Sinclair, Inc. Q3 FY2022 Earnings Call

Good morning, ladies and gentlemen, and welcome to the Sinclair Third Quarter 2022 Earnings Conference Call. At this time, all participants have been placed on a listen-only mode. And the floor will be open for questions and comments after the presentation. It is now my pleasure to turn the floor over to your host, Lucy Rutishauser, Executive Vice President and CFO. Ma'am, the floor is yours.

Thank you, operator. Participating on the call with me today are Chris Ripley, President and CEO; Rob Weisbord, President of Broadcast and Chief Operating Officer; and Steve Zenker, Vice President of Investor Relations. Before we begin, I want to remind everyone that slides and supplemental information for today's earnings call are available on our website, sbgi.net, on the Information page and on the earnings webcast page. I also want to remind you that today's call is a Sinclair-only call. A separate public call for Diamond Sports Group will be hosted in a couple of weeks. Now Billie Jo McIntire will make our forward-looking statement 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 in the company's most recent reports as filed with the SEC and included in our third quarter earnings release. The company undertakes no obligation to update these forward-looking statements. The company uses its website as a key source of company information, which can be accessed at www.sbgi.net. In accordance with Regulation FD, this call is being made available to the public. A webcast replay will be available on our website and will remain available until the next quarterly earnings release. Included on the call will be a discussion of non-GAAP financial measures, specifically adjusted EBITDA, adjusted free cash flow and leverage. The company considers adjusted EBITDA to be an indicator of the operating performance of its assets. The company also believes that adjusted EBITDA is frequently used by industry analysts, investors and lenders as a measure of valuation. These measures are not formulated in accordance with GAAP and are not meant to replace GAAP measurements and may differ from other companies' uses or formulations. The company does not provide reconciliations on a forward-looking basis. Further discussions and reconciliations of the company's non-GAAP financial measures to comparable GAAP financial measures can be found on the company's website, www.sbgi.net. In addition, given the deconsolidation of Diamond on March 1 of this year and in order to have a meaningful discussion around comparative results and trends, all discussions of prior financial reporting periods during this call reflect Sinclair-only pro forma numbers and thus exclude Diamond and any intercompany transactions with them and exclude businesses sold in the prior 12 months. For actual results, including the periods that Diamond was consolidated, please refer to this morning's earnings release. Chris Ripley will now give you an update on the strategic direction of the company.

Good morning, everyone. I'm going to keep my comments relatively brief as we covered a lot of ground at our Investor Day just weeks ago on October 3. Our results for the quarter were in line with our revised expectations provided during our recent Investor Day. Political revenues remain robust, and as mentioned on Investor Day, we're still expecting a record midterm political year. With a week remaining until election day, our full year political estimate is $335 million to $340 million, which is in the $325 million to $350 million range we gave on our Investor Day. Rob will give you more color on the advertising environment in just a minute. Our total adjusted EBITDA of $198 million was within our guidance range, aided by lower-than-expected expenses. During our Investor Day, we spent a fair amount of time on our growth initiatives. When you look at the future of Sinclair, it will be driven by our current television station assets as well as our growth initiatives. These initiatives fall into four categories: multi-platform content, marketing services, data distribution, and community interactivity. A key aspect of our growth strategies is creating additional revenue streams to both incrementally monetize our linear audience and our 80-plus million unique digital viewers, as well as drive new uses for our broadcast spectrum. Today, Sinclair achieves the vast majority of its revenues from linear advertising sales and distribution. We believe these growth initiatives will unlock significant revenues rivaling today's two revenue sources. And we also have our investment portfolio, which we currently estimate is worth approximately $1.2 billion or close to $17 per share. It has generated an internal rate of return of approximately 20% since 2014. I'd like to take the time to give you more insight into this portfolio. It currently consists of real estate, private equity, venture capital investments, and direct investments in companies. The real estate investments are in a number of different properties that are almost all producing, and Sinclair has a majority ownership in most of them. Many are apartment buildings with occupancies over 90%. The earliest real estate investments were entered into as far back as 2007. There are also commercial projects in which the company has an ownership interest. The private equity and venture capital investments are generally minority investments and funds that invest in many different areas, including middle-market companies in the U.S. and India, as well as specific industries, including technology, manufacturing, and environmentally focused services. Sinclair also has minority direct investments in 14 companies, including Bally's and Playfly Holdings, which is a full-service sports marketing company operating at the intersection of sports, media, and technology. Other investments include companies in advertising security software, wireless communication, and semiconductors, and broadcast cloud production. The final piece of the investment portfolio is the Diamond accounts receivable facility loan, which advances funds to Diamond for a portion of its accounts receivable balance. The counterparty risk is with Diamond's customers, such as the big distributors with which we have a relationship in our broadcast business. So these are customers we know well and with which we are comfortable. The rate we have earned on this investment this quarter averaged 6% to 8%. During the quarter, we made additional investments of $6 million in our portfolio and received distributions, including exit payments of $52 million. For the full year 2022, we projected investments of approximately $68 million and distributions including exit payments of $137 million. When you look at the adjusted free cash flow we generate, excluding Diamond's consolidated results for the first two months of the year, Sinclair currently trades at a free cash flow yield of approximately 50%, which is more than double the broadcast industry average and an even greater disparity to major market indices. Simply put, we believe we're grossly undervalued and have continued buying back our shares as one way to enhance returns. Before I turn it over to Rob, I wanted to mention the series of automotive seminars that began last week and which highlight the benefits of over-the-air data distribution for the auto industry. I think you'll find this very enlightening on the significant potential of ATSC 3.0 for data transmission, which offers wide coverage and high reliability at attractive costs. Now I'll turn it over to Rob, who will give you some greater color on the advertising market and our third quarter results.

Thanks, Chris. Total media revenue for the quarter increased 5% over last year. Political ad revenues were strong during the quarter, outpacing 2018 pro forma results by 28%. Year-to-date political ad revenues through the third quarter are up more than 50% over 2018 pro forma and only down 2% over 2020 pro forma, which was a presidential election. October continues to see strong political spending, leading us to project the full year to range from $335 million to $340 million. As Chris mentioned, this would be a record midterm election year for us and would represent an over 30% increase above 2018. The strength in political is the primary reason for core advertising declining versus a year ago as well as the absence of the Olympics and the weakness in the insurance and sports betting categories, which are really not macro but industry causes. We are keeping an eye on how the macro economy might affect us, and we will have a better grasp on demand once the elections are over. We have built into our Q4 guidance some impact from the macro environment and the impact of higher interest rates on consumers. I do want to point out, a couple of weeks ago, we announced a multi-platform creative partnership with Anthony Zuiker. Anthony has created the CSI franchise, and he will help develop content for Sinclair in a number of different areas. The partnership with Anthony underscores our commitment to creating an original program that can be not only utilized on Sinclair platforms but sold to third parties as well. More importantly, Anthony intends to use our deep news content library to bring these stories to life. During the quarter, we launched an enhanced CRM and more in-depth artificial intelligence and machine learning pricing model to be utilized on a forward basis in 2023 and beyond. The revenue model that utilizes algorithms similar to what is used for hotel and airline pricing, facing pricing and supply and demand dynamics. I'll now turn it over to Lucy to go more in depth on the financials.

Thank you, Rob, and good morning, everyone, again. As I mentioned, you can follow along with our slide deck and our financial supplement on our website. Media revenues for the quarter were up 5% versus the same period a year ago driven by higher political ad revenues and higher distribution revenues, offset in part by lower management fees and lower core advertising due to political crowd-out and the other factors Rob discussed. The $836 million in media revenues, while below our guidance range, was primarily due to the timing of political, which we expect to capture in Q4; softness in a couple of ad categories; and higher core advertising crowd-out in certain markets where political is running very strong, themes, all of which I mentioned at our Investor Day. Distribution revenue increased 1% versus last year, but fell short of our guidance range due to higher-than-expected subscriber churn, which was still in the mid-single-digit range versus last year. Looking at total advertising, it was very robust when including political revenues increasing 15% over last year. Core advertising decreased high single digits in the third quarter compared to the same period a year ago as a result of the absence of the Olympics and political crowd-out. The shortfall of the guidance was primarily the result of certain categories that came in lower than expected and increased crowd-out in markets with hotly contested races where political is running stronger than anticipated. Media expenses were 5% higher in this year's third quarter versus last year on higher network programming fees and higher sales and G&A expenses but were favorable to guidance. Adjusted EBITDA for the quarter grew 5% over the third quarter of last year mainly on the strength in political revenues, partially offset by the Diamond management fee deferral and the higher expenses as discussed. As compared to guidance, our $198 million of adjusted EBITDA came in at the low end of our guidance range. Adjusted free cash flow of $170 million in the quarter also was within our guidance range with adjusted free cash flow per share of $2.43 for the quarter and diluted earnings per share of $0.32. We increased our cash balance by almost $200 million during the quarter for an ending balance of $607 million and when combined with our undrawn revolver put our liquidity at more than $1.2 billion at quarter end. Total debt at the end of the third quarter was $4.3 billion, and STG's first lien indebtedness ratio on a trailing eight quarters was 3.3 times, while total net leverage through the bonds was 4.1 times. During the quarter, we repurchased approximately 500,000 common shares under a 10b5-1 stock buyback program and an additional 300,000 shares since September 30. That brings our year-to-date share repurchase to approximately 7% of our total shares outstanding at the beginning of the year. Our total share count at the end of the quarter was 69.9 million. Turning to our fourth quarter guidance. I want to remind everyone that in the fourth quarter of last year, we experienced a cybersecurity incident that negatively impacted advertising revenues by approximately $63 million. As such, when comparing to 2021's revenues, I will speak to the adjusted pre-cyber revenues. To see the comparisons to last year's actuals, please refer to our earnings release from this morning. We expect a record amount of midterm political ad revenue for the fourth quarter of $174 million to $179 million. And as already mentioned on this call, this would put our full-year political revenues at an expected $335 million to $340 million, which would be over 30% more than what we booked in 2018 and only down less than 5% compared to the 2020 pre-Georgia runoff presidential election year. Political revenues are the main driver for media revenues, increasing approximately 10% to 12% versus the cyber-adjusted fourth quarter last year of $862 million. Fourth quarter core advertising is expected to be down high single digit to low double-digit percent versus the cyber-adjusted fourth quarter last year, with the decline in core primarily driven by anticipated political crowd-out and mild macroeconomic weakness, as Rob discussed. Fourth quarter adjusted EBITDA is expected to be between $294 million and $313 million compared to $202 million pro forma last year, which is not adjusted for the cyber incident. The increase is primarily the result of the lost revenues from the cyber incident last year and higher political revenues this year, partially offset by the lower management fee, higher network programming fees, higher technology costs, crowd-out of core advertising due to political, and higher sales costs on the higher revenues. Adjusted free cash flow for the quarter is expected to be $385 million to $409 million or $5.52 to $5.86 per share. So with that, I would like to open it up to questions.

Our first question is from Dan Kurnos with Benchmark Company. Please go ahead.

Maybe, Rob, I guess just regarding the Q4 outlook on the macro impact, it seems your guidance aligns with our core assumptions. Could you share what you're observing, specifically if there are any weaknesses in certain categories mentioned in the release or if there have been any additional cancellations? Beyond the unevenness we’re hearing from the industry, what factors are influencing your guidance, especially considering that we don't have improved visibility past the election? That would be a helpful starting point.

Yes, Dan. I'll take it. It's Rob. As I indicated, from the sports betting, they crossed the 50% mark in the country for legalization. So where we saw that short-term increase in spending in that category, they've now gone the network as well as all the sports networks such as Diamond. And with insurance, because of losses they took from weather as well as COVID-related illnesses, we've seen a pullback in that. And that's more of the industry segment than the macro. And we'll get a better sense how the core is feeling about the macro company and the political because there are a lot of core advertisers sitting on the sideline based on the heavy political spending and the pricing that's taking place. So -- but we have not seen any key categories come in with any types of cancellations today.

Our next question is coming from Barton Crockett with Rosenblatt Securities. Please go ahead.

I have a couple of questions. First, I'm following up on the advertising categories, specifically in the auto sector. I'm curious about what you're observing there, whether you are starting to see improvements despite some challenges. I would like to know the current trend and if there are any additional macro concerns. Any insights on that would be appreciated. My second question relates to your statement about the 50% free cash flow yield, which is remarkable. It raises the question of why a company in that position would consider making significant changes to its share repurchase strategy. You have already reduced the share count by 7%. I'm interested in understanding how you could find a better investment opportunity than a 50% free cash flow return. This situation may lead to some skepticism about the 50% figure given your capital allocation choices. So, I’m wondering what factors would influence your decision or why you wouldn't pursue a large tender offer or a considerable adjustment in your share repurchase approach.

All right. Rob?

I'll address the auto sector first. We're now comparing against the impacts of the chip shortage and COVID, and we did observe year-over-year increases in auto spending. However, there are a few concerns that keep me up at night regarding that sector. In addition to the chip shortage, which seems to be improving, there is now a shortage of sheet metal. Toyota has announced that minivan production will be delayed for at least 18 months. Furthermore, the rising interest rates on car loans could have mixed implications. We believe that inventories will start to build up as interest rates rise, and Tier 3 dealerships will need to begin advertising to sell those vehicles, in contrast to the shortages they previously experienced.

Yes. Regarding your second question, we are nearing a 40% reduction in our shares outstanding due to share repurchases over the last three years. This year, we are approaching a 7% reduction. The activity has been quite significant, and we are committed to addressing our undervaluation. I expect us to remain aggressive in this area. Additionally, we frequently discuss our investment portfolio because when considering it as part of our overall value, it makes our valuation appear quite unusual. We are exploring ways to better highlight and recognize that value.

Our next question is coming from Aaron Watts with Deutsche Bank. Please go ahead.

I've got two questions. I guess, first, Lucy, can you remind me how much of your debt stack is floating rate? And can you also remind us if you have any of that floating rate exposure hedged and how rising rates, combined with the macro headwinds you cited, may or may not impact how much liquidity you keep on hand and capital allocation near term?

We have approximately 60% of our debt at a floating rate, which means that for every 100 basis points increase in rates, we expect an additional $27 million in interest expenses. With the Fed meeting today and an anticipated rate hike, we've factored that into our forward guidance. In the past, we've considered hedging, but the costs to secure those measures for several years have proven to be high. We have experience managing through downturns, having navigated challenges during the Great Recession and the COVID pandemic. We have established a strategy for these situations. As I mentioned last quarter, we have already instructed our management teams to reduce expenses, a process we initiated a few months ago which has positively impacted our expense results relative to our guidance. We have also refinanced our debt maturities, removing any refinancing risk for the next four years. Despite this preparation, we have additional measures we can take if necessary. It's crucial to be judicious with our spending, so we've engaged in buying back stock and debt at discounted rates, while still investing in growth areas, such as our key strategic initiatives. Lastly, in the event of a recession, we are entering that phase with robust liquidity, currently exceeding $1.2 billion.

One other question I had for you is just following the recent Disney ABC renewal. Any changes to your net retransmission fee outlook for the next three years? I believe you were speaking to a low to mid-single-digit growth rate. And maybe any general learnings or takeaways you can share from that recent ABC renewal with Disney, anything around rate increases or commitments to keep content on broadcast versus streaming platforms, etc.

Well, Aaron, when we last provided guidance, we anticipated a three-year CAGR of low to mid-single digits because we already had a good understanding of the economic outcome for ABC. This was factored into our projections. From our discussions and interactions leading up to that, we've noticed a shift in the negotiating dynamics with the networks as they focus more on streaming. They've repositioned some of their content and altered exclusivity terms, especially considering the significant reverse retransmission fees we currently pay. As a result, we observed a considerable decrease in the growth rates for reverse retrans that better reflect the value we contribute, the value they offer, and the current subscriber landscape. We're quite pleased with how things turned out at ABC. Moreover, we believe their commitment to the network has been increasing lately; they added more NFL content to ABC following the latest NFL agreement and secured other key sports properties. To our knowledge, there are no plans to cut prime time programming, which has been speculated about on other networks. We view them as excellent partners. We believed that the negotiation represented the beneficial relationship we share with them while also acknowledging the market dynamics and the give-and-take between both parties.

Our next question is coming from Edward Reily with EF Hutton. Please go ahead.

Just to echo Barton's comment, on the investment portfolio, I'm wondering if there are any scheduled monetization events for the next year that you might be able to recycle back into share repurchases.

There aren't any scheduled monetization events. However, there are several investments that generate income regularly, but it's not a large amount—around tens of millions. This year, we received $137 million in distributions and exit payments compared to investments of $68 million, resulting in a net positive of approximately $60 million to $70 million. I anticipate that next year will also bring further distribution and exit opportunities typical of this portfolio. If the economic environment isn’t as strong, those opportunities may occur at a slower pace than in the past. Aside from that, we generally expect these events to happen annually, but we don’t have clear visibility on what will transpire next year.

Yes, I would like to add that although Chris mentioned we don't have an exit scheduled, we do have one included in our free cash flow guidance, which is just over $20 million in exit distributions. This is factored into our guidance for Q4.

And I was wondering if you could maybe provide some color on just growth in digital. I might have missed that if you guys spoke to that earlier.

Yes. We continue to see growth in digital, so mid-single digits growth. Some of the growth was curtailed by the auto category. But we're seeing continued growth in the fourth quarter as well. Our assets that we've built, not only from our O&O but our marketing services, continue to be strong in the marketplace.

What's interesting, and we tried to highlight this at our Investor Day, is that when you take a look at our overall ad business, you've got the twin pillars of growth are political and digital. And they've compounded over the years, become quite significant in terms of size and are fueling overall growth in our ad business. So as they've gotten bigger, they've overwhelmed some of the other weaknesses in the core ad business. So we've been very pleased with that tailwind that we've had overall.

Our national team and local sellers engage in continuous education and training provided by senior digital leadership. This ensures that we are ready to capture digital revenue in the local marketplace as well as the income generated through programmatic channels.

Our next question is coming from Steven Cahall with Wells Fargo. Please go ahead.

Apologies as I joined a little late. So hopefully, what I'm going to ask hasn't already been covered. Just the first kind of big one on gross and net retrans. When we look at it on like a 4- or 5-year stack, it looks like that net retrans is below where it was in 2018, and gross retrans has definitely been slower than the peer group. So I'm just wondering how you all think about that, if you've done any of that comparative analysis. Have you been less aggressive on retrans rates because you've expected higher cord cutting? Is any of it have to do with RSN carriage? So would just love to get your perspective on why maybe the retrans growth levels have been a little bit below the peer group. And then I have a quick follow-up for Lucy.

I believe that some of our previous deals were made during a time when expectations were being lowered. One notable deal we previously mentioned was our renewed ABC affiliation deal, which had held us back for a couple of years. We're much more satisfied with the new deal. Looking ahead, this renewal is a significant reason why we set a three-year CAGR expectation during Investor Day. Although we don’t anticipate growth in net retrans for 2023, by the end of this year and the start of next year, we will have 70% of our subscribers from the distributor side. We see this as a tremendous opportunity to make significant improvements, which we believe will drive the three-year CAGR.

And then, Lucy, just on cash interest, we've done some modeling and it looks like cash interest could be up a lot next year based on the debt. It could be up even close to $100 million. So just wondering if you could comment on, based on where rates are today, how to think about cash interest in 2023. And just as it relates to cash, I know that what happens to Diamond is a bit of a what-if, but investors certainly care about what happens to the NOLs. The bond market is kind of implying that a Diamond filing isn't such a low-probability what-if anymore. So can you give us a sense of what happens to your NOLs if things do change for Diamond?

Yes. Steven, we can certainly provide you with details about our debt structure offline. Currently, 60% of our debt is at a floating rate. While I don't have the forward curve information at hand, you can estimate the impact on our variable rate debt. For each 100 basis points increase, our annual interest expense would rise by approximately $27 million. A $100 million increase would require a significantly steep rise in the curve, which isn't anticipated at this time. However, we can discuss the specifics offline, noting that we hold all fixed-rate notes as well.

Regarding your question about NOLs, the impact of the Diamond NOLs is not as significant as you might expect due to a considerable amount of disallowed interest at Diamond under current tax regulations, which continues to rise annually. While it's true that losing ownership of 80% or more of the equity would mean we could no longer benefit from those NOLs, they are diminishing anyway because of the disallowed interest.

Steve, I wanted to mention that we currently have a cash balance of $600 million, which is also earning interest. As interest rates rise, depending on your cash balance model, we will generate more interest income. So be sure to consider this aspect as well.

Our next question is coming from Dan Kurnos with Benchmark Company. Please go ahead.

You dropped earlier on the follow-up. But just, Chris, maybe I wanted to actually ask this back at the Analyst Day. Can you just talk about the profitability of tenants right now? And subsequently, given all of this and takes, and Lucy commented on this a little bit, as we go into next year, knowing that there's macro uncertainty, just how are you thinking about sort of the levers around investments next year around these growth initiatives? And obviously, pushing towards DTC, for example, antennas, how much of that's already been encapsulated versus considering pulling back just as to optimize cash flow has been getting messy in the short term?

Yes, that's a valid point. We have incurred at least $50 million or more in losses from our investments in Tennis alone, which equates to about $10 million annually. In the event of a downturn, we would adjust some of our spending. However, due to the strong growth opportunities in international markets, FAST channels like T2, and the direct-to-consumer initiatives expected to launch in 2024, we don't want to overly restrict our investment in Tennis. We believe it has significant potential to become a global brand. Nonetheless, if there is a downturn in 2023, we will prioritize our investment spending accordingly.

As there are no more questions in the queue, I will hand it back to Chris Ripley, President and Chief Executive Officer, for any closing comments.

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

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