Warner Bros. Discovery, Inc. (WBD) Earnings Call Transcript & Summary

Great. So you've been moving fairly aggressively to build out your direct-to-consumer portfolio. You mentioned Dplay, Eurosport Player, Joyn in Europe, Food Network Kitchen. You've got the upcoming launches of Magnolia [ natural industry ] products. I mean, it's really an active area for the company. Could you walk us through the growth potential for these various initiatives? For example, the market served, current penetration rates, capital requirements that you need to execute on the strategy?

Sure. So you're 100% right. It's probably the focus area for the leadership team right now. There's a great team working on this. We were able to bring in a lot of new people, very strong people with a lot of experience in this space, and it's front and center for all of our discussion -- all of my discussions with David, et cetera. So it's an incredibly important part of our strategy right now. And if you want to look at it that way, we need to make sure we know how valuable and how great our content and brand portfolio is, and we need to make that available to as many people on as many platforms as possible. And so you've mentioned some of the launches. And of course, we're also working on additional products such as Magnolia. And as David had said, we're linking into sort of an aggregated product as well. From a financial perspective, there's a lot of synergies here for us. So no doubt, launching anything in that space is always leading to incremental investments. That's why we've been pointing those out for 2 years now. Again, COVID threw a bit of a monkey wrench into our plans, but we were actually planning to generate more than $1 billion in revenues in that space in 2020. It's going to be a lower number now. It's still growing versus 2019 but not at the -- not at that sort of 40% growth rate that we had looked at going into the year. And we had also given some guidance on the net losses from our investments in the range of $600 million. We're tracking that, but it's probably still not a bad number. And one thing to keep in mind is we have been at this now for 1.5 years, 2 years with significant investments. We've built out that global centralized tech platform, which I think is now very close to state of the art, gives us a lot of opportunity to launch new products on one existing platform faster and more efficiently. We've built out a great technology -- a team of software developers under Avi, who's leading our global D2C technology. So we have a lot of that in place, and a lot of that has already gone through the P&L on the expense side over the past 2 or 3 years. So from that perspective, from a fixed cost basis, I think we have a very strong vantage point now. Clearly, going forward, with all of these businesses, one of the key drivers is going to be, in addition to content, of course, which is a bit of -- core of our P&L anyway. But going forward, one of the big factors is going to be subscriber acquisition costs, marketing expenses. As we see churn rates come down, customer lifetime values come up, there is opportunity to increase the spending in order to accelerate subscriber growth. So that's really going to be one of the key factors determining where we're going to land in terms of expenses or start-up losses over the next 12 to 18 months.

Right. So when you try to think about the $600 million losses or so on the $1 billion in revenue or the almost -- whatever it's going to be, what's the cadence of that? And where is the bulk of that investment going? Is it in the tech stack or is it...

Yes. It's 3 main buckets in there, and the 3 key positions here are obviously our content spend. We have invested in a lot of IP, as you pointed out, rightly, investments like the PGA Tour deal, live shows for Food Network Kitchen, individual rights for the Eurosport Player in local sports and some of Dplay markets, et cetera. That's one big factor and obviously has a fixed cost nature. As subscriber numbers scale, that bucket sort of becomes less relevant in -- on a relative basis. Number two is the technology. Again, very much a fixed cost, and we have ramped that up quite significantly over the past 2 years. And I do think that we have a very, very solid foundation now and feel good about the technology setup for our entire D2C portfolio. And number three is that's the big variable expense. We are spending a fair amount of marketing dollars. And again, we cut that back a little obviously in this current environment, but that will be the main swing factor as we roll out and accelerate growth in our products. That's the #1 factor that's going to make the big difference. So...

And when do you think D2C will be a meaningful tailwind for affiliate trends in terms of profitability?

Well, it's just -- it's too early to give you an intelligent answer for this. A couple of building blocks, though. Number one, we have already started to see some smaller contributions to our top line growth, and I expect that to accelerate. And as I said, if you look at our original plan for this year, it would have been a material contribution already. Obviously, now off the table in this environment, but hopefully, we're going to be facing a better environment next year. Number two is from a profitability perspective, I think there's a short- and a long-term answer to that. Again, the short-term impact has to be a negative one because we are spending marketing dollars in order to acquire these subscribers. We will do that in a disciplined way, spending up to as much as we're generating with these subscribers from a lifetime value perspective. But just given the nature and the cadence of how this plays out, you have to spend upfront, and maybe you're benefiting for 12, 24, 36 months, depending on your ability to retain these subscribers. And so that -- there is going to be that trend over time. And from a long-term perspective, I have no doubt that we will be able to benefit from the existing structure. Again, we're adding -- with all of our D2C products, we're adding a distribution channel to some extent. We are still going to leverage our global footprint, the teams that we have in place in every market globally. We're leveraging the same technology platform. And we're also, to some extent, leveraging the large existing content portfolio and the large number of fresh content hours that we're producing every single year and that we're now in a position to distribute across a broader distribution landscape, if you wish, yes? So from a long-term perspective, I do think this should be an accretive addition to our business.

And then as you mentioned, you have like the same tech backbone infrastructure, but how important is having the services under one -- well, from the -- not the tech backbone, but can you tie the products together, whether it's bundling or cross-promotion or some other integration strategy, is that important to you?

Listen, again, I think what's most important for me is the flexibility and the efficiency and the ability to go to market and pivot. And I think we are in a position to do that. Whether in the end game, several of our products are going to come together under one or they're going to be part of a larger aggregation or they're all going to be individual stand-alone products, I think time will have to tell. That's the thing about this whole direct-to-consumer journey. So much is changing from 1 quarter to the next. I think we need to make sure that we have the flexibility. Again, we're already leveraging a lot of the economies of scale because we're using existing teams. We're using existing platform. We're using existing or some of the dollars that we would be spending for content in our linear ecosystem in any case. So I think we already have a very synergistic setup. And some of the points that -- to answer your question, are really going to depend on what consumers want, and we'll find that out over time. We have made certain rights available on a -- for example, on the Eurosport Player and other markets, we've made it part of a sports tier and Dplay, et cetera. It's going to be very much driven by what we see that consumers are asking us for.

So Discovery has been a leader in cost management and operational efficiency. How much of the recent cost-cutting measures that you've undertaken are run ratable for the business versus more onetime nature related to temporary reductions related to COVID?

Yes. Listen, I'm very happy about the progress that we're making. I mean we embarked on this journey with the Scripps acquisition 2.5 years ago. And we have started a major transformation of this company, and we have made tremendous progress. We -- it's getting harder because of a benchmark against a 2017 baseline, but we must be well above the $1 billion in savings since the beginning of this transformation journey. And we're far from being done. We are, as a matter of fact, right now, going through sort of another list of transformation initiatives that we had put on the back burner to some extent because they're getting a little more complex and had other requirements of other prerequisites that had to be in place, et cetera. But we're on it. We still have our transformation team in full steam here, and we will continue working on it. And as I laid out, for the past 2 earnings calls, we're going to continue dropping some to the bottom line into the free cash flow while utilizing some of the savings potential to cross-subsidize those start-up investments that we need to make in the direct-to-consumer world. Now with all that being said, I don't want to take credit for everything here because clearly, from a CFO perspective, this COVID situation's had some very weird windfalls in the cost structure. We've had several months now with literally 0 T&E expenses. Some marketing expenses have come down, et cetera, et cetera. And clearly, a lot of that is going to come back, biggest factor maybe being the content productions. We have found a lot of replacement programming, and we have restarted some of the productions. About 1/3 of the production that were put on hold, we have restarted at this point. But obviously, as everything else comes back, some of those costs are going to come back into the baseline as well. But I can tell you, Jessica, we'll continue to be very disciplined on this. And it's not sort of just a vision or objective, but we have very specific initiatives that we're still working on.

So before we get into programming and sports and stuff like that, let's just talk about free cash flow, which you mentioned. Obviously, despite all of this investment into direct-to-consumer, your free cash flow profile still remains robust. You just announced you'll be allocating 50% of free cash flow to buybacks. Why 50%? And how do you think about the uses of cash left after repurchases? Do you want to bring leverage down further? Like just how do you think about it?

Okay. Well, number one, I continue to be really amazed about the free cash flow potential that we have. Our cash conversion now for several years in a row has been fantastic. And similar to what I said about the general transformation, we have a long list of other things that we're still working on that are going to continue help us generate these free cash flow numbers and this free cash flow improvement. And also, just while we're at it, we've obviously modeled different outcomes for 2020 as well, with the crisis impact on revenues, working capital, et cetera. And again, I pointed out some of the positive drivers as well, and we all know that some of that is timing. But the reality is through this point in the year, we're still pretty much in that $3 billion range from a trailing 12-month perspective, give or take. And we're working really hard to offset whatever negative impacts we're getting. And clearly, as we go into the balance of the year now, as I pointed out, there's going to be content production expenses, cash out for IP rights, et cetera. Some working capital impacts may be coming in, but I feel pretty good about how we're continuing to optimize that. Number two, from a priorities perspective, I'm going to keep giving the same answer again and again. Our priorities haven't changed. We are making every investment in the future of this company. And I will tell you that just this morning, David sort of pointed out again, if this is what it costs, then we'll spend the money. We have conviction about where we're going, and we're investing into the organic growth of this company. M&A, same thing. We will be looking at everything. Bruce Campbell and his team are probably involved in every process that's going on globally. But as we pointed out several times before, we have a very disciplined approach and a high bar because, number three, we continue to believe that our equity is incredibly cheap and incredibly attractive. We have conviction about the future of this company, and we don't believe that, that's reflected in the share price. And that's why we want to take advantage of that and continue to return capital to shareholders. Now you may ask, why only 50% and why not more? At the same time, obviously, we want to be diligent. I mean debt as well is just incredibly attractively priced right now. So we will continue to take advantage of that environment and use the leverage of our balance sheet, but we want to do that in a responsible way. And I have said many times, we are fully committed to our investment-grade rating. And therefore, this 50-50 allocation to shareholder returns on the one hand and then building some cash and working on leverage on the other hand feels the right approach for now.

So let's go on to sports. Sports programming expenses will be more back half weighted due to the suspensions that we've seen earlier in the year due to COVID. Can you give us some detail or color on what the cadence of spend, what it will look like relative to a normal year?

Yes. I mean again, I don't want to sort of go into sort of detailed numbers here, but you should assume that essentially between March and June, the best part of our content rights in the sports space just weren't expensed. There was a significant reduction. So by that rationale, you would now have to expect a second half of the year as those events come back essentially carrying the best part of a full year's worth of expenses, yes? So there's going to be some of that. Obviously, on the revenue side, there is going to be some pickup as well as our sports subscriptions start growing again and as advertisers are coming back. But from a net-net profit perspective, we have had a bit of a tailwind in the second quarter, and we'll have a headwind in the third and fourth quarter.

I mean you won't be the only ones, but anyway. So in less than a year, you have the 2021 Olympics, let's hope that they actually do happen. With the Winter 2022 Games following shortly thereafter, what new opportunities could be created from this -- really unprecedented -- having Olympics so close to each other, how do you think about the selling and output of rights? And do you think you can breakeven on these games? You were expecting a big loss in '21 -- I mean with 2020.

Yes. I mean we -- to start with that last part, we constantly sort of update our planning model for the entire lifetime of the deal. And we 100% continue to expect to breakeven on the deal. The postponement of the 2020 games was a big -- we were ready, but it's obviously very understandable. It's one of the reasons why we had to cut back on our direct-to-consumer growth expectations. It would have obviously been a great platform to push some of our products. That being said, again, we're going to be ready for '21. We have been able to continue working on our sports broadcast technology. The Cube, the virtual studio that we're using, it's being used elsewhere now on the U.S. Open, for example. It's pretty fascinating technology, and we are going to be able to create an even better viewing experience next year at much better efficiency as well. So from that perspective, an extra year of development has helped. And to your point, from a go-to-market perspective, if you remember -- and when we spoke about the 2018 games, we -- I had to explain a lot, speaking with investors, this discrepancy between the European market and the U.S. market, whereby in the U.S., there's always been a clearly advertising-funded product with big importance in the advertising community. Whereas in Europe, the Olympic Games had always been more of a sort of free-to-air public service-funded event. So we've had to work hard to sort of build that market, if you wish. And from that perspective, the team is excited now about the ability to essentially take over an entire 9-month period and sort of keep running that theme and to be able to offer interesting longer-term deals to advertisers, et cetera. It's obviously a much better position to have those games essentially back-to-back as opposed to those short period every 2 years or so. So there's a bit of a positive there. I certainly hope that the games are going to go ahead, and that's what it looks like right now. I think if we have reason to postpone again, what is that, 10, 11 months from now, then we're probably dealing with another problem. So...

Right. Right. I'm going for a double question on programming because it's more like probably a minute left. But you have a diverse range of programming from nonfiction to sports, to kids on a global basis. I'm just wondering like how does the rollout of exclusive direct-to-consumer platforms by some of your peers, whether it's Disney or NBCU or AT&T, how does that affect your programming strategy, if at all? And then in general, with so many buyers in the market right now, with all these SVOD platforms buying, how do you keep a lid on programming costs? How does that affect your cost structure?

To start with your first question, it really doesn't change the way we look at programming. I think we know very well, and our creative teams are very good at sort of creating the content that resonates in our brand portfolio. And we have been doing this for 30 years. We're very good at it. We're a big and important programmer in the space, which our production companies and a lot of the talent values very much. So as David has said a couple of times, you've got sort of that crowded scripted field, and then you've got the area that we're playing in, in sort of real-life entertainment that we're very good at. So there's really not a big change to that. It's very clearly differentiated, and it works. We're gaining share across the globe, and we have people who haven't signed up for cable come through other ways to get access to our content. From a cost perspective, several things to mention. Number one, right now, we're benefiting a little bit from sort of lower cost replacement programming in the COVID environment. Long term, I want to be clear that if we emerge into a scenario where this virus isn't around and security and safety protocols have to be implemented, et cetera, that's going to be a headwind from a cost perspective. Hopefully, those 2 are going to balance each other out to some extent, but that's something that I do want to point out. And from a competition perspective, listen, again, we've been doing this for 30 years. We've got great partners. And to some extent, our talent -- our on-air talent knows and production companies as well, there's a difference between sort of the ability to work with us, get into 300 million-plus households on a global basis in prime time, build those brands and, in case of success, going to many, many seasons of productions as opposed to the more short lived and, in most cases, more niche kind of a deal and positioning that they're getting in the world of the SVOD players. So I feel very good about this.

Right. With that, thank you so much for joining us. It's great to see you. Thank you, Gunnar.

Thank you. It's great to be here.