesinski, CEO of National CineMedia, here today. Of course, if any of you do have questions in between bites of lunch, feel free to ask them. And Tom, thank you for joining us.

Yes. It's nice to be here. Good morning.

Yes. Good morning. So maybe we could start, if you could just give us maybe an overview of what is National CineMedia.

So it's -- given the size of the group, you guys can interrupt me and talk to me and this is a perfect little time to keep it even this intimate as you want. So I don't know how much you know about our company, but we're the largest cinema advertising company in the world, 20 years running. We've got enviable relationships with the 3 biggest exhibitors: Cinemark, Regal and AMC. We've got, in the top 10 markets, 70% market share. Our OIBDA margins are at 45%. And we have a strong tax-deferred dividend of 9%. So the economic fundamentals of the company are really strong. For the past 10 years, we've delivered approximately $200 million a year in cash flow. And when I took over as CEO, my goal was to start growing the company again. We've been a really healthy investment for people looking for a dividend stock. And most of the original companies that were involved in the IPO have stayed with the company. And our goal now over the next several years is to get the company's top line growing again, so we can become attractive to another investor base.

So I read in some of your commentary that phrase -- what was the phrase, tax-deferred dividend? I didn't even know what that meant. So can you...

Well the regular structure of the company when it was done, and Citibank was part of this whole structure, was to create a structure that allowed the dividend to be deferred, and for the next several years is a tax-deferred dividend. It has been since we started. So we have enough net operating losses in the structure of the company. And it gets a little complicated without actually showing you the whole chart.

Oh, this is like with the LLC and all. Got it...

Yes.

Okay. But does that just mean that you're paying out dividends on pretax income? Is that what that means while you have the NOLs?

No. Sorry.

So when you're not a taxpaying entity and you're paying a dividend, it's deemed to be a return of capital to your investors. So what it does is reduces the tax basis for which someone invests in the shares of the company. So that's why it's tax deferred because it whittles down your basis in those shares for each time you receive a dividend and then to the extent those shares are sold above your original purchase price that's a tax -- above your tax basis. That's the tax-deferred dividend.

So it just lowers my cost basis in the stock, but I don't pay taxes on the dividend income that I receive.

Right.

Right. You don't pay tax on the...

Well, that seems hugely advantageous in this sort of reach for yield environment.

It was a really clever structure and it's been really attractive. And that's why the vast majority of the investors who were in the IPO have stayed in it.

Okay. All right. Thank you for clarifying that point. So you said, as the new CEO, your goal is to return it to top line growth. You've only been the CEO since August of last year, right?

Yes. it's a little over 5 months now. I was the Chairman for a year prior to that and I was on the Board for, I guess, a total of around 5 years now. So I've been really involved in the company. I know the company really well. We've got a really good relationship with all the Board. So it kind of gives us an opportunity to take the company to its next sort of natural growth cycle. And there's a variety of things that we're doing. The most important thing we did just in the fourth quarter was we changed the inventory. So if you think about the way our business works is we typically run advertising right before the movie start time. So if the movie starts at 08:05, we were running approximately 20 minutes of advertising before that. We chose to take 6 minutes of that advertising and run it post-advertising start -- advertise start time. So if the movie is at 08:05, we actually are starting our advertising at 08:05, not before. And 1 minute of that 6 minutes is actually starting right before the second to last trailer. So we've created 6 minutes of super valuable inventory and we had a lot of success selling that inventory in the fourth quarter. It was the first change in the inventory model in the company's history. So going from the vernacular of post showtime from pre showtime was a major change for us. And obviously, there's more people in the theater. The lights are down. We actually are calling our inventory lights down inventory because your lights are down, your phones are off, you're paying more attention to the advertising. And so far, we've attracted some really big advertisers, including one advertiser that had never ever advertised in cinema before in the fourth quarter. And these are going out at very premium prices. They're at 50% premium to what we're getting for our current inventory today. So almost regardless of what happens from a box-office point of view, we think we'll be able to grow the company in 2020 just because we're getting higher CPMs on our platinum inventory and on our post-show inventory.

So that 50% higher CPM is for that one slot that begins just before the last trailer.

Yes. So we have 2 different pieces. There's 5 minutes that are called lights down, and that's about a 5% increase versus the prior inventory. And then the post-show platinum spot is a 50% increase. By the way, that cost of that spot is right up there on a national basis what it costs to run a Super Bowl spot. So in terms of having a premium ad unit in the world today with the big screen, it's a really significant opportunity for advertisers to own a really premium piece of advertising.

So presumably, the trailers, right, that run in that window, they don't want to reduce the number of trailers, right, if you're an exhibitor or a movie studio. So it's just sort of adding to the...

It really isn't. And candidly, every exhibitor has a different policy based on the number of trailers they run. And it's not uniform at all. Some run as few as 3. Some run as many as 7. Some are paid for. Some aren't paid for. We're not increasing the total amount of advertising time in the process. We're just moving it up a little bit earlier.

Okay. That's super helpful. All right. So that -- and I'm assuming of -- if the goal is to return the company to top line growth, is this like the most important pillar of that?

Well, there's other things that we're doing as well. We've been building a digital media business out for the last 4 years. And we're finally getting enough scale in that business where we're building a dataset, and we're building direct consumer relationships that are becoming material. It's really critical for us to be able to tell our advertisers, someone saw the ad in a theater and we know from their phone or for some other digital media dataset that we have that we can tell them what they did after the fact. So the home run in any business is someone saw a beautiful ad in a theater and we know from their phone and the location-based data that we have that they went to, let's say, a car dealership afterwards and we know that they drove a car and they ultimately bought a car. That equation for an advertiser is what big sophisticated brands want today. So we're doing that on the digital media side. We've got half a dozen products, but we're also building a dataset out. We have around 100 million datasets today. We'll have 200 million by the end of the year. And we believe if we can have, I'm saying, roughly 20%, 30% of the moviegoing audience's data marry to a big screen ad that that's going to be a really compelling proposition for advertisers.

So when you say dataset, is that just data on a user?

Yes. It's a little bit of a complicated thing, but I'll try to explain it. Basically, when you go out and gather data, you can gather it through your own proprietary means. You can buy it, which is first-party data or you can also buy second-party data, so we can work with an exhibitor, let's say, and we can use their data. And then when you aggregate all that data, your -- some of it's duplicate and some of it isn't. But you might find out that Jason is this age, has this e-mail address, has this cellphone and has these buying habits. Those are all datasets individually. And some of them are duplicated depending on how you aggregate it. But our goal is -- in the long run is to get to 50% of the moviegoing audience's data, I think we'll be, hopefully, around 20% by the end of next year or the end of this year, 2020 now, but we think the combination of that big screen ad plus the digital authentication in micro targeting and targeting back is really what all the brands want today.

So let's say that this -- that the datasets grow and you're able to sort of close the loop for your advertisers and sort of actually tell them what happened, is that something that is almost a discrete business that sort of generates its own revenues or it manifests itself just with better CPMs.

So it's both. So it's going to allow us to increase our CPMs theoretically. It's also going to allow us to grow a separate digital business. Initially, it's really, really married to our core business. So if we're selling a big screen ad, we'll package digital with it and the data along with it, which is what an advertiser wants. We have certain advertisers who say that if we don't have that capability, they're saying, look, we're going to be less interested in you. And it's mostly because Facebook and Google have been so good about convincing people that unless you can get attribution and you can retarget, you shouldn't buy that ad. And they're the old media companies, which we fell into that category, have been slow and not as good at doing it. The big benefit we have is because our average audience is 30 years old. We're the same audience that Facebook and Google are grabbing, unlike network TV and cable where the average demo is in the mid-50s. We're aggregating a really good database for young people, which are super valuable to advertisers. Candidly, it's those 2 things. But the other thing we're doing is we're also looking at our affiliate business. So an affiliate for us is another exhibitor that's not part of our group. We have 50 exhibitors today that are part of the NCM network. And we're going to look to add more of them. We think we can possibly grow that maybe 5% to 10% just by adding more theaters into our circuit.

Now was that someone that is using a competitor of yours in that particular circuit -- or they're just not doing sort of advertiser...

It's most likely a competitor. So there's a little bit of trading that goes on. These are very long-term agreements. A typical exhibitor agreement can be 20 years long, and they come up from time to time. We think we have a best-in-class cinema operation, so we're fairly confident that we'll be able to grow the size of our footprint and we have been doing that for a long time, but there's opportunities that come up over the course of the next year or 2 that could be meaningful to us. So even in the context of a possible admissions change overall in the industry, we think between the growth in pricing and the addition of additional admissions will keep us removed from a little bit of the secular commentary that's come out of exhibition.

Right. So are there -- maybe you can just remind us who are the original exhibitors that were part of the...

Well, there's 3 -- there were 3 founding members they're called, and they were the 3 biggest circuits. It's AMC, Regal and Cinemark. And they represent probably 65% or so, maybe 70% of the theatergoing audience. We have around 750 million admissions a year, 21,000 screens, so we are this giant national footprint. It's pretty much -- it's about as big as you can get, and we can still fill-in little parts of the country, but what we can add is more eyeballs in markets that we're already in. And we sell on a CPM basis. So for every admission and every viewer we have, it gets counted. So there's reasonable benefit to adding more people.

Are your rivals or your main rival sort of also shifting their inventory to the -- what was the term used, lights out?

Well, lights down.

Lights down, sorry.

Lights down...

You're a better marketer than I.

Thank you. Lights down. So there's -- Screenvision has done some of that in the past. It's slightly different than what we're doing. Candidly, it's been going on in Europe, Canada and Latin America for the last, in some cases, 10 years. So if you go to the cinema in the U.K., for instance, you'll see advertising that runs all through the trailers. And it's the same way in Latin America, and it's very prevalent in Canada. So it's -- ironically, the U.S. was actually behind in being an innovative sort of media outlet in terms of cinema advertising and innovating. And normally, the innovations have happened in the U.S. and then they spread. In this case, it's something that we saw happening around the world. And it's proved to be accepted to consumers. So it's -- we haven't had a lot of pushback, candidly, about people complaining about the advertising so far.

If you're able to expand your affiliate network, are those sort of the very small sort of exhibitors, where most of us wouldn't know the names like...

No. You would know these -- I don't want to get into it too specifically because it's a competitive thing. But no, there are significant ones available and small ones. There's a lot of affiliates out there. We have 50 today. There's probably north of 100 other ones we could get, but there's also several really big ones that potentially could become part of our network that we're excited about.

So there's just -- if you're an exhibitor, there's like a long tail of brand names that goes beyond...

Well, there's a lot of one-offs even. There's some exhibitors [ that are delivery ] one theater. They're somewhere 4, 5, and it goes up from there.

And is the industry almost all digitized now? Or if you sort of expand your affiliate network, it's [indiscernible] capital deployment...

Now having said that, there are some old theaters that we need to sort of create a workaround, but it's become more and more digital. And we look at that, obviously, if we're going to add somebody, whether there's additional cost to bringing them on because their theater is just not up to speed, but will help with all that transition. And we've been doing that for, I guess, 20 years now.

Okay. So what about the -- let's say, that I'm a marketer and I'm -- I've been reluctant to sort of buy cinema advertising in the past. Other than the topic you raised about closing the loop and sort of confirming that we help facilitate some change in consumers' behavior, what are the other impediments that you hear from advertisers that prevents them from using this as an ad...

Well, I think we've advertised with almost -- had almost every big brand on our screen, but the one thing I'll say is because Facebook and Google today can get an ad on their network within an hour, their systematic network is so good that it allows a brand to make last-minute decisions. And if money becomes discretionarily available, they can actually run an ad within an hour if you're taking the order. In the cinema business, it can take 3 to 7 days to get an ad put into a network. So we took on an initiative almost 2 years ago to really change out the way we do our planning, our software. And sometimes within the next 12 to 15 months, we'll be able to get adds on within a day. So it will be a...

How long? 12 to 15 months, you said?

It's -- we're working on it a little bit right now. The implementation could happen as early as the end of this year, probably beginning of next year. But at that point, we'll be able to literally serve an ad within a day of getting an order. So we'll take a lot of that friction out of that process?

And what are the -- what are your -- the advertisers, what are they doing? Is it sort of taking a traditional television spot and just running it through your platform? Are they tailoring the content to...

So in many cases, they are creating separate cinema advertising.

Really?

Yes. And in fact, one of the big brands that had never advertised with us before in the fourth quarter, we created a separate ad just for it. And it was impressive because I think the dream of any marketer is to get their message across in a really big screen in a big compelling way. So there's a lot of effort made to doing something special. And our goal is to -- we probably are never going to be like the Super Bowl where every ad is customized and premium, but we do believe, as we've created all this new inventory, that's really close to the movie that people are going to make better and more interesting creative that's designed for the moviegoing experience. And we think that would be really effective and would certainly translate into a good experience for the consumer as well.

Interesting. So what -- let's say, I think most people are sort of cautious, I would say, on the 2020 outlook for the box office. You and I were talking before the mics went live that we're sort of in the camp that there's probably not a secular issue going on with box office attendance.

It's funny because I've been -- I was in the studio business for 20 years, and we forecasted our own slate when I was at Warner Bros. and Paramount, and we were always off and that was just trying to do one studio slate. And it's a very tricky business to forecast. No one forecasted 2 years ago that the business would grow 6%. I think it's very hard to look at a picture and look at the cast and the storyline and say it's going to do x.

It's true.

It's a little easier to do on sequels and some of the big tent poles, and even though as people were off with a little bit on Star Wars this year. So we think it might be flat to down a little bit year-on-year, but we look at our advertising business with the higher CPMs and the growth ideas we have as to being a little bit impervious that we think we can get the company into some low single-digit to mid-single-digit growth just based on all the initiatives we have regardless of what happens from an admissions point of view.

And what would you highlight as the main swing factors that might put that at risk? Is it sort of macro environment? Is it sort of the propensity of this premium CPM to stick? Is it...

Yes. I think it's all about executing a new advertising platform to an industry. So remember, we've been in the same business for 20 years. And I think as you go out to the thousands of brands and you tell them we have whole new ad unit and we have this whole new thing, it takes a little while to get established. I always tell people that when the first Super Bowl ran, there were hardly any hesitant at all and it took a long time for it to get to where it is today. And I think it is a new medium and the way we've positioned it as such, and it's also expensive. So people are getting to have to think about budgeting that. And these things take typically a year or so to get out into the marketplace. And we had a big push in Q4, and we had some success right away. And I think it's probably within this year it will start growing, but we were happy that we had 3 big advertisers just in December.

That's great. And what about your -- how's your sales force aligned? Is it sort of a salesperson sort of targets a particular advertiser? Or is this demographic or...

So we've had a really great national, regional and local sales team for a long time, almost over 100 people. And they all are pushing to sell the platinum unit and lights down and the preshow. So they all sell everything. And they work through agencies as well as directly with CMOs. It's important that you have the CMO equation in it because this is often an expensive special piece of creative that has to get communicated into a company's environment, but we have every salesperson selling pretty much all of it. And that's how we're structured. We have offices in New York, Chicago, L.A., Denver that cover ad sales. And then we have local people all over the country.

And when I was looking at your financial results, they look pretty consistent. But if you sort of get in the weeds, is there something that investors need to worry about in terms of if we have a year where there's more R-rated movies, for example, does that impact your business? Or if there's more G-rated movies, does that...

I can say that what people generally want is PG-13 and PG is the core because you're trying to reach millennials and Gen Z. So those people are the ones that you go to the cinema for. So we never wanted too weighted to G or to R. There aren't that many R-rated movies anyway. But typically, the way the movie slates are programmed, it's mostly PG-13 and PG. And then there's occasionally a lot more G just because they're more animated movies that come out, but we sell, obviously, to that group as well demographically. A lot of our packaged goods clients want to be in family-friendly movies. But the core demand is for millennials and Gen Z, which really are PG-13 and PG.

Is it important enough for investors to care about? Is that looking at the slate coming out or you're just...

I don't think so. We're really selling the movie experience and the overall CPM and the delivery. It's nice sometimes when you have a big Star Wars movie to get an advertiser excited. You say, hey, don't you want to run in front of that. I think that helps. But we're selling really a demographic and a CPM, and I think that's what people are interested in.

So there's been some news lately -- late last year about some of the bigger Internet companies getting out of political advertising. So a lot of investors sort of say, "Wow, this is going to be great for the local TV stations, right, where there's just no place to place political dollars, maybe TV stations and radio. Is there -- does that have any implication for your firm or...

So we made a decision a while ago not to take political advertising in movie theaters. And I think it would be really disruptive in a theater, but the benefit to us is that in big markets, particularly the 8 swing states, there is no local advertising available. So if you're a traditional brand and you want to advertise and making it up Ohio, you can't really get local advertising during the political swing time. So it opens up an opportunity for us to take inventory because that's the only place you can reach people. So if we want to reach everybody in Ohio, we can deliver that audience to you. So it's going to more be the benefit of brands that can't get on because most of the political advertising has been already bought for next fall -- for this fall. So if you're really trying to make a big push in Ohio and you're General Motors, we can deliver that audience because you can't deliver it on television.

What's your mix of national/local today versus what it might be in a political year, if that thesis is right?

Do you know off the top of your head?

70% national.

70% of our business is national. And I guess, what...

About 6% is average, and the rest is local...

And the rest is local.

Rest is local. And have you seen sort of upticks in local in political years as this crowding out occurs? Or you haven't really seen enough evidence of that?

I think we have to go back and look at that, honestly. We know that we have a sales force directed to taking advantage of that because we know that those 8 states are already sold out. So if you're branding, you're trying to do something in Ohio, Florida, Pennsylvania, Michigan, Wisconsin, it's hard to actually get a message out. And the only thing available is that's video oriented is really cinema. You can certainly ask it by radio and outdoor, but given a lot of that radio and outdoor is getting bought up.

Yes. Any questions? What about your capital structure? It seems like -- as I was looking at your financials, you've been sort of chipping away your debt a little bit, right?

Yes. We have an opportunity to pay our debt down as part of our governance. Candidly, our business is focused on delivering 80% to 85% of the cash flows back to the investors and the dividend. And we have a significant cushion, 4 quarters available to do that. We don't have a lot...

Four quarters of cash on the balance sheet that could pay your dividend.

Right. That's the cushion that we have, and we've candidly not spent a lot of money on capital expenditures historically as a company. We spent $15 million, $20 million over the last 3 years building our digital business out, but most of that is behind us, but we are definitely a capital-light business. That's why I think our margins are so high, when you really look at it. So there's no big plans for us to spend a lot of money.

When you say your margins are so high, you don't mean EBITDA margins? And what do you mean when you say margins?

Well, our current operating margins are 45%.

Operating margin, wow. Okay.

So -- and it's an advertising business, which is even high for an advertising business. And part of it is our cost structure and part of it is just the pricing that we have. So the company has done a really good job sustaining its margin. A lot of big ad sales companies have seen a rose in margins, particularly in cable and network. Obviously, the digital guys have done a great job.

Less so recently.

Right. Right. But we're a little -- candidly, we are competitive with the digital media companies. Often when we're out trying to win some business, more often than anything, we'll lose business to Google or Facebook or compete with them. So all the more important that our digital business grow and be part of our cinema business because candidly, we aren't really competing that much with cable and even with television that much anymore.

It's really the big guys. And what about your dividend? I mean when I was just reading through some of the recent transcripts or whatever from your earnings call, it's almost like there's some soft language like the dividend might be at risk or something. And I don't know if that's lawyers that sort of make you say that.

We have to be really careful about the language that we put in to all of our earnings calls, and they generally tend to be fairly cautionary when it comes to the dividend. We weren't intending to have anything negative about that. I think if you look at the growth that we're suggesting and you look at the health of the company, our goal is to increase the dividend. So we'll be making decisions in February come our next Board meeting and earnings call, and we'll be getting more guidance when it comes around during that period.

Okay. And when do you think you'll chew through sort of the NOLs, where it becomes...

It's several years away.

Several years away. And at that juncture, then if you're a shareholder, the -- sorry.

We have to consider we currently have a huge deduction for the intangible asset amortization, so that goes on for another 5 years. So that's [ difference ]. And then the NOLs that we build up continue to burn off. It'll be several years from now. Obviously, you turn into majority taxable.

Okay. And so presumably, as the Board is considering increasing the dividend, they'll be looking at the potential future of tax -- cash tax payments several years out. Is that the right way to think about it? And then...

Yes. I mean it's still several years out, and we have large depreciation and amortization deductions that we take and then the NOLs play into that. So that's -- right now, we're paying -- it's called the TRA payments. So it's a tax receivable agreement. So there's cash flow that all really goes out of the entity and it pays the founding members for the privilege of having those huge intangible assets. So as that TRA -- as we pay taxes, the TRA thing goes down. So cash flow really doesn't change much. That's just a difference between the TRA payment and paying government.

Understood. Okay. Any questions from the audience? And do you sense that most investors understand that dynamic, like everyone is all over this?

It's complicated. It's [indiscernible] structure, so it's not unusual. It was what we put in, in place back in 2007 with the IPO, but it's more commonplace now. There's probably 150-plus companies that have this similar structure. So we became a lot like a REIT, so we throw off a lot of cash and that cash because of the partnership and the ownership of the Inc. entity is the managing partner of the partnership has an obligation to really just pay that to shareholders. There's nothing else that they can do with that cash flow that comes up quarterly from the partnership, which is $200 million on an annual basis, roughly.

Right. Right. Okay. Very helpful. No questions from the audience? Well, this has been great. I learned a lot. I hope our clients did and anyone that listened.

Yes. I mean, I guess, the key takeaway is we've been a really attractive dividend stock for a long time and super consistency in terms of revenue and cash flow, which is attractive to a certain investor base. And our goal is to get the company to mid-single-digit growth on the top line, and we think that combined with the dividend appeal is going to be very attractive to a different group of investors. And we think, given our dominant position in the marketplace and the healthy financial state of the company and the long-term agreements that we have with all of our affiliates, that we're in a really good position. And I think the addition of all of our digital strategies married to cinema will make us really attractive to advertisers as well.

All right.

Well, thank you, Jason.

Yes. It's a great overview.

And thank you for including us.

Yes, absolutely. Thank you for the time.

Take care.