Earnings Call Transcript - SPHR Q4 2023

Ari Danes, Investor Relations

Good morning, and welcome to Sphere Entertainment's fiscal 2023 fourth quarter earnings conference call. Today's earnings call will begin with our Executive Chairman and CEO, Jim Dolan, who will provide an update on Sphere. This will be followed by an update from Andrea Greenberg, President and CEO of MSG Networks; and then Gautam Ranji, our Executive Vice President, Chief Financial Officer and Treasurer, will conclude with a review of our financial results for the period. After our prepared remarks, we will open up the call for questions. If you do not have a copy of today's earnings release, it is available in the Investors section of our corporate website. Please take note of the following. Today's discussion may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Any such forward-looking statements are not guarantees of future performance or results and involve risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. Please refer to the company's filings with the SEC for a discussion of risks and uncertainties. The company disclaims any obligation to update any forward-looking statements that may be discussed during this call. On pages 5 and 6 of today's earnings release, we provide consolidated statements of operations and a reconciliation of operating income to adjusted operating income or AOI, a non-GAAP financial measure. And with that, I will now turn the call over to Jim.

James Dolan, Executive Chairman and CEO

Thank you, Ari, and good morning, everyone. I am pleased to be here today as we embark on our next chapter as a leading live entertainment media and technology company. We've recently completed a number of important transactions, starting with the two-thirds spinoff of MSG Entertainment, which was finalized in April. This was followed in May by the sale of our majority interest in Tao Group Hospitality. And in June, we sold approximately 40% of our retained equity interest in MSG Entertainment. These transactions have supported our growth plans for Sphere, a next generation entertainment medium that we believe will disrupt the traditional venue model. We remain on track to open our first Sphere in Las Vegas at the end of September, and I'd like to share our progress towards that highly anticipated opening. In June, we finished primary construction of the venue and are currently putting the finishing touches on the interior spaces as well as the exterior grounds. And this month, we completed installation and testing of the majority of the technological systems inside the venue. That includes our next generation immersive technologies, such as our interior display plane, Sphere Immersive Sound, an advanced concert-grade audio system, and 4D multisensory technologies that enable effects such as vibration, wind, scent, and changing temperatures. Taken together, these technologies will engage the senses and enable a fully immersive experience. This is essentially a new medium, which we call experiential. While it takes some time to reach its full potential, we have designed Sphere to be busy 365 days a year with multiple events per day. On October 6, we will debut The Sphere Experience. The Sphere Experience will come in two parts. The first part consists of a series of exhibits that chronicle technology's impact on the development of view and potential. It will begin with a replica of Gutenberg's printing press and take you through the creation of a metaverse and the development of AI. The visitor will be guided through this experience by animatronic robots that will utilize holographs, beam forming sound and a 50-foot translucent video wall. It will then continue in the main venue bowl where guests will be fully immersed in a multisensory cinematic journey from Academy Award nominated director Darren Aronofsky. And with more than 40 million visitors annually and over 2 million local residents, Las Vegas is the ideal market to debut this unique content. In addition to The Sphere Experience, we plan to host a wide variety of event types, including concert residencies. As you likely are aware, global rock band U2 will open the venue on September 29th with the first of their 25 shows. We expect to announce additional residencies shortly, which are slated to take place later this fiscal year. Sphere will also host marquee sporting events as well as corporate events with our first taking place in November with Formula 1's inaugural Las Vegas Grand Prix. F1 will have a multi-day takeover of Sphere's exterior and interior, as well as feature Sphere prominently as part of the track. This will be a high profile opportunity to showcase the venue to the millions of race fans watching around the world. Our event schedule through the remainder of the calendar year is now in place and we look forward to sharing more on calendar '24 in the coming months. Another significant opportunity is advertising and sponsorship led by Sphere's exterior, the Exosphere. Last month, the Exosphere's capabilities were unveiled in the July 4 shows that lit up the skyline. It featured a range of dynamic content that generated media coverage across the world and was shared widely on social media. To date, our estimated total reach is over 5 billion, a number that will continue to grow as we increase our engagement with audiences through new announcements and creative content. Following our demonstration of the Exosphere's capabilities, we've seen a significant increase in inbound interest from potential advertisers and marketing partners. In terms of premium hospitality offerings, Sphere in Las Vegas will have 23 VIP suites, as well as other unique hospitality spaces. We expect to license a number of these suites in multi-year agreements and are making progress towards this goal. In summary, Sphere is a brand new, never before seen medium, and we believe it will take the world by storm. We are excited for next month's opening in Las Vegas of what we hope is the first of many Spheres. You should not expect the venue to reach its full economic potential right from the start, but we're confident that we will get there over time as guests, artists, advertisers, and sponsors experience Sphere and all of its unique capabilities. And with that, I will now turn the call over to Andrea.

Andrea Greenberg, President and CEO of MSG Networks

Thank you, Jim, and good morning. As we look back at fiscal '23, we are proud to have delivered another year of exceptional sports and entertainment programming, highlighted by hundreds of live regular season telecasts across our five NBA and NHL teams, extensive postseason coverage for the Knicks, Rangers, Devils and Islanders, including 20 first-round games, a diverse slate of new and expanded content from Gotham FC soccer broadcasts to new sports betting programming on our digital platforms and bet casts across Knicks and Rangers games, the launch of our free ad supported streaming TV channel MSG SportsZone, and most recently, the debut of our direct-to-consumer and authenticated streaming offering MSG+. We were also pleased to have completed renewals with several distributors this past year, including with one of our largest affiliates. Turning to our financial performance for fiscal '23. While affiliate revenue reflected the impact of ongoing subscriber declines, we delivered strong growth in advertising. That included the impact of the playoffs, record aggregate advertising revenue for our NBA and NHL teams during the regular season, driven by higher per game advertising revenues, as well as growth in our non-ratings based initiatives, particularly branded content. We further benefited from the run rate impact of sports gaming, which once again was our single largest advertising category in fiscal '23, as well as the strong core of returning advertisers and increased demand from categories such as auto and financial services. With respect to adjusted operating income, our annual results also reflect the impact of the cost reduction program we implemented at the beginning of the calendar year, which has resulted in meaningful cost savings. But this was just one of the ways in which we believe our business is now better positioned going forward. As I mentioned earlier, in June, we launched our direct-to-consumer streaming product, MSG+, which now allows us to reach the millions of homes in our region who do not receive our networks through a traditional linear TV package. MSG+ is also available free of charge to authenticated subscribers of participating TV operators, replacing MSG GO as our authenticated streaming product. For most of these subscribers, MSG+ was installed as a seamless app update, establishing a strong foundation of engaged users for our new product following all-time high viewership and ad revenue levels on MSG GO this past season. Similar to MSG GO, MSG+ features our two linear networks, including all our live local NBA and NHL team telecasts, as well as other live sports events and programming. The consumer research we conducted shows that among fans who do not receive our network, there is significant interest in subscribing to a D2C offering that includes games of their local teams. These fans have the option to subscribe to MSG+ directly by purchasing a monthly subscription for approximately $30 or an annual subscription for approximately $310. They will also have the option to purchase single games for $9.99 each, a first of its kind offering for any regional sports network. We believe that this individual per game option will drive entry point transactions, wider reach and upsell opportunities. And I'd add that all of our direct-to-consumer price points are designed to help reinforce the value of the traditional bundle. Also, creating one unified app for both D2C and authenticated subscribers has allowed us to leverage existing efficiencies in place such as staffing, technology, and marketing, and has provided for wider availability on devices which will add value for viewers and advertisers alike. As we approach the start of the '23, '24 NBA and NHL seasons, we will begin our targeted marketing efforts for MSG+ and look forward to sharing more on our progress in the coming months. So while we remain mindful of the evolving media landscape, we are proud of our achievements this past fiscal year, and we'll look to build on our strong track record of innovation in sports programming in the year ahead. With that, I will now turn the call over to Gautam.

Gautam Ranji, Executive Vice President, CFO and Treasurer

Thank you, Andrea. Now let's review our financial results. Since we completed the spinoff of MSG Entertainment and the sale of our majority interest in Tao Group Hospitality during the fiscal fourth quarter, both businesses are reflected as discontinued operations for all periods presented. In addition, results through the April 20th spinoff date include certain corporate overhead costs that Sphere Entertainment did not incur after the date of the spin and does not expect to incur in future periods, but did not meet the criteria for inclusion in discontinued operations. On a total company basis, we generated revenues of $129 million and an adjusted operating loss of $60 million for the fiscal '23 fourth quarter. This included $90 million of adjusted operating loss in the Sphere segment, which primarily reflects corporate overhead expenses related to Sphere Studios and associated content and technology development, as well as costs related to the Las Vegas venue as we prepare for the opening next month. We expect Sphere operating costs to increase in the fiscal '24 first quarter as we ramp up operations in Las Vegas. With the venue opening on September 29th, Sphere's impact on our financial results will really begin to show in our fiscal second quarter, including U2's multi-month run, the debut of The Sphere Experience featuring Postcard from Earth and Formula 1's multi-day takeover in November. Turning to MSG Networks, the segment generated $128 million in revenues and $31 million in AOI in the quarter, decreases of 8% and 22% respectively as compared to the prior year period. The decrease in AOI primarily reflected lower affiliate revenue and higher rights fees expenses, partially offset by lower advertising and marketing costs. As we look ahead to fiscal '24, we expect MSG Networks segment results to reflect continued declines across the traditional subscriber base, partially offset by affiliate rate increases and our expectation for strong ongoing advertising demand, the impact of our direct-to-consumer launch and the run rate impact of cost savings initiatives. Turning to our balance sheet. As of August 18th, we had approximately $341 million of unrestricted cash and cash equivalents and our debt balance was approximately $1.2 billion. Our cash balance includes the benefit of approximately $205 million in proceeds from our sale of 6.9 million MSG Entertainment shares in June. It also benefits from $65 million of proceeds from the delayed draw term loan from MSG Entertainment, which we drew on subsequent to the end of the quarter. Since then, we have repaid the balance using approximately 1.9 million retained MSGE shares. Our remaining interest in MSGE is now 8.2 million shares, which as of August 18th was worth approximately $270 million based on the closing price on that date. Finally, with the majority of work for Sphere in Las Vegas now behind us, we expect final project construction costs to be approximately $2.3 billion. Through August 18th, project to date construction costs paid for approximately $2.25 billion, which is net of the $65 million received from The Venetian. With that, I will now turn the call back over to Ari.

Ari Danes, Investor Relations

Thank you, Gautam. Operator, can we open up the call for questions, please?

Operator, Operator

Certainly. And your first question comes from Brandon Ross from LightShed Partners.

Brandon Ross, Analyst

Jim, we haven't had you on an earnings call since you announced the Sphere. The project came in above the initial budget range and you've had to engage in a number of strategic transactions to keep it moving forward. Can you explain why you believe this investment makes sense and will generate an appropriate return, given that level of investment you put in? And then I guess going forward from here, today's results show a significant amount of overhead in the business. Is that overhead to support the additional Spheres you mentioned in the prepared remarks? And will those Spheres be CapEx-light for the company?

James Dolan, Executive Chairman and CEO

That's a complex question, but I believe the investment is justified. I must admit that we did not expect to spend $2.3 billion, and we certainly didn't anticipate COVID. However, I think we are still in a strong position. The business is fundamentally based on transforming the current model for operating entertainment venues. Currently, this model resembles a landlord approach. You construct the building, and if you have a team, they become the first tenants. However, this typically results in only 40 to 50 events a year, leading to limited revenue as you are mainly renting out the space. When an act performs, they might generate $5 million or $6 million in ticket sales, but you only receive the rental fee, which constrains your earnings. Additionally, performers usually prefer to schedule shows on Wednesday through Saturday, leaving Sunday and Monday quiet, which means you're not utilizing your capital effectively. The Sphere changes this model entirely. It is designed to be busy all year round, operating 365 days because, when we are not hosting top acts like U2, we will be presenting our own content. This approach has a high profit margin, and as you've seen from our current numbers, we've already invested significantly in this product. Now, it's time to reap the benefits. Although this venture is capital intensive, the potential return on investment is much higher than the traditional venue model. What was the second question? Ah, the overhead, right?

Brandon Ross, Analyst

Yes. Overhead and CapEx for additional…

James Dolan, Executive Chairman and CEO

We built this one entirely ourselves but don’t intend to do that again. We are looking for partners and considering a franchise model for constructing the Spheres. I want to emphasize that we have designed the Sphere product for other markets, starting from as low as 2,500 seats with a construction timeline of under two years. We've innovated quite a bit in construction and have architectural plans to enter various markets. This is an exciting time for us, as we are about to launch this product. We should be able to share concrete numbers on our next call. We are optimistic about the product and the business model, and we believe the results will soon speak for themselves. Moving forward, building additional Spheres will be capital-light for the company since we'll be utilizing a franchise approach, and the overall costs for constructing these venues will decrease significantly. The initial one was the most expensive, but we gained invaluable insights from that experience that we intend to leverage going forward. Regarding content creation, we have also learned a lot. Darren, our talented director, had to adapt to new cameras we used for capturing content globally. I believe the upcoming show will be spectacular. While it has been capital-intensive so far, we are now shifting towards starting to generate returns on that investment. I am quite positive about what I have seen of the product, and I think you will be impressed soon as well.

Brandon Ross, Analyst

As you're about to start making money, I know you've mentioned a lot of incoming interest, but you haven't announced any new residencies or sponsorships yet. Could you give us more insight on why that is and when we might hear any updates? Then I'll stop talking.

James Dolan, Executive Chairman and CEO

We have seen strong interest from the artist community, and we will be announcing additional residencies soon. While U2 has 25 sold-out shows, we expect other artists, although perhaps not as high profile, to be coming forward to discuss residencies. This concept resonates with artists because it allows them to establish themselves in one location, like Las Vegas or the LA market, instead of traveling extensively. Therefore, I'm confident in our ability to attract talent. Regarding sponsorships, it's challenging for sponsors to invest in something they haven't viewed or gauged public reaction towards. However, when we lit up the Exosphere on July 4th, it sparked their interest. We are beginning to secure advertisers and sponsors, and we are also seeing considerable interest from partners who recognize the potential of this experiential medium as a new form of entertainment. They want to be involved.

Operator, Operator

And your next question comes from a line of David Karnovsky from JPMorgan.

Unidentified Analyst, Analyst

Hi, this is Ted on for David. We had two questions. The first is on original content. What have early demand indicators been like for Postcard from Earth? And how should we be thinking about other types of original content over time beyond Postcard from Earth? And the second question…

James Dolan, Executive Chairman and CEO

Okay. Well, I mean, it's early for demand. We haven't even started actually doing any of our paid marketing. And we will start towards the end of this month. We feel we're kind of uniquely qualified to look at this part of the business because maybe one of the most similar kind of businesses that's out there is the Christmas Spectacular. It runs roughly 200 shows in eight weeks. So it has the same amount of volume that we are planning for Sphere. But with a product like that, you generally don't see the ticket demand until you get pretty close to the actual opening in the event itself. So for instance, with the Christmas Spectacular, we know that better than 50% of the tickets gets sold in the last three weeks prior to. I expect that the Sphere will follow the same kind of model in Las Vegas. So no, we don't have a lot of results yet, we haven't started marketing yet, et cetera. But we got a great product. Now what was the other part of your question?

Unidentified Analyst, Analyst

Yes. And the second question is, how to be thinking about initial profitability in terms of AOI in the near-term, and how quickly that can ramp over time?

James Dolan, Executive Chairman and CEO

Well, let's see. Are we giving guidance on this, Gautam?

Gautam Ranji, Executive Vice President, CFO and Treasurer

No.

James Dolan, Executive Chairman and CEO

No guidance. Look, without giving you any guidance, because we didn't intend to do that today. What we need you to understand with that is that it's a new product. It's a new medium, et cetera. It's not going to behave like other products, et cetera, that you see in this kind of space, and we're learning at the same time. So it's early to project that. But when you do something like this, the first thing that you look to, right, is to see if you have a product that you think is going to appeal to the public, right? We really, really believe we do. So once you start off with that, with a great product and you introduce it, right, you get people interested in it, you explain it to them, et cetera, and then you reap the benefits of. But we're at that point today. I told you this is an interesting time for this call because we're at the precipice. We're about to unveil the product to the public, and the next call that we have will have a lot more for you to sink your teeth into.

Ari Danes, Investor Relations

Thank you, Ted. Operator, we will take the next caller. Go ahead.

Operator, Operator

Certainly. Your next question comes from line of Daniel Duran from Morgan Stanley.

Daniel Duran, Analyst

So given cord cutting, creating revenue pressures at MSG Networks, how do you weigh whether to refinance the Networks' term loan coming due next year versus separating Networks from Sphere and leaving Sphere as a live entertainment equity pure play?

James Dolan, Executive Chairman and CEO

I'm going to allow Gautam to respond to that question. However, before he does, I want to highlight something for everyone observing this sector. There has been significant interest in sports, which continues to grow and resonates strongly with consumers, especially in New York. When we examine businesses like Diamond Sports, it's evident that the ways to monetize this interest are fundamentally flawed. I've mentioned this in previous calls, and it still holds true. We have a strategy to tackle this issue. Nevertheless, the underlying demand for live sports remains robust and has not decreased at all. While the monetization aspects may be struggling, the public's enthusiasm is intact. I believe we can recover this business. Andrea, feel free to continue.

Andrea Greenberg, President and CEO of MSG Networks

Yes. I was just going to add to what Jim is saying is that we are the first and only regional sports network going to our direct consumer market with a per game offering. I think that particularly in this market, and particularly with our premier teams, opens up a funnel that brings people into our ecosystem, allows us to super serve them and market and speak directly to them, upsell to them. So when Jim says that we believe we have a very, very strong and viable plan, that's a key piece of it.

Gautam Ranji, Executive Vice President, CFO and Treasurer

Thanks, Andrea. And just in terms of the refinancing, I think it is important to note, it's still early in the process. The loan matures in October of 2024, and we have great relationships with our bank group. And as we move forward with this process, all of our options are on the table.

Daniel Duran, Analyst

And just my second question. Now that Sphere's retained interest in MSGE has been roughly cut in half and the Sphere is set to open next month, how, if at all, does the operational performance of Sphere impact what you do with Sphere's remaining MSGE shares? Thank you.

James Dolan, Executive Chairman and CEO

Well, let's see. Look, the operational performance affects everything. So, before we get to what we do with the retained interest, right, that's obviously going to be our focus and we will adjust the business depending upon how that operational performance turns out, right? We won't be making our decisions on the first show that we sell, right? But I think that over a fairly short period of time, we'll get a good sense of where the right balances are for the business. We will adjust to make sure that we have a profitable business and that it builds value for our shareholders. You want to take the second part?

Gautam Ranji, Executive Vice President, CFO and Treasurer

Sure. No final decisions have been made with regard to what we're going to do with the retained stake. We continue to have the three options for the retained stake: monetization, exchange offer and a follow-on spinoff. And to the extent we sell some or all of the retained stake, we're going to be deliberate in our approach around that.

Ari Danes, Investor Relations

Operator, we have time for one last caller.

Operator, Operator

And our final question comes from a line of David Joyce from Seaport Research Partners.

David Joyce, Analyst

Two questions, kind of building on some other discussions here. But first, could you please walk us through the different event types and their respective or relative margin profiles, be it the proprietary content versus residencies versus corporate branding events versus other things you might do? And then secondly, kind of further on that MSG Networks, that question. Could you kind of explain how the ramp up in Sphere cash flows can offset the challenges that MSGN is facing as they look to bring to refinance? Thank you.

James Dolan, Executive Chairman and CEO

Let me address the first part of your question. Our original content is fundamentally the backbone of our business and operates at a high margin since the capital investment has already been made. After producing a show and establishing an attraction, the ongoing costs primarily include expenses like ushers, security, and merchandise, leading to a strong return. Residencies represent a traditional model where we rent the venue to various acts. While this model carries less risk in ticket sales, it also limits potential upside. However, residencies enhance the profile of our products and venue, attracting a large audience that can convert into customers for our own content. Lastly, we have what we call corporate rentals, with F1 being a prime example. This is very low risk, and it's debatable whether discussing margins is even relevant here. Essentially, there is a rental fee, and all other operational expenses are borne by the renter, which guarantees revenue for our business. These represent the three primary streams of usage, alongside sponsorship and advertising sales.

Ari Danes, Investor Relations

Which is not insignificant.

Gautam Ranji, Executive Vice President, CFO and Treasurer

And then with regard to your second question. There are a number of important factors related to the refinancing. Obviously, Sphere's performance and ramp up in year one is a large one and important to that. And as we think about it going forward, we're going to monitor the situation, as Jim mentioned, and all options are on the table as we move forward.

Operator, Operator

And this concludes our question-and-answer session. Mr. Ari Danes, I turn the call back over to you for some final closing remarks.

Ari Danes, Investor Relations

Thank you all for joining us. We look forward to speaking with you on our next earnings call. Have a good day.

Operator, Operator

This concludes today's conference call. Thank you for your participation. You may now disconnect.