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

Okay. Great. Good morning, everyone. My name is Jason Kim from Goldman Sachs. I'm the high-yield media and telecom analyst here in the high-yield research group at Goldman. Today, we are excited to welcome the management team of National CineMedia to our conference. We are joined by Tom Lesinski, Chief Executive Officer; and Ted Watson, Senior Vice President of Finance. So Tom and Ted, thanks again for coming to our conference this year, and I'll turn it over to you to share the National CineMedia story.

Thank you. You want to read the disclosure, Ted, or no?

Yes. We'll start the conference with that this presentation may assume some forward-looking statements. And again, you can read through that slide for all the typical disclosures. Go ahead, Tom.

Okay. So I want to talk a little bit about what NCM is and then get into a lot of the specifics of our strategy and what's been going on in the post-COVID world. NCM is far and away the largest player in the cinema advertising space. We have over 21,000 screens in movie theaters. We reach about 700 million people a year. I think -- one second I'm just turning something down so it doesn't beep, okay. We've got about a 70-plus market share in the top markets in the United States. We only have 1 significant other competitor. Importantly, besides being the market leader, we've got a very long-term agreement with distributors on the theater side. We have about 20 years on our agreements with the 3 largest exhibitors, AMC, Cinemark and Regal. We have a total of 54 affiliates that are also part of our network. The most important thing we've done in the last year since I took over was we have future-proofed our ad platform by putting more improved inventory in what we call the lights-down inventory, which is the time the theater lights go down, including a 60-second premium spot that runs just before the last 2 trailers. In addition, from a financial metrics point of view, we've got operating margins of around 45%; 95% unlevered free cash flow; and a very light asset model, which we'll talk about a little later as it relates to what we've done during this COVID period of shutdown. I think the only thing that's important is there's been consistent growth in the media business, 7% compounded growth since 2015. And we are projecting growth of almost 8% in the business in 2020 before COVID came along. And I think finally and most importantly, given what's going on from an economic point of view, historically, the movie business has responded very well during recessionary periods. The low cost of movie tickets the key driver of that. So I want to switch to -- I'm moving up in the slide deck now to why do advertisers love NCM. It's Slide 6. I think the most important thing is we've got a very attractive demographic. Unlike the traditional network TV or cable business, our audience skew is much younger. We are around 30 years old in terms of our average demographic compared to network TV, which can be closer to 50 to 55. We have a significantly above-average income compared to the U.S. population. And we are significantly distributed across all diversity groups, in Hispanics, Latinos, African-Americans and Asian Americans. So as the world becomes harder and harder to reach millennials and Gen Z, besides digital, one of the best places to reach a capital audience is the cinema business. On the next page, Page 7, I want to talk just a little bit more specifically about our audience. As I mentioned before, we've got a little over 70% market share in the top DMAs, 67% in the top 25 and you can see how it goes down all the way to about 63% when you cover the entire United States. Importantly, on an opening weekend, our market share can be even higher than that. It can get up to 73%. Importantly, of the 21,000 screens, we cover all the major U.S. markets. And in fact, we're the dominant player in all those markets. We are in almost 1,800 theaters in the United States with an average of 12 screens per theater. Shifting to the next page, I want to give you just a sense of what our ratings look like compared to traditional television ratings. On a typical Friday, Saturday, our network generates about a 6.5 share in terms of a rating. That's higher than the Sunday Night Football, higher than Thursday Night Football and higher than any network TV show. In fact, twice as high as a show like This Is Us, which is the highest-rated show on NBC. On the next page, I want to talk a little bit about how we sort of connect to the audience. Besides the big screen, we also connect to people in lobbies physically as well as through our lobby entertainment network as well as digitally. And I'll talk more about that as we go through this presentation. We established a new growth strategy about 9 months ago. And I want to outline sort of the key pillars of that and what's been driving the success of our business, which led to a record fourth quarter number and a 52-week peak in our stock price. So the 5 key growth strategy here, one is to increase the quality and the value of our media inventory, and we've done a really good job at that. Secondly, we've done a significant 2-year run at upgrading our planning proposal and inventory system to be more efficient but also to cut out cost and to create a more seamless buying experience for today's media buyers. We've continued to invest in creating digital entertainment, which is an important part of our growth strategy and building digital ad inventory. Fourth, we've accelerated the growth of our first- and second-party consumer databases. We have over 150 million data sets today, and that's growing into 2020 and 2021. And importantly, we're looking at expanding our affiliate network by adding key affiliates and additional screens to grow the business. So I'm going to spend a little time on each of these. So in terms of increasing the quality and value of our inventory, as I mentioned at the top of the show, we've done 5 minutes of new additional inventory in what we call the lights-down period of the show. So if the showtime is at 8:00 from 8:00 to 8:05, those are additional 5 minutes of advertising. In addition, there's a 60-minute (sic) [ 60-second ] Platinum Spot that we had a lot of success selling in the fourth quarter last year to big clients, which is embedded right at the end of the trailer pack just before the movie starts. Sometimes there's 1 trailer right in between or 2. We've also done a good job improving what I would say the overall quality and relevance of our pre-show changing the content to be more appealing to Gen Z and to millennials. And then finally, we've improved our attribution capabilities to create a more competitive currency in the marketplace with advertisers. So that's the first point. If you look just on Page 13, this gives you a sense of if you -- those of you who haven't seen our show, what it looks like. If you kind of go from the far right to the left, there's a beverage ad that runs right before the movie starts. There's a trailer. There's our Platinum Spot, which is one of the most expensive spots you can buy in media today. There's other trailers before that. There's a second beverage spot. There's a courtesy spot, and then there's that 5 minutes of lights-down inventory that I mentioned before. So all of that is just basically our new inventory strategy. Prior to that, our 4 segments of content, which are all embedded with advertising, which is our traditional pre show. Maria Menounos has been the host of that for some time now. You probably have seen it. Okay. So secondly, I want to talk a little bit about how we've upgraded our planning and proposal and inventory system. This is really the sausage-making part of the company, but it's really important given how labor-intensive, historically, the ad business is in terms of creating contracts and actually inserting ads into inventory. We've invested for over 2 years an ability to really do a better job of optimizing our inventory. We've upgraded these systems so we'll be faster and more efficient in the way we generate orders and actually get our collections credited into our accounts. We also are going to reduce our CapEx during this process, once it's finished and implemented, and we're still targeting an early '21 first quarter launch of this plan. The third thing is investing in this creative consumer-facing businesses. Historically, we've been an on-screen company. What we've done instead is build digital alternatives, so we can talk to consumers before during and after the movie theater. noovie.com is a center hub for all that. We also have Noovie Arcade, Noovie Trivia and Noovie Fantasy, all apps and games that generate more connectivity to our consumers before, during and after they go to the movie theater. This creates additional inventory for us, but more importantly, it creates a very valuable, addressable first-party consumer data. And to be a modern media company, you have to have first-party data, and you have to have data that allows you to attribute activity to an individual consumer who goes into the theater and what they do after they leave. And we've been packaging that up with our core product as well as selling it separately. So if you look on Slide 16, you can kind of see how we've reinvented the pre-show, and what we're doing before, during and after the movie theaters, importantly, the pre-show is the hub of our business. But now we have the ability to engage consumers on screen and online after they leave the theater, even before they get to the theater. We will have one of the best movie trivia games launching this year, and we're confident that's going to be a big success. All of that is ultimately creating more audience engagement for us, better consumer data, better ad inventory and more brand attribution. Cinema Accelerator is another product that helps us reach advertisers at every point along the movie-going journey. We do this in a variety of ways. We identify consumers through our own and own (sic) [ operated ] properties. We identify them through geo-fencing, and we've identified them in-theater through beacons as well as far behind the screens portal. Ultimately, this allows us to deliver messages to NCM's movie audience through a cross-platform strategy. And ironically, during this theater closedown business for the last 3 months, we've been continuing to generate digital revenue through Cinema Accelerator to our millennial and Gen Z fans who love sort of the whole tech-savvy nature of this delivery system. So you can see on page -- on the next page, which is Page 18, we're ultimately connecting brands to movies everywhere not just on the big screen but on tablets, on mobile and on desktops, so we're really digitizing the company. So we're more diversified beyond just a typical screen business. So the fourth strategy, which I just talked about is building a data business. As I mentioned, we've got 150 million first- and second-party data sets as of this past quarter. It is critical to have a data business to support your core business, monetizing data, using data. It's what advertisers expect today. And NCM will be right there, competitive with other digital companies in terms of delivering a solid data story and attribution story around our big screen data. Just a couple of quick examples of how this has been working for us. We've done 4 tests in the last 6 months or so: 1 with a telco, 1 with a cable programmer, 1 with a retailer and 1 with a QSR fast food chain. In all these cases, we used both our on-screen product and digital programming and data to do attribution. So for example, if someone saw the ad in a theater and we were linked to their digital device, we were able to track what they did once they saw the commercials in-theater and how they responded. In each of these cases, we had a lift of anywhere from 12% to 42% in terms of sales metrics as provided by our partners. So we know the combination of around screen programming plus digital works and it delivers audience and sales to our advertisers. Our last key strategy is really building our affiliate network out. Even though we've got a 70% market share, there's still opportunities for us to grow our business outside of our current footprint. So we're actively talking to new theater chains in order to expand our inventory and to grow our demographic profile and to grow our number of impressions. A couple of more slides, and I'll wrap it up. If you think about our core strategy, it's to really unite brands with the power of movies and engage these fans anytime and anywhere. And we're doing that before the movies, long before a move even comes out, in the social media space, at Comic-Con, through the trailering relationships, other partnerships we have, in the lobby, in the theater and then after the movie is post social media. So that 360-degree story is we are the best way to reach movie fans. And movie fans matter to brands because they're primarily Gen Z and millennials, the hardest people to reach and the most desirable ones to reach. And no one reaches them better than we do. I'm going to turn this financial highlights section over to Ted Watson, our Senior VP of Finance, to go through some of the highlights. We're now on Page 24.

All right. Thanks, Tom. So yes, starting with the ownership and corporate structure of the business on Slide 24, you can see the layout of how the business is constructed. We have National CineMedia, LLC down there at the bottom, that's the operating entity. That's where the cash flow is generated each quarter. That's also where the debt sits. And then at the end of each quarter, the available cash is then pushed up to the 4 owners. So you can see the ownership structure being -- the founding members owning 52% of the business. So AMC, Cinemark and Regal; and then the other 48% being owned by the public shareholders being National CineMedia, Inc. If you want to go to the next slide, Slide 25, this is the ad revenue construct of the business. You have 77% of the business being generated with national and regional revenue; 15% being generated with local revenue; and then the remaining 8% being beverage. If you want to move on then to Slide 26 here. We've done a great job over the last couple of years of really expanding and diversifying the national client base. If you look in 2019, we've added over 49 new customers, done a great job of growing 3 verticals, in particular, insurance growing 68%; restaurants and foodservice also growing 68%; and then professional and business services growing 56%. And if you look over to the left part of the pie chart, you'll see again that NCM is not beholden to any one customer or category. Our top 5 or 6 categories there, you can see were led by media and entertainment comprising 17% of revenue. And then you have insurance, communications, electronics, auto sales and CPG. Those categories represent anywhere from 10% to 12% of revenue. Moving on to Slide 27, looking at the historical financial performance in the business, starting with advertising revenue. I think it's safe to say it's been a model of consistency. A stable business with revenue over the last 5 years, continually being over $400 million. We had at $445 million of revenue in 2019. I would note to folks that that was culminated with a record Q4 revenue performance. So as Tom had talked about a minute ago, with the new post showtime and Platinum inventory, we're really able to drive demand from the advertisers, resulting in a record quarterly performance. That did carry over into Q1 of 2020. We were able to continue that momentum up until the time of the COVID pandemic. If you want to go over to the top right, looking at adjusted OIBDA, again, a business of high margins. In 2019, pushing 47% adjusted OIBDA consistently over $200 million, so $208 million in 2019. Looking -- again, to reiterate what Tom said, it's an asset-light business model, typically about 3% of revenues as far as what we spend on CapEx. About half of that CapEx is oriented towards growth. The other half of that CapEx oriented towards maintenance. And then, again, high free cash flow conversion, well over 95% or $200 million as you look over the last 5 years. If you want to go on to Slide 28, looking at the capital structure of the business. We really are in a good position as far as thinking about any maturities. The first maturity we have coming due is in 2023. That's our $175 million senior secured revolver priced at L+200. And then as you move beyond that, 2025, you have the term loan, $266 million priced at L+300. And then you move into 2026 with the senior unsecured notes priced at 5.75%. And then we just refinanced last fall the $400 million senior secured notes priced at 5.875%. As far as the overall debt structure, about 70% of the debt is fixed. So we feel good as far as controlling the interest expense in the business and we have pretty good control over that. And the credit rating of the business is B2/B. If you want to look as far as covenants with our debt structure, we have 2 maintenance covenants that we have to be mindful of. There's a senior secured maintenance covenant at 4.5x. There's also a total leverage maintenance covenant at 6.25x. As of Q1, we were well within both of those covenants. Now that said, with exhibition and theaters being shut down during Q2, we knew we were going to have to address those covenants at some point. So we were actually able to work with our bank and lender group back in April, and get covenant relief for the next 5 quarters or through Q2 of 2021. So we feel good that that gives us plenty of runway to get the business back up and going, operations normalize, get the leverage ratios well within those bounds. There were 2 conditions to get that waiver. One is that NCM must maintain $55 million of minimum liquidity during the 5 quarters and the second being the available cash that I talked about that historically is typically distributed each quarter. That cash has to stay at LLC during the waiver period. Now assuming we get back in line with the covenants and we come out of Q2 of 2021 we're in compliance, the business can then resume distributing that available cash. And then I'll conclude, if you want to look at Slide 29. Again, Tom already mentioned this, but it's a strong business with strong margins, 47% plus, stable cash flow, it's an asset-light business model. I would highlight on the dividend side, it's a tax-advantaged dividend, and that's because it's deemed a return of capital to shareholders. So you're currently not taxed on that dividend. It's really a reduction in the cost basis of the equity. So that's something that I'm not sure everyone appreciates, but I think is a good story for people to understand. And then I would also finish it up with back in Q1, we reduced the dividend from $0.76 annually to $0.28. Again, with exhibition being shut down, with the restriction on cash flow, we understand that for the next 5 quarters, there isn't going to be any cash coming out of the business. That said, we had $83 million in cash sitting up at Inc. And we certainly wanted to continue to reward our shareholders and pay them something. So we reduced the dividend from $0.76 to $0.28. And as of yesterday's closing share price, that's a 9% dividend yield. With that, Jason, I'll open it up to you with Q&A.

Yes. It sounds good. Thanks so much for that Tom and Ted. So we have a couple of minutes left and we've gotten a bunch of audience questions, so I'll sort of ask some of the more relevant ones. So as we start the process of reopening the economy, the movie release schedules are being closely watched by investors. How much of an impact will further delays to major releases such as Tenet and Mulan would have on your liquidity position and your 2020 financials?

We have enough liquidity right now. Basically, if nothing happens in the theater business for 18 months, we have enough liquidity to keep the company going. So while every movie that moves has some impact in generating revenue, we have enough liquidity to sustain for a very long time. Obviously, we're talking to the studios constantly about the release schedule. We're optimistic that Tenet and Mulan will stick on their dates. We know that Tenet's already moved once. I think it would be unusual to move a movie more than once. Unfortunately, much of this is predicated on the COVID situation in major states including California and New York. So the government has much to say about it but, obviously, the studios do too. We do believe that gradually in August, the release schedule will become more firm, and there'll be more content available for consumers that will drive our audiences. So look, we're all anxious to go to the movies. People have been in homes for going on 90 days, so we know there'll be a significant amount of pent-up demand once movie theaters do open. Many of them already started opening. It's just a question of getting that first big movie out this summer.

Sounds good. And then there has been a couple of different questions, but I'm going to try to combine them into one. What level of traffic in terms of relative to 2019 does NCM need the theaters to have in order to generate positive cash flow? Or maybe ask another way, you gave a lot of helpful details on monthly cash operating costs on your first quarter call. As you mentioned, you're able to reduce your cash cost by almost half to optimize the cost structure during this time. As the theaters do reopen, how should investors think about the ramp-up in your OpEx to drive the top line recovery?

Well, let me start with that answer, and then Ted can add more detail to it. We're running an overhead structure today, not including interest, of around $4.5 million a month. And if you look at our liquidity position, you can see that we've got a very long runway as it relates to that. So we don't need a lot of traffic in theaters to obviously cover our operating cost. We also have $4 million in interest cost a month. So if you figure our OpEx per month of around $8.5 million, $9 million, there's not a significant amount of traffic that's needed. Ted, I don't know, do you have a number on the percent of traffic or the percent of revenue that we need to get to, to breakeven on that?

Yes. So we actually talked about on the earnings call in May that if you want to look at covering cash flows, so it's not just profit but it's cash flow, including the debt service, we need about 40% of the 2019 level of revenue to cover OpEx and debt services. It's how you should look at it.

Okay. That's very helpful. And one of the strengths of your business mix in the downturn is that the majority of your revenues come from national advertisers, whom we would assume should -- they're better in the environment we're in right now versus local advertisers who tend to be smaller businesses. What kind of conversations are you having with these big national advertisers as theaters prepare to reopen? Are there any particular categories that you see as being more active at this stage than others?

Yes. So it's a good question. We are not particularly affected with what I would call COVID-impacted advertisers. We're not particularly large players in the airline space. We have a very small business really in travel and tourism. Our biggest categories tend to be in the streaming categories, which have obviously been thriving. Amazon, Hulu, Google are major advertisers of us, insurance companies, which continued to perform well during this. So we believe -- and we've talked to every one of our advertisers many, many times over the last 90 days, and they're fully supporting this business. We don't know what people's budgets are going to be over the next 12 months. And I think the most interesting thing we're focused on as these big national advertisers come into the upfront market and then to scatter in Q4 is what would their budgets be versus last year. And I think a lot of that depends on how people -- what category you're in, but also how you're being impacted by the recession and other economic variables. But thankfully, we don't get a lot of advertising historically from the airlines, hotels and a little bit from the travel industry, but not a lot. So I think -- I don't want to say we're insulated from this but, thankfully, the categories that we're in, which are largely targeted to millennial and Gen Z, are not as affected as this -- as a traditional television network might have.

Okay. Thank you very much. I think that's a good place to end as we're out of time. So Tom and Ted, thanks so much for joining us today. And thanks, everybody, for listening in. Thank you.

Appreciate it.

Jason, take care, bye.

See you at the movies.