Warner Bros. Discovery, Inc. (NASDAQ:WBD) Q1 2024 Earnings Call Transcript May 9, 2024
Warner Bros. Discovery, Inc. misses on earnings expectations. Reported EPS is $-0.27957 EPS, expectations were $-0.24. Warner Bros. Discovery, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Ladies and gentlemen, welcome to the Warner Bros. Discovery First Quarter 2024 Earnings Conference Call. At this time, all participant lines are in a listen-only mode. After the speaker’s presentation, there will be a question-and-answer session. Additionally, please be advised that today’s conference call is being recorded. I would now like to hand the conference over to Mr. Andrew Slabin, Executive Vice President, Global Investor Strategy. Sir, you may begin.
Andrew Slabin: Good morning, and thank you for joining us for Warner Bros. Discovery’s Q1 Earnings Call. Joining me today is David Zaslav, President and Chief Executive Officer; Gunnar Wiedenfels, Chief Financial Officer; and JB Perrette, CEO and President, Global Streaming and Games. Today’s presentation 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 may include comments regarding the company’s future business plans, prospects and financial performance and involve risks and uncertainties that could cause actual results to differ materially from our expectations. 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.
With that, I’d like to turn the call over to David.
David Zaslav : Hello, everyone. And thank you for joining us. As we kicked off the New Year, our focus was simple. To continue building this company for the future, recognizing that it’s not business as usual, and that we are transforming ourselves for what’s next in an industry undergoing tremendous disruption, largely driven by technological innovation impacting consumer behavior, and we’re embracing that innovation here at Warner Bros. Discovery, with bold and courageous decision making. To that end, we’ve had a productive start to the year, and we are pleased to see positive momentum building in several critical areas. Most notably, Max is gaining subscriber traction in all regions, adding 2 million subs this quarter with our total Direct-to-Consumer subscriber count nearing the 100 million mark, and while our U.S. subs will be impacted by some seasonality, particularly related to sports in Q2, we’re on track for continued robust international growth this quarter and new subscriber highs through the remainder of the year.
We’re also gaining ground in ad sales with an acceleration in Direct-to-Consumer and sequential improvement in linear this quarter, helped in part by a record March Madness Men’s Basketball tournament and steadier overall ratings. At the same time, we’re taking meaningful steps to rebuild our studios as the cornerstone of our storytelling engine, and we’re proud of the recent creative successes that have supported our Number 1 box office share this year, including Wonka, Dune: Part Two, and Godzilla x Kong. We’re excited about the quality and breadth of our future pipeline. We’re also leaning into the ways that new technologies like data-driven systems and AI can improve our consumer offerings and enable us to run our businesses more productively and effectively.
This is one of our top priorities. Regarding the balance sheet, we continue to see tangible results from our focus on transformation and efficiency. Even in our seasonally weakest free cash flow generation quarter, our free cash flow improved by $1.3 billion year-over-year to roughly $400 million in Q1 and $7.5 billion in trailing 12 month free cash flow. We will continue to opportunistically manage our capital structure evidenced by this morning’s debt tender announcement. While we’ve accomplished a lot over the last two years, we’re still just scratching the surface of our long list of to-dos that we see as catalysts for change and ultimately levers of growth for Warner Bros. Discovery. The current media landscape is increasingly dynamic, and in response, we’ve had to make some tough and at times unpopular decisions.
But we are doing what we believe is necessary to best position the company for the future. While transformation success is not easily measured in short-term months or even quarters, we’re very confident in the strength of our assets and believe we will see both strategic and financial progress in the quarters ahead. I’ll briefly touch on a few key operational milestones and objectives as we look out over the near-term landscape. On direct to consumer, this is a pivotal and critical year for Max with an aggressive relaunch and rollout underway that will meaningfully expand our global presence and growth potential. Since the start of the year, we’ve expanded from a single market in the U.S. to 39 countries and territories with the launch of Latin America, and over the next several weeks, we will roll the service out in over 25 additional markets across Europe, including our first new markets, France and Belgium, with more to follow.
We’re launching it ahead of the Paris Olympics. Max will be the only place where viewers across Europe will be able to watch every part of the Olympic Games. Our goal in 2024 is to drive top-line improvements and build upon the profitability we have achieved last year, while positioning us to achieve our $1 billion EBITDA target for 2025 with further growth beyond. We’re off to a strong start with nearly $90 million positive EBITDA generated this quarter, despite absorbing some of the launch cost of LatAm. But more importantly, we’re laying the critical groundwork and infrastructure from which we expect to build a broader and more profitable Direct-to-Consumer segment. Three key metrics underpin our strategic and financial objectives for Direct-to-Consumer.
The first is subscriber growth. As I said, we’re nearing the 100 million mark and see strong indicators of continued growth in Q2 and the remainder of the year. We’re also leveraging our best practices from the U.S. and LatAm rollouts, such as our strongest content slate yet, more partnerships in place to accelerate our rollout, an enhanced subscriber migration experience that reduces one-time churn and more optimized marketing investment. Second, engagement and monetization. Thanks to a combination of stronger content and product enhancements, engagement reached an all-time high, and we are taking meaningful steps to grow it further. The team continues to improve the product to deliver more personalized consumer experience, feature set, and more impactful content offerings.
Additionally, we grew global ARPU 4% in the quarter. This in part reflects a greater mix shift of lower ARPU international subscribers as compared to U.S. subscribers. This quarter, U.S. ARPU grew by a healthy 8%. While we still have lots to do, I am pleased to say the content lineup on Max over the next 12 to 18 months is one of the strongest ever. March was particularly strong with March Madness and Quiet on Set, a huge hit coming out of our ID Networks. In Q2, we’ll benefit from the third season of critically acclaimed series, Hacks, the streaming premiere of The Iron Claw and Dune: Part Two, Champions League in LatAm, and the June 16th premiere of Season 2 of House of the Dragon, which was one of the most successful series in terms of engagement and subscriber acquisition, just to name a few.
In addition to House of the Dragon, over the next 18 months, Max will premiere a robust combination of high-impact global original series, including Season 3 of The White Lotus, Season 2 of The Last of Us, Season 3 of And Just Like That, along with highly anticipated Tentpole original series, including The Penguin, Dune: Prophecy, IT, Welcome to Derry, A Knight of the Seven Kingdoms, a spin-off of the Game of Thrones franchise, plus an ongoing slate of fresh new Warner Bros. theatrical releases such as Godzilla x Kong, Furiosa, Beetlejuice, Joker 2, and more. The third metric is churn, which, while still above our longer-term target, continues to trend downwards, and in fact was at an all-time low in the US at the end of the first quarter. The bituality and diversity of viewing are the most correlated inputs to churn, and we saw continued healthy improvements in both in the first quarter, and with our even stronger content lineup coming over the next few quarters, as well as our ongoing user experience enhancements, we feel confident about our trajectory.
As you know, I have been a big proponent of bundling, and yesterday, together with Disney, we announced a first of its kind offering that gives US consumers the option of an Ad-Lite or Ad-Free package that includes Max, Disney+, and Hulu. The product will go live later this summer, and we couldn’t be more excited. Two of the world’s most storied content companies are joining forces to deliver consumers the best and most diverse offering of entertainment at a very attractive price, and in addition to the unprecedented consumer value this product will provide, there’s real business benefits as well. The modest overlap between the three services means we have an opportunity to drive incremental subscriber growth, and also because the consumers will have to retain all three, Disney+, Hulu, and Max, to take advantage of the price value in the offering, we expect this product will help increase retention and lower churn, and thus support higher customer lifetime values.
Finally, over time, if the bundle gets more traction, we will benefit from increased efficiencies and greater marketing effectiveness. The bundle will go live later this summer and we’re excited about what it could mean for our business going forward. Of course the heart and soul of our company is storytelling and we are using all the formidable assets and the greatest creative minds to tell the best stories in the best ways possible as we strive to return the luster to Warner Bros. pictures. Clearly this takes time and it’s not something that can be accomplished overnight. In the heavy lifting taking place under Mike and Pam’s leadership at Warner Bros. Pictures and under Peter and James at DC isn’t something that you see fully reflected yet in our financials.
However we are confident it will become more apparent with time and in fact we are seeing some strong proof points of our bold, more disciplined approach while we continue working through the remainder of the slate that was in place when we took over the business. Warner Bros. generated more than $1.8 billion in global box office since the start of the year and it was the first studio this year to reach $1 billion in both overseas and worldwide box office. They’ve got a great slate in the works. This morning I’m excited to announce that the team is now in the early stages of script development for the first of the new Lord of the Rings movies which we anticipate releasing in 2026 and will explore story lines yet to be told. Peter Jackson and his long-time writing partners Fran Walsh and Philippa Boyens are producing and will be involved every step of the way.
Lord of the Rings is one of the most successful and revered franchises in history and presents a significant opportunity for our theatrical business. Warner Bros. Discovery’s great storytelling IP including Harry Potter, Lord of the Rings, Superman and many other parts of the DC universe are largely underused. We are hard at work fixing that. It’s a core value and a key advantage for us. We have the characters and stories people love and yearn for everywhere in the world in every language. Unfortunately the studios Q1 financials were overshadowed by the tough comp at games following the great performance of Hogwarts Legacy last year and the disappointing release of Suicide Squad in Q1 in our gaming group. On the advertising front while, total company ad sales were down 7% in the quarter we continue to see sequential improvement Q2 to date led by what we anticipate will be our biggest direct consumer quarter ever.
As we highlighted last quarter and underpinning some of this improvement is the resiliency of international linear advertising primarily from our free-to-air channels in EMEA which outperformed in the quarter with positive revenue growth. This was primarily driven by robust revenue growth in Poland, Italy and Germany. These firmly entrenched legacy broadcast assets continue to serve as highly effective platforms for advertisers to reach consumers. While we just launched our international Ad-Lite offering in LatAm with EMEA soon to come these platforms will be critical to enhance our portfolio offerings. While linear has obvious secular challenges, we continue to see select opportunities. For example, US networks production hubs can be sources of popular high ROI content for both linear and streaming.
This is a benefit we will pursue where it makes sense particularly as a more intelligent Max platform helps to inform how we allocate content budgets across specific genres and verticals. For example, Max’s hit Quiet on Set which I mentioned earlier was created by the team at ID became the most watched title on streaming in its debut week with a massive 1.2 billion minutes of viewing time. The true crime vertical has great traction on Max and by leveraging the production scale at ID we will be able to curate additional series very effectively and efficiently that work across Max and our other distribution platforms. I mentioned AI earlier. We recognize that AI is going to have an increasing impact on society and our industry and we intend to take full advantage to enhance the products and experiences we deliver to consumers and to achieve greater efficiency company-wide.
We are focused particularly on improvements to our ad targeting and recommendation algorithms. Our AI-based understanding of our customers and content are being activated in our product, marketing, and ad sales, which you’ll hear more about at our next week’s Upfront. Since the initial launch of Max, we’ve been using AI and machine learning to personalize content discovery. We’ve continuously innovated to improve our models to present the right content in front of our consumers at the right time. And this is helping us to drive better content diversity on Max. We’ve also been leveraging AI to more efficiently and swiftly identify and optimize ad-break opportunities in our Premium HBO content, which typically does not have natural ad-breaks.
This has enabled us to offer the premium content on our Ad-Lite tier, and it’s also allowed us to create variable ad-load for our content as we monetize it using multiple tiers and platforms. We have dozens of other experiments across a spectrum of areas ranging from corporate and developer efficiency, to marketing optimization and targeting. All this experimentation is guided by clearly defined AI principles. We believe strongly that creativity and the kind of empathy and humanity necessary to create world-class storytelling can only be found in people, not systems. We also believe that AI is another in a long line of technology and tools that will enable creators to innovate and evolve how we tell stories and inspire audiences. Before I close, I want to mention a topic I know is top of mind for everyone, and that’s the NBA.
We’ve enjoyed a strong partnership with the NBA for almost four decades. We’re in continuing conversations with them now, and we’re hopeful that we’ll be able to reach an agreement that makes sense for both sides. We’ve had a lot of time to prepare for this negotiation, and we have strategies in place for the various potential outcomes. However, now is not the time to discuss any of this. Since we are in active negotiations with the league and under our current deal with the NBA, we have matching rights that allow us to match third-party offers before the NBA enters into an agreement with them. With that in mind, please understand that this is as much as we’re prepared to say about this topic today. These are challenging times for our industry.
There’s no question, but the reality is, and I tell my team this all the time, there isn’t a more exciting moment to be in this business. We continue to do the hard work to transform our company to drive meaningful growth in the future. We are positioning ourselves to take full advantage of opportunities that we see around us, and we’re more confident than ever in our assets and our playbook. With that, I’ll turn it over to Gunnar, and he’ll walk you through the financials for the quarter.
Gunnar Wiedenfels: Thank you, David, and good morning, everyone. I’d like to begin by spending a minute or two on the balance sheet and highlighting the key factors that underpin the $1.3 billion positive year-over-year swing in Q1 free cash flow in what is our seasonally weakest cash production quarter and where we typically see more cash outflows than in flows. Namely, number one, the continued benefit from the many initiatives to improve working capital, which we are still in the early innings of realizing. Number two, the more disciplined and analytical approach to content investment and allocation. Number three, meaningfully lower cash restructuring costs. And number four, lower cash interest expense as a result of the more than $6 billion of debt we repaid over the past 12 months.
The primary use of our free cash flow remains delevering the balance sheet. We remain committed to our gross leverage target range of 2.5x to 3x, and I’m confident that we will continue to make progress towards further delivering this year. We paid down over $1 billion of debt during the first quarter, including nearly $400 million from open market purchases at a discount. I continue to view our debt stack as an important and valuable resource. Our weighted average maturity is roughly 15 years with very manageable average annual maturities for the foreseeable future, with maturities in any given year significantly less than what our annual free cash flows have been, even normalized for the strikes. Our debt is virtually all fixed with an average cost of 4.6% in line with the yield on comparable US long-data treasury.
Based on the difference of current market value to book value, reflecting the current rate environment versus when issued, we have a $6 billion asset in our debt stack. And you should expect that we will begin to be more opportunistic in monetizing this asset as evidenced by the debt tender that we announced this morning. We intend to repurchase outstanding debt using up to $1.75 billion of cash. Turning to the segment results, I’d like to provide some brief commentary to supplement the discussions in the earnings release. Starting with Studios, the $400 million plus year-over-year decline in Q1 was primarily due to the very tough comp we faced in games against the success of Hogwarts Legacy last year in the first quarter, in conjunction with the disappointing Suicide Squad release this past quarter, which we impaired, leading to a $200 million impact to EBITDA during the first quarter.
This overshadowed an otherwise very bright spot from the contributions of recently released theatrical films, where we have had excellent traction to start the year. I’m excited that we have broken ground on a significant expansion project at our world class production facility in Leavesden, UK, a great example of where we are making long-term investments at the heart of our company with an attractive return profile. It’s also another example of how our new 1WBD processes are supporting the studio leadership team and combining creative excellence with overall financial discipline, while the studio business will always be characterized by hits and misses. With these more rigorous processes in place, I have no doubt that we should realize more upside for the bottom line with our hits, while reducing the bottom line drag from our misses.
Turning to D2C, we have successfully migrated the HBO Max subscriber base of Latin America over the past couple of months. To be clear, this was no easy feat, with 160 platform integrations that were required to migrate existing subscribers to the new service. This required significant management time and resources, and we transitioned subscribers with better than expected migration-related churn, in part attributable to the best practices from the US relaunch. An important outcome from the LatAm relaunch is the ability to now offer more consumer-friendly pricing and packaging across Ad-Lite, Ad-Free, and Premium tiers, with more flexibility in subscription options and additional paths to monetize the base. For example, installment billing for consumers who are unable to pay the full multi-month subscription price up front.
We will apply a similar approach to customer segmentation in EMEA. Levers of D2C growth include our significant opportunity to further scale the international subscriber base, while improving worldwide monetization. As we push further into this geographic expansion, we are taking a more holistic view of our distribution deals with partners that both distribute our linear content offering, as well as wholesale or our Max streaming service. Thus far, we have in many cases captured greater overall value to WBD while managing the transition from linear to streaming. And with our strong start in Q1, I expect us to remain profitable in the D2C segment during 2024, despite the heavy launch investments, and I remain fully confident in our path to achieve our $1 billion plus EBITDA target for 2025 and our growth ambitions thereafter.
One final note on D2C. Content revenue was down 46% during Q1, and as a reminder, we will have a more difficult comp in Q2, both of which are the product of timing of output deals renewed last year, availability of content, as well as our content utilization choices. Turning now to advertising, we did see sequential improvement both linear and D2C in the first quarter. Total company advertising in Q1 was down 7%, a sequential improvement of 300 basis points, and was supported by a 70% growth at D2C, which is beginning to scale nicely, and where we expect another record quarter in Q2. It also, in part, reflects an increasingly more holistic portfolio approach to monetizing viewership on both linear and Max, supporting our ability to offer our partners incremental reach and more customized ad solutions spanning all platforms, particularly in the US.
The trend in quarter-to-date linear cash pacings in the US continues to improve modestly, even excluding the positive impact of the NCAA Men’s Final Four and the Championship Games. As a reminder, we will benefit from having these games exclusive to WBD this year, but we do not have the Stanley Cup finals, and the exit of the AT&T SportsNet will continue to be a headwind to revenues with marginal profit impact through the end of Q3. Internationally, EMEA continues to be a standout bright spot, particularly in our free-to-air markets. Advertising revenue grew nicely in Q1, and we are seeing a continuation of this trend in Q2. Poland, Italy, and Germany were notable outperformers among the key EMEA markets. In fact, except for the UK and the Nordics, advertising revenues were flat to up in virtually all EMEA markets during the first quarter.
Though materially smaller, Latin America has been and continues to be a different story, particularly given cyclical and secular headwinds in Brazil and Mexico, our two largest markets in the region. And unlike in Europe, where we are a scale broadcaster in several markets, we are more exposed to the less resilient pay-TV ecosystem that is experiencing a more pronounced secular shift of advertising dollars to streaming. With Max now in the region, we have a growing Ad-Lite presence and are better positioned to capture a share of this migration. We look forward to updating you on our progress here, which, while early, is exceeding our expectations thus far. Finally, I’d like to update you on our continuing transformation efforts, where we’ve made enormous progress on capturing cost efficiency throughout the company over the last few years.
We continue to push forward with new initiatives and have added to the pipeline of opportunities. We now see a path to meaningfully exceed the more than $1 billion of remaining cost savings that we had previously guided to, which is on top of the more than $4 billion that we already realized through the end of 2023. I would best characterize these efforts as a continuous improvement mindset, having become muscle memory for the WBD team. We see tangible further benefits from consolidation of real estate, facilities and taking advantage of the great talent across our global capability centers. As well, we see meaningful savings from the ongoing consolidation of one dozen global content workflow systems. As noted, identifying opportunities to utilize AI to increase productivity in all facets of business operations remains a top priority that may drive further upside to our updated cost savings target.
I am proud of the continued progress we are making to best position Warner Bros. Discovery to respond to the changes taking place in the industry. Indeed, this demands us making difficult and bold decisions. We are focused on doing what is right for the long-term health and sustainability of the business to best serve the need of customers and partners while positioning the company to drive long-term shareholder value. Now I’d like to return the call back to the operator. And David, JB, and I will take your questions.
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