Warner Bros. Discovery, Inc. (NASDAQ:WBD) Q1 2023 Earnings Call Transcript

Warner Bros. Discovery, Inc. (NASDAQ:WBD) Q1 2023 Earnings Call Transcript May 5, 2023

Operator: Ladies and gentlemen, welcome to the Warner Bros. Discovery, Inc. First Quarter 2023 Earnings Conference Call. [Operator Instructions] Additionally, please be advised that today’s conference call is being recorded. I would like to hand the conference over to Mr. Andrew Slabin, Executive Vice President, Global Investor Strategy. Sir, you may now begin.

Andrew Slabin: Good morning and welcome to Warner Bros. Discovery’s Q1 earnings call. With me today is David Zaslav, President and CEO; Gunnar Wiedenfels, our CFO; and JB Perrette, CEO and President, Global Streaming and Games. Before we start, I’d like to remind you that today’s conference call will include forward-looking statements that we make pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. The forward-looking statements include comments regarding the company’s future business plans, prospects and financial performance. These statements are made based on management’s current knowledge and assumptions about future events and involve risks and uncertainties that could cause actual results to differ materially from our expectations.

In providing projections and other forward-looking statements, the company disclaims any intent or obligation to update them. For additional information on factors that could affect these expectations, please see the company’s filings with the U.S. Securities and Exchange Commission including, but not limited to the company’s most recent annual report on Form 10-K and its reports on Form 10-Q and Form 8-K. A copy of our Q1 earnings release trending schedule and accompanying slide deck is available on our website at ir.wbd.com. And with that, I am pleased to turn the call over to David.

David Zaslav: Hello, everyone and thank you for joining us. We have had a very busy and productive year thus far. And while we have lots more to do and more to attack and we are aggressively doing just that, the diversified nature of our company continues to provide a strong foundation that enables us to weather challenging environments, like the one we are in and still generate meaningful free cash flow. We expected the marketplace to be challenged. And with clear eyes, we remain confident in our strategy and our ability to generate free cash flow and end this year below 4x levered with our streaming service as a tailwind. Gunnar will take you through the specifics. But for some perspective, on a trailing 12-month basis, we generated $2.1 billion in free cash flow, even after absorbing $1.2 billion in cash restructuring and merger-related costs.

Turning to the quarter. While Q1 is seasonally our weakest and we saw challenging revenue headwinds, mainly on the Linear TV and Studio sides, we are on track to achieve this year’s financial targets and we see a number of positive proof points emerging across our businesses with direct-to-consumer, perhaps the most prominent. We have strong command and control of our DTC business. We made a meaningful turn this quarter, generating $50 million in EBITDA and adding 1.6 million new subscribers and we feel really good about the trajectory we are on. We now expect our U.S. DTC business to not only breakeven ahead of schedule, but to be profitable for the year 2023, this year, a year ahead of our guidance. And it’s worth noting, HBO Max and Discovery+ are still only available to less than half of the global streaming market.

So there is significant runway ahead of us and we are attacking this opportunity. Max launches here in the U.S. on May 23, with Latin America to follow later this year and markets in EMEA and APAC in 2024. And the service looks terrific and is a broad and compelling offering for everyone in the family. We anticipate having a healthy pipeline of our new content added to Max monthly. And recognizing that one of the real advantages we have as a company is the strength and depth of our franchises, including Harry Potter for a decade, Game of Thrones and D.C., we are delivering on our commitment to reinvigorate the best of them with new exciting stories for fans around the world. While at launch the Max offering will feature the full range of entertainment, this is really just the beginning.

We are actively working on options to expand our lineup to include news and sports acknowledging that this live programming has the power to keep consumers coming back for more and staying longer. We look forward to sharing further details with you in the months ahead. As part of our marketing campaign, under our One Company strategy, we are taking full advantage of the range of available media assets company-wide to include our U.S. cable networks and our popular digital outlets like Bleacher Report and cnn.com. We are planning to rollout Max in most key markets around the world. In an effort to reach the broadest possible audience and in keeping with our second strategic pillar, to monetize our content in the most financially advantageous ways, we are also going to continue pursuing other licensing and output deals in markets where either that makes better strategic and financial sense, or where HBO Max isn’t currently available, often with paths to eventually launch Max when we are ready.

Our recent deals in Canada and India, for example, are very lucrative with no expenses against them. We already own that content. How we serve consumers is important, but the wealth of our media assets, brands and IP, and our ability to deliver diverse, high-quality content that viewers want to watch and will pay for is what truly differentiates us and makes the opportunity we have to drive real value so compelling. It’s the reason we brought these two companies together. This year, we celebrate Warner Bros. 100th anniversary. This studio has historically been the crown jewel of the industry and we are working hard to rebuild it to its former glory. We are driving meaningful, creative momentum with more and more of the most talented storytellers in the business choosing to partner with us.

On the film side, after a very challenging year at the box office, we are excited and optimistic about the slate of movies coming, including Dune 2, Barbie and DC’s Blue Beetle and The Flash. We screened the flash at CinemaCon last week and early reactions have been overwhelmingly positive. We are committed not just to expanding the size of our film slate next year, but even more important, we are committed to making great high-quality films that have an impact. As I have said many times, and we believe it, it’s not about how much, it’s about how good. One of the real strengths of our company is the diversity of our storytelling. And in this centennial year, we are especially excited to be reinvigorating our feature animation business, which has a long history and a wealth of great IP.

Bill Damaschke, the former Head of DreamWorks Animation, has taken the helm of our film animation group and is hard at work together with Mike and Pam developing a new slate. While at DreamWorks, Bill oversaw hit productions, including Madagascar, Kung Fu Panda, How to Train Your Dragon and The Croods and is a great addition to our all-star team. On the interactive side, we are also seeing continuing momentum in our gaming business. Hogwarts Legacy has amassed more than $1 billion in retail sales and over 15 million units sold worldwide to-date. And today, the team is launching the game on the PlayStation 4 and Xbox One platforms. This is our fifth $1 billion plus gaming franchise alongside Mortal Combat, Game of Thrones, our LEGO games and DC.

And there is lots more games coming, including Hogwarts Legacy on Switch later this year. Another area we are very focused on is ad sales. While our results for Q1 continue to reflect the current soft ad market, we are optimistic for a gradual improvement and an eventual upturn in the second half of the year. In a couple of weeks, we will host our Upfront. Last year’s Upfront was right on the heels of closing of our merger. And since then, we have refined our sales organization and our approach and the team is executing against what we believe is a strong strategy. We are also advantaged by the diversity and strength of our ad-supported platforms. In particular, sports and streaming are two key areas for this year’s market and we are extremely well positioned in both.

Photo by Chase Yi on Unsplash

Looking ahead to the next couple of months, we will host the NBA Eastern Conference Finals in a few weeks. Given the 4 teams in the mix, it’s shaping up to be a great series. And in June, we have got the Stanley Cup Finals on TNT. The first time ever that one of the four major professional team sports will air its final series solely on a cable network. We are very excited about that. On the direct-to-consumer side, we now have more than 15 foundational advertising partners, purely on HBO Originals something you couldn’t buy just 3 months ago and a truly unique offering for brands. The Mercedes-Benz title sponsorship of Succession is a good example and a first-of-its-kind opportunity. The combination of impactful campaigns and a limited ad watching experience for consumers, on average, ad-supported subscribers will see 1 to 2 minutes of ads per hour, represents a real win-win for all involved.

When you consider the quality of the service, the attractive price point and the limited amount of advertising, it simply can’t be beat. We are also providing huge value to advertisers by creating these Sunday night buzzy shows like Euphoria, Game of Thrones, The Last of Us, and of course, Succession. These shared experiences enable advertisers to build the desired reach quickly. This is expected to be a big year for news as well with the Presidential cycle kicking off soon. We anticipate real growth out of CNN and we will be selling heavily into the Upfront for town halls, primaries and conventions. Needless to say, we have got a lot of irons in the fire and this busy year is looking to get even busier. We are driving leverage down, generating free cash flow and continuing to build a sustainable business for the long-term.

And as the macro environment begins to improve, we believe given the efficiencies we have put in place, command and control, and our diversified portfolio of media assets storytelling IP and talent, we are strongly positioned to achieve even higher free cash flow and EBITDA heights, and ultimately, meaningfully grow shareholder value. And now, I will turn it over to Gunnar and he will take you through the financials and the specifics of the quarter and what’s ahead. Gunnar?

Gunnar Wiedenfels: Thank you, David and good morning. On balance, I am very pleased with where we are and very encouraged by the progress of our priority initiatives, which are all moving forward as planned. We generated 12% constant currency EBITDA growth this quarter a strong starting point for the year and also the first quarter of EBITDA growth since closing the merger. I remain confident in our guidance of adjusted EBITDA in the range of low to mid-$11 billion and one-third to one-half conversion to free cash flow, with net leverage at the end of 2023 comfortably below 4x. As always, there are a number of moving pieces and this quarter is no exception, so I’d like to address the key puts and takes impacting our results and outlook.

Starting with D2C, as we enter this next leg of the journey, kicking off with the launch of Max on May 23, we are already very pleased with the traction we are seeing, having generated $50 million of EBITDA this quarter. Perhaps more importantly, we are continuing to see improvements across key operating KPIs, such as in our retention metrics. We also added 1.6 million subscribers globally in part due to the strong creative success of The Last of Us. We have driven a healthy amount of lasting efficiency improvements across this business through the initial phase of D2C integration. In fact, D2C operating expenses were down over $760 million or 24% excluding FX on a pro forma basis in the first quarter. All of this now provides much greater clarity on the path forward to establishing a sustainable platform setup for dynamic and profitable growth for years to come.

As we relaunch here in the U.S. and plan additional launches later in ‘23 and into ‘24, we will continue to be guided by a focus on prudent and rational investment. Additionally, we have benefited from greater insight into the efficiency and effectiveness of our marketing efforts over the last 12 months and we have seen that we can do more with less. As JB noted, during our precedent, we will undertake the largest marketing campaign in the company’s history to support the launch of Max. This was of course anticipated in our internal budget and guidance. We will continue to focus on driving efficiencies throughout our D2C non-content cost structure as we launch Max around the world and get more and more of our digital products on a common platform.

As such, we expect the D2C segment to continue to show improvements with peak EBITDA losses for the year in the second quarter. And when I say peak, I am talking around $300 million or so. In fact, we are tracking ahead of our profitability target and now expect to be profitable in the U.S. on a full year basis this year. That is a full year ahead of our original plan of breakeven in 2024. And I remain ever confident in our outlook of generating $1 billion or more of profitability in 2025 globally. Finally, I’d like to remind you about the approximately 4 million overlapping subscribers between HBO Max and Discovery+, consistent with what we outlined for you last summer. While we intend to keep Discovery+ going as a standalone product, we expect a large portion of these 4 million subscribers will likely churn off Discovery+.

The exact cadence of course being unclear at this time, but we do expect a fair amount of it to happen in the first few months after launch. Turning briefly to the other segments of our portfolio, starting with the advertising market. As expected, we did see a modest sequential improvement in Q1 when adjusting for the Olympics. And we do see this underlying trend continuing into Q2 on a like-for-like basis. That is after accounting for the NCAA Men’s Final 4 last year and the Stanley Cup finals this year, which combined will account for a net 200 basis points headwind to Global Networks advertising revenues. While we see this as encouraging, visibility remains limited and the improvement is gradual. Though the market remains challenged, we are cautiously optimistic, particularly coming into the Upfront, which will take place over the next couple of months.

With discussions ongoing, we will soon have a much better handle on Q4 in the 2023-2024 season. We see a particularly strong advertising opportunity on Max, both with respect to the more traditional ads on shows like Friends and Big Bang Theory as well as the very impactful and high-profile opportunity on Max Originals. You will hear a lot more about this at our Upfront presentation in a few weeks. Recall this really only kicked off in February and we are moving slowly and deliberately ensuring a high-quality, rich advertising experience and we see significant further upside for this product line, particularly when the advertising market improved. Briefly on our international markets. On the whole, they continue to perform relatively better, led by key markets like Poland, the Nordics and Italy, with the UK, Germany and Brazil on the weaker side, though as in the U.S., there is limited visibility.

In the Studio segment, there are a number of moving pieces that will be helpful to unpack. Obviously, Hogwarts Legacy was the key driver here, having performed amazingly well. It is thus far the best-selling game across the industry with over $1 billion in retail sales and it is on track to be a top game for all of 2023. Studios results were however negatively impacted by disappointing box office performance and this was exacerbated by a very difficult comparison against the success of The Batman last year. Similarly, TV licensing revenues declined year-over-year against certain large deal in Q1 of 2022. As David mentioned, we are coming up on the 2023 summer slide and early reviews and tracking for The Flash, premiering June 16 and Barbie on July 21, look very promising.

Both titles have enjoyed major buzz and we are leaning in. Keep that in mind for the second quarter when the Studio segment will see the expense associated with these marketing campaigns, while the revenue opportunity largely impacts Q3 and beyond. Now, let me provide some color on free cash flow, our financial North Star, as you know. As a reminder, free cash flow of negative $930 million in Q1 of this year is not comparable to the positive $238 million reported last year, as the latter represented Discovery as a standalone company. And while our first quarter free cash flow was negative, as guided to on our fourth quarter earnings call, we have made significant progress with strong improvement versus the underlying trends in the prior year when WarnerMedia had heavily negative free cash flows.

A few additional key factors to keep in mind. First, Q1 for both legacy companies has always been the seasonally weakest quarter in part due to the cadence of the production schedule over the year and the timing of certain payments, such as for sports rights. Second, Q1 and Q3 carry the additional burden of the semiannual coupon payment in large part for our merger bonds, an impact of over $800 million included in our Q1 free cash flow. Lastly, Q1 also contains significant and expected cash out from restructuring and integration costs, close to $500 million during the quarter. Given the quarterly puts and takes, I’d like to point to the trailing 12-month free cash flow to give you a better sense of the true run-rate. Our trailing 12-month free cash flow is now at $2.1 billion with a very clear path to our guidance range.

The key drivers for the balance of the year are: number one, expected adjusted EBITDA growth, back-end loaded this year as transformation initiatives continue to unfold, and hopefully, with a little help from the ad market backdrop. Even though, I should say, I have confidence in our guidance range even if ad sales don’t fully recover in H2 against a much easier prior year comp. Second, seasonally positive change in working capital versus a drag in Q1. Third, a significantly narrowing gap between cash content spend and amortization, as our D2C business absorbed sequentially higher amortization expenses, and we deploy content cash with a more and more rigorous focus on ROI. Finally, the cash benefit from key transformation initiatives will be backloaded over the year, while cash out for restructuring and integration will be more front loaded.

In fact, our trailing 12-month free cash flow number at the end of Q1 contains $1.2 billion of restructuring and merger-related cash costs in this line item. We expect that these factors will contribute to a higher conversion rate in the second half of the year and likely, again, with a disproportionate amount in Q4, not unlike our nearly 100% conversion rate in the fourth quarter of last year. Looking ahead to the second quarter, we are expecting to see a significant positive swing from negative $900 million in Q1 to around positive $900 million for a roughly cash neutral, maybe positive, H1 free cash flow overall. This will support further debt reduction this quarter on our way to sub-4x leverage. Separately, as you will see in our 10-Q, we temporarily drew down $750 million on our revolver in April to accommodate the intra-quarter timing of certain sports rights payments.

I expect this to be fully paid down by the end of this month. To sum up my discussion of free cash flow, the level of transparency into and focus on free cash flow and its drivers has changed dramatically over the past 12 months, and we are in a strong position to capture this tremendous value opportunity over the course of 2023 and beyond. In closing, as we lap the 1-year mark since closing the merger, candidly it feels like 3, I do come back to the statement I made a few months ago that we’ve turned the corner at WBD. I continue to view the structural heavy lift as more behind us than in front of us, and I see more and more opportunity with every day I am spending with the iconic brands and the massive global footprint of this combined company.

With billions and efficiency gains already in implementation, we really are still in the early innings of unlocking the full potential of Warner Bros Discovery. We remain as well positioned, as any, to lean into the many avenues of growth in front of us. With that, I’d like to turn the call back to the operator, and David, JB and I will take your questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] Your first question comes from the line of Doug Mitchelson with Credit Suisse. Please go ahead.

Operator: Your next question comes from the line of Robert Fishman with MoffettNathanson. Please go ahead.

Operator: Your next question comes from the line of Steven Cahall with Wells Fargo. Please go ahead.

Operator: Your next question comes from the line of Peter Supino with Wolfe Research. Please go ahead.

Operator: Your next question comes from the line of Bryan Kraft with Deutsche Bank. Please go ahead.

Operator: Your next question comes from the line of Jessica Reif Ehrlich with Bank of America Securities. Please go ahead.

Operator: Your last question comes from the line of Matthew Thornton with Truist Securities. Please go ahead.

Andrew Slabin: Great. I think that’s it. Thank you very much for joining. And we will speak with you soon.

Operator: Ladies and gentlemen, this concludes today’s conference call. You may now disconnect your lines.