Sinclair, Inc. (SBGI) Earnings Call Transcript & Summary

Good day, ladies and gentlemen, and welcome to the Diamond Quarterly Update Third Quarter 2022 Conference Call. [Operator Instructions] It is now my pleasure to turn the floor over to your host, Billie-Jo McIntire, Associate Vice President of Investor Relations for Sinclair. Ma'am, the floor is yours.

Thank you, operator. Participating on the call today are Chris Ripley, President and CEO of Sinclair; Rob Weisbord, President of Broadcast and Chief Operating Officer of Sinclair; Scott Shapiro, Chief Financial Officer and Chief Operating Officer of Diamond Sports; and Steve Zenker, Vice President of Investor Relations of Sinclair. Before we begin, I want to remind everyone that supplemental information for today's call is available on Sinclair's website, sbgi.net, on the Diamond Sports Group page under the Investors menu. Now I'll make the forward-looking statements disclaimer. Certain matters discussed on this call may include forward-looking statements regarding, among other things, future operating results. Such statements are subject to a number of risks and uncertainties. Actual results in the future could differ from those described in the forward-looking statements as a result of various important factors. Such factors have been set forth on the Investor Information page of Sinclair's website and are included in Diamond's third quarter unaudited financial statements and Management's Discussion and Analysis of Financial Condition and Results of Operations which can also be found on the Investor Information page on Sinclair's website. Diamond undertakes no obligation to update these forward-looking statements. Diamond uses Sinclair's website as a key source of Diamond's information, which can be accessed at www.sbgi.net. A webcast replay will be available on Sinclair's website and will remain available until Diamond's next quarterly update call. Included on the call will be a discussion of non-GAAP financial measures, specifically adjusted EBITDA, adjusted free cash flow and leverage. Diamond considers adjusted EBITDA to be an indicator of the operating performance of its assets. Diamond also believes that adjusted EBITDA is frequently used by industry analysts, investors and lenders as a measure of valuation. This measure is not formulated in accordance with GAAP, is not meant to replace GAAP measurements and may differ from other companies' uses or formulations. Also, just a reminder that Marquee was deconsolidated from Diamond and changed to the equity method of accounting within Diamond's financials as of March 1. Like last quarter, we will not be giving Diamond pro formas due to the confidentiality around deconsolidating Marquee from the Diamond results. On the Investor Information page on Sinclair's website, however, you can find Diamond's third quarter actuals and fourth quarter and full year guidance. Now Chris Ripley will take you through our operating highlights.

Good morning, everyone. The third quarter was a busy one for Diamond as it prepared for the full launch of Bally Sports+, its DTC product, encompassing all of the Bally Sports RSNs. The launch occurred on September 26, and we could not be more pleased with the performance of the product and user engagement. We have seen encouraging demand for the service despite relatively low product awareness in the marketplace. The conversion rate after the free trial period is strong at approximately 70%, consistent with what we saw after our June soft launch. DTC sub engagement continues to outperform a TV [indiscernible] user streaming 1.3x more minutes on average since our full launch. In addition, the DTC subscribers return more frequently to the app and have longer average session times. We are seeing particularly impressive results at Bally Sports North, where the Minnesota Wild and Timber Wolf games have had over 23 million minutes streamed through the first month of the season, with average unique streamers per game routinely exceeding a 1.0 rating in the Minneapolis CMA. These early data points not only indicate robust engagement, they underline our significant opportunity to generate revenue beyond DTC subscriptions as we continue to iterate the platform to include gamification elements, targeted ad capabilities and e-commerce components. I would also like to give kudos to our D2C team. The strong early adoption of Bally Sports+ speaks to the quality of the product they have built, and that is reflected in the 4.5 average app store rating since full launch. We would also note the fantastic support we received from our team partners. Our coordinated marketing efforts are helping them increase their reach, and we anticipate future partnership arrangements will allow us to be efficient with our marketing dollars. Now I'll turn it over to Rob to go through some operating highlights.

Thanks, Chris. Media revenues for our third quarter came in a little below our guidance on lower-than-expected distribution revenue, primarily due to higher-than-expected subscriber churn as well as slightly lower-than-expected advertising revenue due to fewer gains in the quarter than forecasted. On a per game basis, ad revenues were up mid-teens percent, driven by healthy demand in many categories with the largest gains in service, retail, food and entertainment. Looking forward, we see some positive signs for advertising demand. The upfronts were successful, and we're seeing substantial commitment from the auto category, which is expected to benefit from a lessening of supply constraints and building inventories. We continue to face the prospect of a difficult macro environment that could accelerate churn as well as potential for higher interest rates, which could impact consumer behavior. Impressions continue to hold up as well to the RSNs for the just completed MLB season. Impressions for all RSNs were up low single digits percent. And for Diamond RSNs, including Marquee And YES Network, impressions were even better, up mid-single digits percent. And many of the Bally RSNs continue to average the highest ratings for all stations in their DMAs for times when there are game there. The ratings and ad demand validates the continued value and attractiveness of live local sports. Finally, during the quarter, we executed multiyear rights renewals with the Clippers and [ basis ] continuing our long relationships with both teams. I also wanted to thank our direct-to-consumer team led by Mike Allen and Michael Schneider. They have done a tremendous job getting the app shipped and having terrific early results. With that, I'll turn it over to Scott to review the financials.

Thanks, Rob. Diamond's revenues were $684 million in the third quarter. Distribution revenues of $565 million reflect an increase in subscriber churn to 10%. Total ad revenues were $112 million, an increase year-over-year, excluding Marquee driven by higher digital revenue and political revenue. Advertising revenue on a per-game basis for the Bally RSNs grew at mid-teens percent. Diamond's media expenses for the third quarter were $664 million, up from the prior year, excluding Marquee on slightly higher sports right amortization, a higher management fee and promotion expenses related to the DTC launch, partially offset by lower engineering expenses due to the absence of facility transition costs that were in the year-ago period. Average production cost per game increased mid-single digits percent due to an increase in certain labor expenses. As compared to guidance, media expenses were lower by $9 million, in part due to 40 less games in the quarter produced and forecast, and the timing of certain expenses. Diamond's adjusted EBITDA for the third quarter, excluding $23 million for nonrecurring items and the deferred management fees was $233 million, within our guidance range of $229 million to $237 million. Diamond's cash at quarter end was $585 million, and its $228 million revolver was undrawn, bringing liquidity to a little more than $800 million as of September 30. Total debt at the end of the third quarter was $8.674 billion. The AR facility was $193 million. During the quarter, we took a noncash impairment charge of $1 billion related to our customer relationship intangible assets as well as other intangible assets brought on by elevated levels of subscriber erosion. Looking ahead to the fourth quarter, media revenues are expected to be $634 million to $640 million. Distribution revenues are expected to be $553 million to $555 million with a sequential decrease from 3Q, driven by continued subscriber churn. Included in the estimate is year-over-year subscriber churn of approximately 10%. Advertising revenues are expected to be $76 million to $80 million. And for the full year, media revenues are expected to be $2.778 billion to $2.784 billion. Fourth quarter adjusted EBITDA is expected to be negative $48 million to negative $42 million, which includes an adjustment for the management and an incentive fee deferral of $22 million. As a reminder, the first and fourth quarters are typically the lowest in terms of EBITDA as those quarters have a higher percentage of sports rights payments. Full year adjusted EBITDA is expected to be $158 million to $164 million, lower than our prior guidance due to the acceleration of subscriber churn previously mentioned. With that, I'd like to open up to questions.

[Operator Instructions] Your first question for today is coming from Avi Steiner at JPMorgan.

I have a couple here. One, if I could start just on the DTC launch, and thank you for the early info. But now that both the NHL and NBA season has begun, I'm wondering if you can extrapolate anything from the numbers as what it might mean for the full season? And maybe how these early results compare to what you had been expecting when you provided an outlook with different cases in your 8-K? And then I've got a couple of follow-ups.

Thanks, Avi. I think it's too early for us to extrapolate. I mean we've literally just gotten through sort of 1 month, 1.5 month of being up. And we're very pleased with the results in terms of engagement, app ratings, the quality experience, engagement of the subscribers, and I think it bodes well for the future. But at this point, just extrapolating, I think, would be -- give you a false indication.

Okay. Fair enough. My second question, there's growing consensus that we're moving into an economic downturn at some point, '23, albeit mild, and again consensus on -- doesn't mean it's right. But I'm curious how that might impact both kind of your linear traditional part of the business and then the launched DTC side?

Well, it's an interesting question, Avi, because we have continued to outperform on the advertising side quite significantly, especially relative to what we've seen on the broadcast side. Our advertising per game continues to go up on -- at Diamond, and that's despite some macro weakness that we've seen. So that tends to be where the business gets hit first is on the advertising side when you have a downturn, and we're just seeing the strength of sports continue to shine through any sort of weakness in the macro economy. Beyond that, the business is driven primarily by subscriptions, as you know, from either the DTC side or the pay TV side, which with the vast majority being pay TV. And those tend to also be fairly sticky. And so we'll have to see how things play out in '23, but this model should be fairly resilient, at least relative to expectations.

Yes. And Avi, I'd add from the upside is that over the last couple of years, the sellers, and what we've instituted from a digital knowledge, they've been able to capitalize not only in the linear ad market, which tends to even now in a tough time to be moving the live sports on the ad side, but also from the digital expenditures that take place on sports not only through this DTC launch, went through the [ TVE ] app as well as marketing services. So the team is a much more well-rounded sales organization and everybody loves the fandom of the local team. So they're able to capitalize on large-scale deals.

Appreciate that -- the color. Very last question for me, and thank you all for the time. So if I'm not mistaken, your heaviest team payments on a cash basis are due in the first quarter that's coming up. I'm curious if anything DTC-wise or maybe recent negotiations have changed that? And then in the 10-Q, you noted you have sufficient liquidity for the coming 12 months. And I'm curious if -- just thinking through the first quarter, if you might need to draw on the revolver to get through that?

So as it relates to your first question, nothing has changed there in terms of heavy payment flows. We do expect those to continue in Q1. And we'll have to follow up with you, Avi, on revolver draw. We don't know offhand. I would suspect no, but we'll follow up with you.

Your next question for today is coming from David Hamburger at Morgan Stanley.

A couple of questions, if I may. So looking back when you first gave guidance for 2022, your EBITDA guidance was kind of well north of $300 million. And now your updated guidance is about half or less than half of that for 2022. And I was wondering if you can unpack kind of what's transpired between that initial guidance that you gave, some of those case studies you gave for the DTC? Importantly, I guess, one thing you're calling out is churn. Can you give us some specificity about how churn has increased significantly this year? And then secondly, I know not necessarily comparable when I look at your sports rights payments. Again, in that initial guidance you gave for 2022, you expected sports rights payments to increase about 2% to 3% annually. If I'm just looking at your financial statements, and I don't know if it's because of the Marquee, the consolidation or not, but it looks like year-over-year for the 9 months, your sports rights payments are up like 9%. So could you help kind of reconcile maybe all of that in the context of where you are with your EBITDA guidance this year?

So let's start with the guidance question. So I do think a chunk of that relates to, or a piece of it, relates to Marquee's deconsolidation and used to be included in obviously full year guidance as we entered the year, and then it came out. And in terms of churn, which is just really the underlying, I think, force here that's pushing the guidance down. When you look at our expectations as we entered '22, it was for somewhat stable to moderating churn, which was based on a well-known industry resources. This was a pretty sort of significant macro concerns and inflationary environment. And we have seen quite a bit of acceleration over the year, and that's probably driving at least 75% of the change to guidance when you look at the magnitude of where churn expectations were at the beginning of the year to what we're projecting for the full year. So I think that addresses your guidance question. Sorry, what was the...

Sports rights.

Sports rights. Yes. So we'll circle back to you certainly on the moving pieces with the deconsolidation, that's certainly part of it. I would add that I think on a go-forward basis, even though we're not providing an outlook, that range is probably fair. But we'll...

I know you have a bigger pop-up in the...

There's also quite a bit of rebates -- there's also quite a bit of rebates that make that number move around. So we have to be -- make sure we're comparing apples-to-apples and clean numbers.

Yes, David, when you compare 2022 to 2021, you got to remember, 2021 had a lot of rebates in it from the teams because of COVID. So that is creating this increase year-over-year that you're seeing. But the underlying deals would be on a pro forma basis well within that previous indication.

And I guess just stepping back and looking at the trajectory, as you mentioned churn accelerating on the linear side of the business. What's now your level of confidence as you gave those cases, when you did the transaction earlier this year, your level of confidence that the uptake on the DTC offering, your ability to pivot the business in that direction is going to offset what you're seeing now is an accelerated churn on the linear side of the business that you say -- that being 75% of your EBITDA expectation. I guess, as you look into 2023, some of those large payments in the early part of the year, I know there's a step-up like in the Atlanta Braves payments next year. Otherwise, I guess, wonder your level of your confidence that the DTC offering is going to be a sufficient offset.

Well, look, I think we'll have to see how 2023 plays out. And right now, we're very happy with the product. We think it's performing exceptionally well. Got great response from our team partners, and it's only going to build from here. So the great thing about this DTC strategy is that the freight -- the biggest cost of the strategy is already paid for sports rights. Now we're not -- we're spending significantly on the app and the experience and marketing, et cetera. But the single biggest cost was already paid for. So the incrementality of the strategy, we believe, is quite strong. And as this brand builds, as market awareness builds, and as more and more people that are outside the bundle come in to watch their favorite home teams, that should definitely make up for some of these losses that we're taking.

And the first goal was to ensure video quality because that's what the hard core fan is looking for. And it proved out in the app ratings. The app ratings for the DTC product significantly higher, as Chris pointed out, than when we first launched the TVE app and -- continues to iterate. This is a one notch over when they came out with a very high rating in the app stores, and we expect it to get nothing but higher ratings as we add features to the apps as the months go on. So it's very encouraging to see the app come out of the gate with such a high rating from the hardcore fans.

Okay. And if I could just one kind of balance sheet question. So I'm just curious, like, given where the securities are trading, the coupon payment on your unsecured notes in the first quarter of 2023, I mean, you could buyback more than half of that bond issue in theory in the open market with that coupon payment. I'm just curious, like, are you having any discussions with bondholders, or any contemplation of any liability management here with the balance sheet given you do have some liquidity?

Yes, I appreciate the question, David. And I think it's mathematically certainly true what you said. I can't speak to discussions specifically because those are subject to confidentiality arrangements. And -- but we have -- we're very focused on liquidity and deleveraging over time. Those are our two key goals. And as previously reported, we have advisers involved LionTree and Moelis, who helped through our last transaction earlier in the year. And it's -- we're very open to any and all strategies to affect deleveraging.

Your next question is coming from Lance Vitanza at Cowen.

Maybe a couple on the OTT platform and then one on programming expense. The first on OTT, how do you -- how are you guys thinking about price point versus penetration? I mean, you could obviously -- if you charge $1 a month, right, you could have 100 million subscribers, or some crazy number, and if you only wanted 10 subscribers, you could probably charge $200 a month. But is the strategy that you're employing here, could you talk about what's the right number of subscribers for you? What's the price point that you think is going to maximize revenues? Is the strategy to lure more subscribers with a lower minimum and then boost the effective ARPU with gamification and advertising? Or is it really just something else? I guess how are you thinking about that math?

It's a great question, Lance. So this is something that we thought a lot about going into this strategy and did significant amounts of market research with Bain actually. Bain are our key consultant there helping us out. And we wanted to maximize revenue, not maximize subscribers. And given this was about adding extra incremental cash flow to Diamond, the maximum revenue was the objective, and a $15 to $20 price point per month, which it's around $15 for our annual and it's about $20 for our monthly, was the -- that was the range for revenue maximization, not subscriber maximization. The other consideration in the pricing was giving enough of a gap in retail pricing to the wholesale pricing that we give the distributors since this is a hybrid strategy. We don't believe the pay TV linear channels will be going away anytime soon. And so you need to have a wholesale price that's significantly lower than the retail price. And so those two factors played into decision around pricing. But independent of the wholesale retail dynamic, we are currently priced at what all the evidence that we've seen, and all the research we've done, delivers maximum revenue from a subscriber perspective. Now over time, pricing obviously may change. I feel like the -- when we did this research, which was about 2 years ago, relative pricing has increased in streaming land. And so the relative value of what we're offering, I think, has only increased because we essentially are using the same price points that we envisioned 2 years ago. The rest of the streaming marketplace has gotten more expensive. So arguably, we might have some pricing power to go up, but we're in the early stages right now. And until we build out the rest of the monetization around gamification, commerce, various social sharing, et cetera. That is, I think, going to be a major driver of ARPU going forward since these sports fans are so passionate. They spend multiples more than regular streaming users on these ancillary items. And so I think over time, you'll see the ARPU skew more into these other areas of the ecosystem as we develop the app further, and there'll be less reliance on subscriptions. Now does that mean we reduce our price over time? Perhaps, or that means that just that the most of the growth is coming from the other areas.

That's really helpful, Chris. Let me ask you the other streaming question. You mentioned that you've had some advisers helping you on the balance sheet, but we've obviously seen some press reports that you've also hired, or maybe they're the same advisers, but they are working with advisers to potentially market the Diamond Sports Group is and that the leagues are perhaps interested. Is there any truth to that? Can you comment on that at all?

So the advisers that I have mentioned are the same ones that were commented on in the press, the LionTree and Moelis & Company. And there is -- there is no sale process, but they're talking to parties about deleveraging, strategic partnerships and things of that nature.

Okay. And then my last question, just in terms of the sports rights, the contract rights. I mean, churn going up, revenue is going down and yet these sports rights are increasing, and whether it's low single digits or high single digits or wherever it is, it seems like it's out of proportion to the economic propose to the economic realities. And I'm wondering, am I missing something there? Or is -- are you having discussions? Is there room to have discussions with some of the sports partners? I mean, I would not -- I guess I'd be a little surprised if there were other groups beyond Diamond that were out there that were willing to pay as much let alone more for the rights to broadcast 150 daily baseball games in Cleveland as an example. And I'm just wondering if you have any opportunities there to address what, in my opinion, at least look to be potential disconnect in terms of what you're paying versus how you can monetize this stuff?

Thanks, Lance. So those -- you're right in that there discussions are occurring. Now they're largely timed with renewals. It's hard to have those off-cycle discussions. But certainly something that is used in renewal discussions and is the reason why the percentage growth in rights, if you've tracked over time, has been declining because those renewals have been coming in at lower levels. And the other thing you need to remember, though, in the broader context is that national rights and sports rights, in general, have increased in value tremendously, and relative to local rights have -- there's been a massive change there. And so what I think is happening on the local rights side is we're just -- we're going through this transition of going from a single source of revenue, linear pay TV to a hybrid approach. And we've just made that first step of doing that. And so it just -- it takes some time for the model to play out, but that transition, we believe, will ultimately make these rights even more valuable in the future. And we just have to bridge through that moment in time.

There appear to be no further questions in queue. I would like to turn the floor over to Chris Ripley, President and CEO for Sinclair for any closing remarks.

Thank you all for joining us today. Should you need more information or have additional questions, please don't hesitate to give us a call.

Thank you, ladies and gentlemen. This does conclude today's conference call. You may disconnect your phone lines at this time, and have a wonderful day. Thank you for your participation.