Outlook for studios depends on hits, cuts

Weak DVD sales continue to affect companies

News Corp. and Time Warner ran the most profitable filmed entertainment businesses out of all media congloms in 2009 as hit movies and cost cuts boosted their bottom lines.

Meanwhile, Viacom saw the biggest percentage improvement in the bottom line of its film division last year as the long-struggling Paramount boosted its margins, a THR analysis of financials reported by sector giants shows.

On the downside, Disney and Sony posted profit declines for their creative output operations last year amid fewer boxoffice hits. NBC Universal also struggled.

Showing how close an eye the studios' corporate bosses keep on their performance, last year's financial disappointments led to executive shakeups, strategic shifts and belt-tightening of varying degrees at these companies.

The film biz tends to be so volatile that more than one year of results is needed to draw broader conclusions about studio performance. But the data for 2009 provide the most recent financial snapshot of an industry marked by such disparate trends as layoffs, the folding of specialty labels and weak DVD sales on one side and boxoffice records, enthusiasm for 3D films and growth in electronic sell-through on the other.

The boards of directors of congloms and Wall Street have increasingly required a focus on profit margins and financial returns at studio operations in recent years.

"Every little bit helps in overall valuation," Miller Tabak analyst David Joyce said about the film units' need to squeeze out more profit at a time when stock prices have remained well below past levels. "There are positive compounding valuation benefits from higher earnings, earnings growth and the like."

For the 2009 profitability analysis, THR focused on the six major companies with filmed entertainment units, which typically include film and TV production, home entertainment and studio facility operations of a company along with the related consumer products operations, although each unit is slightly different.

While the annual boxoffice grosses are available at the end of each year, we waited for congloms' 2009 calendar year financials, reported in recent weeks, to get to the bottom line numbers. Since all companies, except for NBC Uni, break out operating profit for their film units, we used that metric to compare performance in the core creative business.

Disney, News Corp. and Sony have fiscal years that differ from the calendar year, and they may well argue that they run their business with an eye on their fiscal year results. But we did the math to compile results for the calendar year 2009 to enable us to fairly compare all studio units' figures for the same standardized period.

Our analysis shows that while Hollywood remains a hit-and-miss business, several sector giants managed their risks so well in 2009 that they even wowed Wall Street -- a rarity given that the majority of conglom profits is typically provided by TV operations, particularly cable networks.

Lower expenses and hit titles helped TW and News Corp. exceed expectations and boost film profit even early in 2009 when analysts had forecast weaker film results. Smaller release slates and cost cuts were key drivers.

"For those entertainment conglomerates that undertook cost reduction efforts in 2007 and 2008, the benefits appeared to be realized in 2009," said Ted Garcia, media and entertainment lead at consulting firm North Highland. "The old axiom plays out well: $1 in hard dollar cost reduction = $6.87 in new sales when evaluated against the impact to the bottom line. Therefore, when you have sluggish sales, that reduction of $1 really does impact profitability."

News Corp. leads the THR ranking of most profitable studio, and that even though the record-breaking boxoffice run of "Avatar" started so late in the year that the company booked much of its cost, but only a small portion of its revenue and profit before the end of 2009.

Key theatrical releases included "Ice Age: Dawn of the Dinosaurs" and "Night at the Museum: Battle of the Smithsonian." Like TW, News Corp. surpassed the $4 billion mark in worldwide box office this past year.

Chairman and CEO Rupert Murdoch on his earnings call also lauded his TV studio for old hits like "The Simpsons" and "24" and new success like "Modern Family" and "The Cleveland Show."

The $1.2 billion profit for 2009 is near the record $1.25 billion that News Corp.'s studio had reported for the fiscal year that ended in mid-2008 and that became its seventh consecutive year of record performance. For those interested in the difference between fiscal and calendar years, in News Corp.'s most recent fiscal year, which ended on June 30, profit had fallen to $848 million.

Without promising new records going forward, management sounded optimistic that it can build on the recent success.

Indeed, things are off to a strong start in 2010 thanks to "Avatar," leading vice chairman, president and COO Chase Carey to say: "Last year we had a very weak first half and we had a much stronger second half, so we have, comparative to last year, we have got a big benefit in the first half," he told analysts.

Among upcoming theatrical releases through mid-year are "Date Night," "Diary of a Wimpy Kid," "Wall Street 2" and "The A-Team."

TW management in its fourth-quarter earnings conference call also highlighted the strong results at the Warner Bros. film unit, which included a 34% profit improvement for all of 2009 and an all-time high full-year income before depreciation and amortization of $1.48 billion despite a 3% revenue decline. Such blockbusters as "The Hangover" and the sixth installment of "Harry Potter" helped it to break the global boxoffice barrier of $4 billion and claim the number one share in the home video business for the ninth consecutive year; TV shows like "Big Bang Theory" and continuing cost benefits from the 2008 folding of New Line into Warner Bros. also helped make the bottom line improvement possible. That was despite a tough year-ago comparison which included 2008 hit "The Dark Knight," the studio's most profitable title ever.

"It is hard to ignore that Warner Bros ended the year at decade-high margins of 13% and all-time high OIBDA," said Sanford Bernstein analyst Michael Nathanson in reviewing the company's results.

Barclays Capital analyst Anthony DiClemente highlighted that in an industry that has rarely seen film margins above 10%, TW's studio margins expanded to 16% in the fourth quarter from 12% in the year-ago period. "Prudent spending and a strong hand for cost-cutting were helpful," he concluded.

For 2010, TW chairman and CEO Jeff Bewkes predicted "another year of very strong profits" driven by big titles such as the seventh Harry Potter, "Sex and the City 2," Christopher Nolan's "Inception" and "Clash of the Titans," another likely strong year in TV production, and growth in the digital delivery of films, which is more profitable than DVDs. But he made sure not to promise another record-breaking performance.

One dent in profits will come from the decision to self-distribute New Line films internationally rather than pre-selling them. Nathanson expects an approximately $100 million profit drag due to accounting rules.

At Viacom, Paramount and the other parts of its film unit closed the year with the biggest percentage gain in profit in the industry and a 4.3% margin, reversing the decade-long trend of margin declines, as Nathanson highlighted. "Transformers 2: Revenge of the Fallen" and "Star Trek" were among the theatrical and DVD hits that helped the studio reach its highest profitability in seven years.

Looking ahead, CEO Philippe Dauman touted a 2010 slate that includes three DreamWorks Animation films, "Iron Man 2" and Nickelodeon tentpole "The Last Airbender" by M. Night Shyamalan.

But when Nathanson asked on a conference call about the sustainability of studio profitability, management acknowledged that it will ultimately be driven by hits. "That being said, the company's cost initiatives should still carry through," Nathanson offered. He forecast 2010 film revenue to decline 7%, as Paramount will be challenged to match the success of its 2009 summer blockbusters, and profits to decline 16% this year.

According to Joyce, News Corp.'s and TW's film units have been performing so well "because their studios have depth and breadth, and they tend to own their movies (but offset/share some risk) and tend toward blockbuster franchises." For its part, Paramount has not owned its more successful releases, "which is why their performance level is lower," but it has still benefited from distributing Marvel and Dreamworks Animation films.

Dauman though emphasized that he feels the studio is now on stronger financial footing than in a long time. "What we have done is reduce the overhead structure, saved on cost, operated more efficiently, and our release strategy is such that we have fewer films," he said. "We are anchored on several existing and new franchises. So we think we're a structurally sounder studio and a great creative pipeline."

As for Sony, Disney and NBC Uni, they have also pushed to restructure and optimize their film studios, but lagged others' performance in 2009.

Sony announced key restructuring and cost moves in 2009 and early 2010. "They are a bit behind, and their profit statements reflect this," Garcia said.

Disney, Sony and Universal all saw drops in income at their movie units in 2009, the biggest being a 70% fall to $231 million at Disney. (No wonder there has been a management shakeup at that studio.) Disney's relevant unit is the purest film unit to scrutinize.

Disney president and CEO Bob Iger said during the Mouse House's most recent earnings call that creative changes are job one for the studio's new management.

Disney's profit plunge accompanied a comparatively modest 8% drop in revenue, so reining in expenses is another primary goal for the new management. Along those lines, the distribution and marketing efforts of theatrical and home entertainment have been combined.

And in its effort to ring more profit from home entertainment, Disney is tinkering with distribution windows. "Alice In Wonderland," for example, will be on DVD just three months after it begins its theatrical run on March 5.

"It's time, on a case-by-case basis, movie-by-movie, to take a look at how we're windowing the home video products into the marketplace," said Disney CFO Jay Rasulo.

Iger also said Disney has "a long-term commitment" to 3D and remains "focused" on creating films that are branded Disney, Pixar and Marvel. Miramax is another matter, as Disney is hoping to sell it for $700 million.

The upcoming titles Iger said he is most excited about include "Alice in Wonderland," "Prince of Persia: The Sands of Time," "The Sorcerer's Apprentice," "Tron Legacy" and "Toy Story 3."

NBC Uni doesn't separate the performance of its film unit from its more robust TV business, which includes the Peacock network, cablers and TV production.

Judging from boxoffice results only, Universal had a tough year, with grosses down 25% to $2.1 billion worldwide. And during a recent GE earnings call, CFO Keith Sherin called film "the toughest part of NBC Uni" and said film profit fell by $200 million in the fourth quarter alone. Also in the same frame, DVD units sold plunged from 33 million in 2008 to just 12 million in 2009.

"The fact is Universal has had a difficult year, that comes on the heels of its two most successful and profitable years in history," NBC Uni chief Jeff Zucker said at an investor conference in December.

He compared Universal's performance in 2009 to Fox's performance in 2008.

"Last year News Corp. had a terrible year on the film side, and this year it's having a very good year," he argued. "So they were able to return to their glory in a year."

Zucker said the mistakes his Universal executives made were two: "They didn't have the commercial titles, and they spent too much on them."

For Universal, Zucker expects "a return to glory days in the next couple of years," he said in December.

Overshadowing all other news regarding the Universal film studio will be an ongoing effort to convince lawmakers to approve -- with minimal concessions -- GE's plan to sell 51% of NBC Uni to Comcast.

At Sony Pictures, income in 2009 fell 53% to $246 million even though revenue was nearly flat at $7.4 billion. Sony, though, settled a bankruptcy claim in 2008 and claimed restructuring charges in 2009. Without those extras, income took less of a hit.
And there's no denying success at the boxoffice, since Sony set itself a worldwide record in 2009 by surpassing the $3.3 billion mark it set in 2006.

But while theatrical and DVD titles like "2012," "Angels & Demons," "District 9" and "Julie & Julia" helped boost sales, income suffered from underperforming titles, high marketing costs and development writeoffs.

And, like every other studio, Sony complained about shrinking DVD sales, leading to 800 jobs axed at the studio in 2009 and 2010, mostly in its home entertainment division.

But Sony Corp. CFO Rob Weisenthal said he saw "signs of stabilization" in the fourth quarter, in part due to the popularity of Blu-ray, courtesy of cheaper hardware and more retail space dedicated to the discs.

He said 6% of "Angels & Demons" transactions were of the Blu-ray variety, which repped 8% of the overall value. So there's lots of room for Blu-ray to grow.