Discovery (NASDAQ: DISCK) (NASDAQ: DISCA) (NASDAQ: DISCB) had some good news for investors in its first-quarter earnings report. The TV content giant met its Q1 growth targets both in the U.S. and across its international markets.
And the $15 billion acquisition of Scripps Networks, which brought brands like HGTV and Food Network together with Animal Planet and Discovery Channel, is now delivering a financial windfall as combined operating costs plunge.
Discovery's growth picture is still complicated by the steady decline in pay-TV subscribers. However, management thinks their new portfolio positions them to generate better returns from here. Those gains might be supercharged by acquisitions and investments, management said in a conference call, now that Discovery has reached its debt pay-down target, according to CEO David Zazlav and his team.
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Outgrowing the industry
I'm extremely pleased with our very strong first-quarter operational and financial performance. ... Discovery achieved or exceeded all of our revenue guidance metrics.
-- CFO Gunnar Wiedenfels
Discovery notched healthy advertising results in both the U.S. and international segments. Sales were up 4% at home despite a roughly 4% drop in pay-TV subscribers. The company more than offset those losses through strong ratings and more revenue from digital sources, including Hulu, SlingTV, and now YouTube.
Internationally, sales gains accelerated from the prior quarter after stripping out the impact of Olympic Games broadcasts in 2018.
Our laser focus on cash flow and cost management has allowed us to end the quarter with a net leverage ratio below 3.5X, inside the top end of our target net leverage range, well ahead of our original stated goal to be back within our target range of 3 to 3.5X by early 2020.
The integration of the Scripps Networks business is having a positive impact on the books. In fact, operating expenses fell as a percentage of sales this quarter so that overall margins improved to 43% of sales from 34% a year ago. Free cash flow for the combined entity jumped to $2.8 billion and directing most of that haul toward debt allowed Discovery to reach its pay-down target a full year ahead of schedule. "We are finally in the position to be more opportunistic with our excess capital," Zazlav explained.
What a difference a year makes. This time last year, we had just closed on [the Scripps merger], and there were questions about the future of our businesses, our lack of inclusion on [digital platforms], our ability to leverage home and food around the world, and the amount of debt we had taken on to close the transaction. A year later, while we don't have all the answers yet, we have made remarkable progress.
Discovery affirmed a full-year outlook that calls for modest advertising growth in the U.S. that roughly tracks with what investors saw this past quarter. The international segment should grow slightly faster, and both regions will benefit from growing audiences on digital platforms like Hulu and YouTube. Executives say there's still efficiency to capture from the Scripps integration, but investors should expect much more modest profitability gains over the next few quarters.
Stepping back, Zazlav highlighted the fact that Discovery has reduced its debt risk, improved its finances, gained digital exposure, and strengthened its hand with advertisers and content distributors. It's still too early to call the merger strategy a clear win. Yet just a year from closing, it's obvious that many of investors' biggest worries heading into the acquisition were overblown.
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