STARZ ENTERTAINMENT CORP quarterly report, Q2 FY2017

Business context and reporting period

The filing is Lions Gate Entertainment Corp.’s unaudited Form 10-Q for the quarter ended September 30, 2016 (fiscal Q2 2017), with six-month comparisons to September 30, 2015. The request identifies Starz Entertainment Corp., but the filing registrant is Lions Gate Entertainment Corp.; the filing discusses Starz as a proposed acquisition target.

Lionsgate operates Motion Pictures and Television Production businesses, spanning film and television production, distribution, licensing, and related activities.

Financial performance and position

Unless stated otherwise, amounts below are in U.S. dollars.

For the quarter, revenue rose 34.1% year over year, but the operating loss widened. Six-month revenue rose 34.7%, while the company moved from operating income to an operating loss. Six-month net loss was larger than the prior-year loss, notwithstanding a substantial tax benefit. The filing does not provide a single consolidated gross-margin measure; gross segment contribution was $48.0 million (7.5% of revenue) for the quarter and $122.2 million (10.2%) for six months, versus $28.0 million (5.9%) and $130.7 million (14.8%), respectively.

Cash and cash equivalents were $106.0 million at September 30, 2016, versus $57.7 million at March 31, 2016. Total assets were $3.765 billion and total liabilities $2.815 billion. Corporate debt principal was $1.028 billion (carrying value $1.010 billion); production loans were $468.9 million (carrying value $468.1 million). The revolving facility had $301.0 million drawn and $499.0 million available. Management reported compliance with applicable debt covenants. The filing does not provide a separate consolidated liquidity ratio.

Six-month investing cash outflow was $9.4 million and financing cash outflow was $138.3 million. Cash generation reflected $194.4 million in operating inflows, offset in financing mainly by $221.4 million of net production-loan repayments, dividends paid of $26.8 million, and $27.3 million of tax withholding on equity awards.

Material changes versus prior comparable periods

• Motion Pictures revenue grew 31.2% for the quarter and 31.4% for six months, driven by theatrical, home-entertainment, and international titles, including Now You See Me 2.
• Television Production revenue rose 42.6% for the quarter and 42.8% for six months. The November 2015 Pilgrim Media Group acquisition contributed $43.0 million and $70.2 million, respectively, to those periods’ revenue.
• Despite higher six-month Motion Pictures revenue, gross segment contribution declined 14.2% to $84.1 million; increased theatrical marketing spend and somewhat higher direct costs weighed on margin. Television Production contribution rose 16.5% to $38.1 million, while its contribution margin fell, partly because newer programs initially carry higher amortization relative to revenue.
• Distribution and marketing expense increased to $222.0 million for the quarter and $347.0 million for six months, primarily due to more wide theatrical releases and related marketing. General and administrative expense increased 25.1% for the quarter and 27.1% for six months, including higher share-based compensation, Starz transaction costs, and direct-to-consumer start-up costs.
• Six-month operating cash flow improved by $363.0 million versus the prior year, as collections increased and film and television investment outlays were lower. The comparison also reflects timing and working-capital changes.
• Film and television investment, net, declined to $1.329 billion from $1.478 billion at March 31, 2016. The company recorded film fair-value write-downs of $4.4 million for the quarter and $6.3 million for six months, below the respective prior-year amounts.

Outlook, management commentary, risks and unusual items

• Management said operating cash flow, cash on hand, revolver availability, tax-efficient financing, and production financing should meet known operating and debt-service needs for the foreseeable future. It expected fiscal 2017 cash tax requirements not to increase significantly from fiscal 2016, citing tax attributes and loss carryforwards. No numerical revenue or earnings guidance was provided.
• The board suspended the quarterly dividend beginning immediately on September 22, 2016, in view of the proposed Starz merger. No shares were repurchased during the quarter.
• The proposed Starz acquisition was valued at approximately $4.4 billion enterprise value and remained subject to shareholder, regulatory, and other closing conditions. Lionsgate had announced financing commitments of approximately $4.57 billion; after quarter-end, it issued $520 million of 5.875% notes due 2024, replacing the planned $520 million unsecured bridge facility. A proposed term loan B facility was increased to $2.0 billion; definitive financing terms remained subject to documentation.
• The merger could materially increase leverage. The filing’s pro forma disclosure estimated post-merger corporate debt of $3.822 billion, plus $530.9 million of production loans and $62.0 million of capitalized leases. Financing execution, higher interest costs, integration, synergies, dilution, and management distraction were identified as risks.
• Merger-related professional fees and severance contributed to restructuring and other costs; approximately $2.4 million of the quarter’s charges reflected accelerated vesting of stock awards. The $53.6 million quarterly and $79.9 million six-month income tax benefits used the cut-off method because management could not reliably estimate the annual effective tax rate; the benefit was affected by jurisdictional income mix and tax treatment of certain foreign-affiliate dividends.
• Putative shareholder lawsuits in Delaware and Colorado challenged aspects of the proposed transaction; a Lionsgate shareholder lawsuit in New York alleged fiduciary-duty and disclosure issues. Defendants said they intended to defend the actions; the filing did not quantify potential exposure. The court denied plaintiffs’ motion for expedited proceedings in the consolidated Delaware action.
• Other relevant exposures include $290.7 million of tax-credit receivables, film and production-loan commitments, variable-rate debt, and $93.0 million of redeemable noncontrolling interest. Management noted that film revenue and cost estimates are judgmental and actual performance may differ.

Important facts for investors to verify

• Confirm the issuer and period: this is Lions Gate Entertainment Corp.’s quarter ended September 30, 2016, not a filing by Starz Entertainment Corp.
• Track the Starz merger’s approvals, closing conditions, financing documentation, final borrowing costs, and any changes to transaction consideration or termination exposure.
• Assess whether film and television releases convert into sustained cash generation, especially given higher marketing costs, title-performance uncertainty, and the film investment balance.
• Monitor debt maturities, revolver availability, production-loan repayment needs, covenant compliance, and the effects of additional merger financing on leverage and interest expense.
• Evaluate the sustainability and cash implications of the tax benefit, tax-credit receivables, share-based compensation, and the dividend suspension.