VIA - Q1 2008 Viacom Earnings Conference Call

FINAL TRANSCRIPT

Event Date/Time: May. 02. 2008 / 8:30AM ET

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CORPORATE PARTICIPANTS Jim Bombassei Viacom, Inc. - SVP-IR Sumner Redstone Viacom, Inc. - Executive Chairman Philippe Dauman Viacom, Inc. - President, CEO Tom Dooley Viacom, Inc. - CFO, CAO

CONFERENCE CALL PARTICIPANTS Doug Mitchelson Deutsche Bank - Analyst Alan Gould Natixis - Analyst Michael Nathanson Sanford Bernstein - Analyst Kevin Holt van Kampen - Analyst Ingrid Chung Goldman Sachs - Analyst Spencer Wang Bear Stearns - Analyst Jessica Reif-Cohen Merrill Lynch - Analyst Michael Morris UBS - Analyst Tuna Amobi Standard & Poor's - Analyst Benjamin Swinburne Morgan Stanley - Analyst Imran Khan JPMorgan - Analyst

PRESENTATION Operator Good day, everyone, and welcome to the Viacom first-quarter 2008 earnings release teleconference. Today's call is being recorded. At this time, I would like to turn the call over to the Senior Vice President of Investor Relations, Mr. Jim Bombassei. Please go ahead, sir.

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Jim Bombassei - Viacom, Inc. - SVP-IR Good morning, everyone. Thank you for taking the time to join us for our first-quarter earnings call. Joining me for today's discussion are Sumner Redstone, our Chairman; Philippe Dauman, President and CEO; Tom Dooley, Chief Administrative Officer and CFO; and Jimmy Barge, Controller and Head of Tax and Treasury.

Please note that in addition to our press release, we have slides containing supplemental information available on our website. Before we begin, let me refer you to page number 1 in the web presentation and remind you that certain statements made on this call are forward-looking statements that involve risks and uncertainties. These risks and uncertainties are discussed in more detail in our filings with the SEC.

Reconciliations for non-GAAP financial information discussed on this call can be found in our earnings release or on our website. And now, I would like to turn the call over to Sumner.

Sumner Redstone - Viacom, Inc. - Executive Chairman Good morning, everyone. I thank you for joining us today. You know, it is always great to start the day off with great news. And that is exactly what we did today. Viacom's results in the first quarter were strong, more than strong, and I assure you that we will continue to build on this momentum as we move throughout the year.

Fact is, we have all the right ingredients for success at Viacom. Year after year, the value of our compelling entertainment brands continues to rise as new audiences discover and embrace the superior creative content that we deliver. As we move that content on to more and more platforms, here and all around the world, we become a part of our audience's lives.

Whether they're kids or teens or adults or even baby boomers, these are the consumers that advertisers value most, and we know how to reach and how to connect with them.

Philippe has brought visionary leadership and a focus on execution that has generated a palpable change throughout this entire company. Philippe and Tom and the other members of Viacom's senior management are pushing creativity and efficiency to new heights. They are capitalizing on new opportunities across our businesses. They are fully exploiting our existing partnerships and entering into new relationships that open the door to attractive revenue opportunities in the short- and in the long-term, including, of course, the new premium Entertainment joint venture.

I have enormous confidence in our entire team at Viacom and their plans for delivering even greater value for our shareholders. As a matter of fact, I constantly think what a wise decision it was to ask Philippe to join Viacom as the CEO and Tom as the CFO.

Now I will turn this over to Philippe.

Philippe Dauman - Viacom, Inc. - President, CEO Thank you very much, Sumner, and good morning, everyone. I am pleased you could join us today. We have started 2008 with strong momentum. Last year, we made substantial changes to our infrastructure and processes, and today we are realizing the benefit of that work.

While we continue to make improvements, the Company is operating at a higher level of effectiveness and efficiency across the board. Our brands and our content continue to be unmatched in the entertainment business. We cater to some of the most valuable and dedicated audiences across every platform and every screen. Our task is to remain authentic and true to those audiences, providing them with content and experiences that tap into their passions and interests. That task really has not

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© 2008 Thomson Financial. Republished with permission. No part of this publication may be reproduced or transmitted in any form or by any means without the prior written consent of Thomson Financial. FINAL TRANSCRIPT May. 02. 2008 / 8:30AM, VIA - Q1 2008 Viacom Earnings Conference Call changed over the years, but how we go about doing it and the types of experiences and engagement we provide have changed dramatically.

Today, I am confident that we are fulfilling our mission as well if not better than ever before, and that view is supported by our results. Throughout the Company, we remain focused on our core strategic objectives, continuing to fuel the creativity that drives our business across platforms, continuing to grow, nurture, and monetize our brands and create new ones, growing and monetizing our digital business, and maintaining the highest level of execution across the Company.

Let's begin with our financial results. For the purposes of our discussion this morning, Tom and I will speak to certain adjusted numbers.

Consolidated revenues grew 15% for the quarter to $3.12 billion. Media Networks' revenues were up 16% for the quarter to $2 billion. Worldwide Advertising Sales grew 8% and Domestic Advertising Sales grew 7% in the first quarter, as we continued to benefit from a strong scatter market, which again increased double digits over the upfront. One month into the second quarter, the scatter market continues to hold up, and while it is still early in the quarter, we anticipate our second-quarter Domestic Ad Sales growth to be comparable to growth in the first quarter.

Worldwide ancillary revenues rose 72% in the quarter, driven largely by the ongoing success of Rock Band. Affiliate fees were up 13% in the quarter, with both rate and subscriber increases contributing to the growth. The Filmed Entertainment segment delivered 12% revenue growth in the quarter to $1.15 billion.

Operating income for the total company was $567 million in the first quarter, a 14% increase over the comparable adjusted results in the prior year. Adjusted net earnings from continuing operations increased 19% to $282 million in the first quarter, and adjusted diluted EPS from continuing operations were $0.44, a 29% increase over the comparable results in 2007.

Now, let's turn to our Media Networks business. The underlying strength of our brands is derived from the powerful connection we establish with our audiences. We are in constant touch with our consumers, using research throughout the process to better understand what is important to them, what our brands mean to them, and how they want to experience our brands in their lives.

This research informs the content we create. It informs how we market it and we tailor it, how we expand it and how we deliver it in digital and other platforms. With a deep understanding of our core demographics, we bring innovative solutions to our advertising partners, making that connection even more valuable as it moves across multiple platforms.

For example, working with Unilever, MTV developed a five-episode microseries called Fresh Takes for Dove. Featuring Alicia Keys, each 3 1/2 minute episode airs during The Hills and deals with issues young women face. The results from the first two episodes were very encouraging, breaking through an all brand recall metric, boosting brand opinion, and importantly, retaining viewers through the commercial break.

The demographics our networks cater to are the very ones shaping the digital world. This gives us a distinct competitive advantage as we expand our digital presence. Better execution means we are moving more quickly to capture opportunities, and we still have room to improve our execution further.

With interactive web tools, we now have the ability to launch digital extensions of new shows at the same time they go on air to enhance the audiences' experiences with that program, immediately creating a higher level of engagement.

Of course, engaging audiences is key not only in the digital realm, but also in the linear television world. In our business, there is one fundamental constant -- hits matter. They drive every aspect of our business, allowing us to build our brands and expand geographically. Over the last few quarters, I've talked about the surge in the creative energy in our company. That, coupled

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© 2008 Thomson Financial. Republished with permission. No part of this publication may be reproduced or transmitted in any form or by any means without the prior written consent of Thomson Financial. FINAL TRANSCRIPT May. 02. 2008 / 8:30AM, VIA - Q1 2008 Viacom Earnings Conference Call with very effective process improvements, has fueled the development of new programming as well as new series and extensions of established shows.

And we are seeing the returns from this investment and renewed focus. Our ratings are strong, which bodes well for us going through the upfront season. Overall, our first-quarter ratings were up 5% in total day, with four of our networks delivering double-digit growth. During the quarter, our networks had eight of the top 20 series on cable in the 18-to-49 demographic, three on MTV, three on VH1, and two on Comedy.

The first quarter was VH1's highest-rated quarter in the channel's history. Comedy Central also delivered its best quarter ever, and it was the number one ranked cable network for young men 18 to 24. Spike TV had its most-watched quarter in three years in total day, and its primetime audience was up 14% versus last year.

At TV Land, the new programming slate, including original programming hit High School Reunion, delivered its best quarter ever among its core demographics, with double-digit gains versus last year. High School Reunion will soon be complemented by several new original programs targeting boomers in their 40s and 50s.

And BET brought back two of its proven hits in the first quarter, Celebration of Gospel '08 and College Hill Atlanta.

Among young audiences, including tweens, Nickelodeon swept all kid demos, further distancing itself from the competition. Among kids 2 to 11, Nickelodeon owns 14 of the top 20 shows across cable and seven of the top 10 across all television. Its collective digital sites also topped the competition, bringing in more than $130 million of business and 2.2 billion page views.

Through its portfolio of sites, Nickelodeon has developed a leading online position with each of its targeted demos, preschoolers, kids, teens, and parents, and it is steadily building its revenue stream.

In addition to its multitude of hit series, Nickelodeon's events and movies are pulling in huge audiences -- more than 7 million total viewers for the Goodbye Zoey movie, more than 5 million kids for Fairly OddBaby, and 6 million total viewers for SpongeBob's Pest of the West special. The Annual Kids' Choice Awards was a multiplatform megahit again this year, with 7.4 million total viewers, an incredible nearly 90 million votes cast, and a record 1.7 million unique visitors to Nick.com that day, who spent an average of 40 minutes each on the site. The event attracted new top-level sponsors, and total ad sales increased more than 20% across all platforms.

These appointment television events, of which we have many across our networks, provide our advertisers with unique opportunities to reach a large and loyal audience on-air as well as online.

Many of our international territories are also experiencing ratings success, with notable growth in several European markets, including the UK, Germany, and Benelux. In fact, Nick UK delivered its highest ratings ever in the network's 15-year history and continues to be the UK's number one commercial kids television network. We also continue to expand our presence with the launch of VH1 Denmark and Nickelodeon in Denmark, as well as the upcoming Nick Arabia and Nick Poland this summer.

Creating ratings successes with breakthrough hits is only the first step. Leveraging great content to build our brands and grow our business is a strategic imperative across all of our networks. Let me highlight just three examples of original programming that only resonates, but also migrates, moving comfortably into this online world through dedicated program sites, virtual worlds, and casual games.

One of Nick's newest hits is a prime example of on-air and online convergence rooted in great, engaging content. I'm referring of course to iCarly, which is well on its way to megahit status. It averaged 2.8 million total viewers per episode in the first quarter, and among tweens 9 to 14, iCarly was second only to our own Zoey 101 on cable.

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In addition, the online site iCarly.com, which solicits user-generated content from viewers, has received more than 100,000 submissions. Since the website is an integral part of the on-air show, we are effectively creating more ways for them to engage with the show's characters, send e-mails, play games, and create their own content. In March alone, this site had 3.3 million unique visitors, up 22% over February.

Hits like iCarly translate well in other regions. It recently launched in the UK as the number one rated program on any kids' channel in cable or satellite home, with an audience in the UK of 2.2 million viewers. It also debuted strongly in Latin America and Germany in mid-April.

Extending the brand even further, Columbia Records signed iCarly star, delightful Miranda Cosgrove, to a recording deal as part of the global partnership between Nick and the Sony Music label group. First up will be the release of a full-length CD of music inspired by iCarly, featuring songs by Miranda and a number of Sony's most popular artists. And there is more to come.

Over at MTV, the multi-platform success of The Hills franchise is another compelling illustration of our brand-building strategy. It is worth highlighting that The Hills is a spinoff of another highly successful entity show, Laguna Beach, demonstrating again how we leverage great content into new opportunities. During the first quarter, The Hills' extended Season 3 premier was the highest-rated telecast of a show ever among 12 to 34 year olds, and it was the number one show across all cable in 2008 in that core demo. In fact, the show garnered more than double the viewers of the Season 3 premiere of its predecessor, Laguna Beach.

In addition to generating great ratings, it also delivered very impressive ad revenue growth.

[During] the season premiere to an event also drove online traffic. The show has dedicated airing on MTV.com and more than 850,000 unique visitors during that one week, up 36% versus the previous season's premiere week. With the type of dedicated fan base The Hills has attracted, it was a natural to create Virtual Hills within our virtual MTV world. With more than 2 million registered users who spent an average of 30 minutes in world per visit, this provides yet another way for viewers to engage with and even become a part of the content they love in an environment that offers rich opportunities for our advertising partners. We know that interactive content and user participation drive engagement. That is exactly what all of our virtual worlds deliver.

The Hills is also a dominant presence on MTV Mobile, delivering close to 1 million mobile video streams across all carrier partners. One of the features that makes us so attractive for fans is that they can watch full episodes on their phone at the same time the show airs on television, so they never have to miss a thing.

Our final example also happens to be one of the biggest franchises we have on our networks. It has stood the test of time and continues to attract huge audiences for multiple generations. Now in its 12th season, South Park is a multimedia juggernaut for Comedy Central. It continues to generate impressive ratings performance and profit growth, which we fully exploit through DVD sales, domestic and international syndication, digital media licensing, and casual games.

The premiere of South Park's 12th season was the top-rated show on all television among males 18 to 24 and 18 to 34 in its time slot, with ratings up 28% versus the premiere of the previous season. South Park's digital performance is equally impressive, and importantly, it has been additive to its linear audience. The show is MTV Network's best-selling franchise on iTunes and Xbox, with nearly 7 million episodes downloaded to date.

South Park studios.com relaunched in March, and its first week streamed almost 5 million videos. Internationally, the South Park 10 mobile game has sold more than 300,000 units and generated nearly 6 million video streams. This is another hit that drives our growth geographically and across the digital landscape. We now distribute it in 96 countries worldwide, and it is the largest driver of Comedy's international sales revenues. We already have more projects and extensions in the works with the incredible creators of this show.

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All of these shows, iCarly, The Hills, and South Park, are unique in their approach and cater to very different demographics. But they share one critical element. Each is the very definition of compelling content, and we know how to cultivate that content into a brand that can be expanded and extended in many ways.

Not all of our success stories are born out of linear TV programs. Another example of great content driving our business results is the music video game Rock Band, which is continuing to redefine the category. Since the launch in late November, we have shipped more than 3 million bundled units. More than 10 million songs have been downloaded and purchased at an accelerating pace, I might add. We have nearly 100 songs available on Xbox LIVE and the PlayStation Network, and have several major acts in the pipeline for future song downloads.

We are looking at new peripherals, applications, and Consumer Products for Rock Band. In June, we will be launching Rock Band for Nintendo's Wii video game system, and we are rolling out the game in Europe this month. This is a major new brand and long-term franchise for Viacom, and we intend to nurture it and grow it in the same way we maximize our television brands.

Moving now to our Filmed Entertainment business. As I mentioned in our last call, we started the year off with Spiderwick Chronicles and Cloverfield, which had a record opening in January. Today, we debut Iron Man, which is part of our distribution agreement with Marvel and is on of our two tent poles this month. This is a fantastic film, and I can tell you right now that it will be one of the most memorable hits of the summer.

In just three weeks, our second mega tent pole arrives, as Indiana Jones returns in another blockbuster adventure, Indiana Jones and the Kingdom of the Crystal Skull, directed by the master, Steven Spielberg. And DreamWorks Animation will present Kung Fu Panda in June.

Other summertime releases include Love Guru with Mike Myers, and DreamWorks' Tropic Thunder, with an all-star cast.

After much hard work, Paramount's development slate is in a strong position. In addition, we now have new processes in place to shape our slate consistent with our long-term strategy of focusing more on franchises and our MTV, Nickelodeon, and BET labels. We also have in place new processes designed to improve our margins.

Speaking of long-term strategy, let me turn to the exciting news we announced less than two weeks ago. As I trust you've heard by now, Viacom and Paramount have formed a joint venture with MGM and Lionsgate to launch in the fall of 2009 a Premiere Entertainment service that will encompass a premium television channel and video-on-demand service.

The joint venture will have access to the new and classic feature films and original premium television series of five leading studios. From our perspective, this new venture is a perfect fit with our strategy of driving our content onto every platform. It also takes full advantage of the tremendous affiliate services capabilities and infrastructure of MTV Networks.

This joint venture is feasible because we find ourselves at a unique point in time when there is product available from multiple studios for the pay television window, an opportunity that will not be replicated for many years. We now have the chance to reinvent this window, and we intend to do so, no longer encumbered by the restrictions previously placed on us and our partners. We will determine our own destiny, controlling our content and how that content is distributed and marketed.

We are exploring multiple distribution platforms and partnerships that also contemplate emerging forms of content delivery. We believe there is significant revenue opportunity here, as we will be able to better serve our audiences across platforms and derive greater value from our own product.

The joint venture will have more announcements in the coming weeks and months, and I look forward to updating you on our plans for this game-changing endeavor.

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I would like to close with a brief discussion of what you can expect from this management team. We view ourselves as the stewards of your investment. With this team, you can count on strategic focus, financial discipline, and strong execution. Tom and I met with our divisional management teams over the last few weeks to review our progress and their forecasts for the rest of the year. We came away encouraged by the initiatives and optimism of our operating management.

In addition, each unit has taken steps to prepare for whatever the economy brings. We are off to a strong start to the year. We are moving forward with a clear vision of what we need to do to achieve our objectives of growing and expanding this company profitably. This year, we'll show strong progress in the financial performance of the studio and we will also reflect the core strength of our Media Networks as they grow their brands creatively, digitally, and globally.

I have tremendous confidence and pride in this management team, which will continue to drive this company forward. Now I will turn it over to my partner, Tom.

Tom Dooley - Viacom, Inc. - CFO, CAO Thanks, Philippe, and good morning, everyone. I hope you all have had a chance to review our earnings release and web presentation summarizing our first-quarter results. Our 10-Q will be filed shortly with the SEC and should be available later today.

This morning, I'm going to take you through our first-quarter results in more detail and I will update you on the key factors impacting our outlook for the balance of the year. My remarks will focus on our adjusted results from continuing operations, as discussed in our earnings press release. We believe that adjusted results are a better indicator of our core performance.

Now, turning to our performance in the quarter, I'm going to focus most of my remarks on segment results, and I will start with the Media Networks group. The Media Networks group continues to generate strong top-line growth, with revenues up 16% to $2 billion in the first quarter. If you would like to follow along using the web deck, page 9 provides a breakdown of Media Networks' revenue growth.

Turning to Worldwide Advertising, revenues rose 8% in the first quarter to $1 billion. Foreign exchange contributed 1% of the growth, so organic growth in Worldwide Advertising was 7%.

Domestic Advertising revenues increased 7%, led by strong growth at Nickelodeon, Comedy Central, and TV Land. International advertising revenues grew 13% over 2007. However, the first quarter of 2007 included ad revenues of our India operations. As you are aware, we entered into a joint venture with TV18 in India, and as a result, we deconsolidated those revenues. This deconsolidation had a 4% adverse impact on international advertising comps.

Foreign exchange benefits were 9% in the quarter. Therefore, the organic growth was 8%, and this was driven primarily by ratings performance and ad market strength in the UK, Benelux, and German markets.

Worldwide Affiliate revenues grew 13% to $637 million, with foreign exchange benefits contributing 1% of the growth. Domestic Affiliate revenues increased 11%. About 60% of the growth in Domestic revenues came from rate increases, while 40% of the growth came from increased subscribers, primarily at our digital channels.

International Affiliate revenues increased 21% on a reported basis, with 9% of the growth driven by foreign exchange benefits and the deconsolidation of India having a negative 2% impact. Organic growth of 14% was driven by both subscriber and rate increases, principally in Europe.

Worldwide Ancillary revenues grew 72% in the first quarter to $332 million. Domestic Ancillary revenues were up 94%, reflecting the continued success of Rock Band. Domestic revenues were also impacted by lower home video and licensing revenues.

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International Ancillary revenues increased 15% in the quarter. Foreign exchange contributed 4% of the growth. The organic growth of 11% was primarily driven by higher Consumer Product licensing revenues. As Philippe mentioned, we will be rolling out Rock Band in Europe this month and this will impact our International Ancillary revenues in the future.

Media Networks' adjusted operating income for the quarter was up 6% from last year to $694 million. We continue to make strategic investments in our brand and key franchises to drive long-term growth. The decline in operating margin in the quarter was due to the manufacturing and distribution costs related to our growing Rock Band franchise, as well as continued investment in programming.

As with last year, we expect our investments at the Media Networks group to weight the growth in operating income to the fourth quarter of this year.

Now let's take a look at Filmed Entertainment. Filmed Entertainment revenue for the first quarter was up 12% to $1.1 billion, and operating income was a loss of $63 million, which is a $45 million improvement from last year.

Page 11 of the web presentation provides a breakdown of Filmed Entertainment revenues.

Theatrical revenues declined 7% to $247 million, as 2007's results benefited from higher carryover revenues associated with the 2006 hit motion picture Dream Girls.

Home Entertainment revenues increased $89 million, or 22%, versus the first quarter of 2007. However, the quarter included a new Home Video distribution agreement that required gross revenue treatment, and $29 million of revenues recognized in connection with the conclusion of our HD-DVD agreement. Home Entertainment revenues would have been down slightly if those items weren't included in the quarter. That decline was driven by lower catalog sales.

TV License Fees grew 10% to $340 million, principally reflecting an increase in the number of titles available for international pay-tv and international syndication. The $45 million improvement in Filmed Entertainment operating income was driven by income recognized in connection with prior years' titles, including Transformers, Beowulf, and Disturbia, as well as income recognized from the conclusion of an HD-DVD agreement. This was partially offset by the performance of certain first-quarter releases.

Moving on to free cash flow, in our buyback program, page 5 of the web deck presentation provides a breakdown of free cash flow. Cash flow declined to $3 million in the first quarter. The principal drivers of the decline were working capital and cash taxes. The working capital decline of $387 million in the quarter was largely due to timing issues that will reverse during the second half of the year.

Over $200 million related to an increased number of films in production, with 10 films production in the first quarter of this year versus four in production last year. The majority of this year's film production has been accelerated to the first half of the year. All our productions are scheduled to be completed by June 30, given the possibility of a SAG strike.

In addition, we made an advance payment of $100 million in the quarter related to our new video distribution agreement with CBS. The cash flows related to this advance will be recouped over the next three quarters.

Cash taxes increased $74, million principally due to 2008 tax payments being spread more evenly over the year than 2007 tax payments, which were weighted more to the second half of the year. For the full year, we continue to believe that free cash flow will be comparable to last year, if you exclude the onetime capital expenditure of $75 million to $100 million related to relocating several cable channels into new office space.

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However, excess free cash flow will be generated largely in the third and fourth quarters. Factors impacting this include the timing of this year's production spend, which I just discussed, and the launch of Rock Band in Europe and on Wii, which will impact working capital in the second quarter.

First-half free cash flow will also be impacted by a more even impact flow of cash tax payments this year versus last year.

As far as leverage goes, at the end of the quarter, we had $8.6 billion of debt and capital leases outstanding, and our leverage ratio was 2.8 times.

We continue to believe that the best way to return capital back to our shareholders is through our share repurchase program. Accordingly, during the quarter, we repurchased 10.4 million shares for an aggregate purchase price of $414 million and had 635 million shares outstanding at the end of the quarter.

Now turning to our guidance, for the three-year period, 2008 through 2010, we continue to expect to deliver low double-digit annual growth in diluted net earnings per share from continuing operations. This outlook is based on adjusted earnings and reflects growth from 2007 adjusted diluted net earnings per share from continuing operations of $2.36.

Now I want to cover a couple of trends impacting our performance for the balance of the year that have not already been addressed. The continued rollout of Rock Band on new platforms and in new markets and its lower relative operating margin will reduce the overall Media Networks margins in the first half of the year.

In Filmed Entertainment, we continue to expect the seasonality and profitability to be weighted to the back half of the year. Looking at the second quarter, we expect approximately $175 million of incremental worldwide P&A expense associated with the release of our summer movies, Iron Man, Indiana Jones and the Kingdom of the Crystal Skull, Kung Fu Panda, and Love Guru.

Wrapping up, we continue to seek new ways to monetize our brands and new ways to gain efficiencies in how we operate our businesses. Deploying our capital more efficiently in combination with the selective strategic investments in our brands is enhancing our long-term growth. We believe that our focus on leveraging organic opportunities in our businesses and driving EPS and free cash flow will increase shareholder value over the long-term.

With that, thank you for listening. I now will turn the call over to questions.

QUESTIONS AND ANSWERS Operator (OPERATOR INSTRUCTIONS) Doug Mitchelson, Deutsche Bank.

Doug Mitchelson - Deutsche Bank - Analyst Philippe, you have given a ton of detail on your digital initiatives on these calls over the past year. And I was hoping you could take a step back and help us understand what these efforts mean to Viacom in the aggregate. I guess what I mean by that is are these efforts driving profit growth in the short-term? And if so, how much is it adding to growth?

And if instead -- digital, obviously, is long-term strategy and a long-term driver of profit growth. When you look out three to five years, what percentage of revenue do you think comes from digital and where should those digital margins settle out? I'm just trying to get some aggregate context around your efforts there.

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Philippe Dauman - Viacom, Inc. - President, CEO Thanks, Doug. We start from the point of view of looking at our content and our brands, and really having those travel on every platform. And really we create a virtual -- a virtuous cycle effect in what we do. It is becoming increasingly difficult, for example, in measuring our advertising revenues to separate the digital component from the on-air component in that a large proportion of our ad sales, our integrated convergence ad sales that we effectuate with our major clients, where we will sell them packages that go on-air, online, on mobile now, including Virtual Worlds.

So it would be somewhat misleading to break it out. We view it at this point -- having built up to the scale that we needed to get to to begin to have the digital part of our business become significant -- we view it going forward to be overall additive, both from a short-term and long-term perspective.

And the good news is that all of our creative executives are now simultaneously focused on developing content across all of the platforms. I might add, it is also a big part of our long-term international story, where we have a very strong digital presence, and it allows us to penetrate areas and audiences where we are not fully penetrated on-air, as we are in the US. So in some cases, it is the leading edge of our getting into new territories for some of our brands and networks. And in other cases, it just expands our reach. That helps Consumer Products sales. It helps everything we do.

Doug Mitchelson - Deutsche Bank - Analyst Thank you.

Operator Alan Gould, Natixis.

Alan Gould - Natixis - Analyst Thank you. Philippe, you have called the [Channel X] a game-changer. Do you anticipate after additional partners at Viacom will be the majority owner of Channel X? And how will this be available in other windows other than Pay TV, as opposed to Pay TV having exclusivity today?

Philippe Dauman - Viacom, Inc. - President, CEO Alan, it is a game-changer. It gives us a lot of flexibility. There were a lot of limitations that exist, really, in the pay television business as it is conducted today. With our partners -- what I've said before and it is the case -- we are the lead investor. We will not be at the end of this the majority owner, but we will be a significant owner of the business.

The joint venture was established to better serve consumers and better monetize the pay window for us. We are very optimistic about where it stands. As I mentioned in my remarks, we announced it less than two weeks ago. Having it be announced allowed us to speak very freely to potential distributors across many, many platforms. The level of interest and, in many cases, enthusiasm has been extremely encouraging to us. And we believe this is another example of how we can take our content, look at the world in new, different, innovative ways and create more value for Viacom.

Alan Gould - Natixis - Analyst Okay, thank you.

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Operator Michael Nathanson, Sanford Bernstein.

Michael Nathanson - Sanford Bernstein - Analyst Thanks. I have one for Tom. We see obviously the cable network margins fell in the quarter. And as we know, there's a lot of moving pieces, especially from Rock Band. So I wondered if you can give us an understanding of the movements in the core domestic cable margins, both domestically and internationally for the core. Then you've mentioned the fourth-quarter recovery margins. Do you think that domestic cable markets this year will be flat or up for the year, ex Rock Band?

Tom Dooley - Viacom, Inc. - CFO, CAO Yes, we think if you take Rock Band out of the mix, you'll find that the margins are relatively consistent year-to-year. International margins for the first quarter were high single digits, higher than last year's first quarter. But due to the seasonality of the business, it is a little bit less than the low double-digit margins we were pacing at the end of last year. It will regroup to that as it rolls out through the rest of the year.

We see the margins strengthening in an absolute basis, even with the inclusion of Rock Band, between now and the end of the year. But we think that the business overall will hold its margins on a comparable basis, excluding Rock Band, on a year-to-year basis. We are very comfortable and we manage very aggressively to get those margins.

Michael Nathanson - Sanford Bernstein - Analyst Okay, thank you.

Operator Kevin Holt, van Kampen.

Kevin Holt - van Kampen - Analyst I had the same question Michael did, so, thank you.

Operator Ingrid Chung, Goldman Sachs.

Ingrid Chung - Goldman Sachs - Analyst Thank you, good morning. So I think Philippe talked about ad growth in the second quarter being in the US on a similar level as in 1Q. I was just wondering if that includes any impact or assumption for an ad slowdown in the second quarter. And secondly, I was wondering if -- actually, I'll take that back. Let's just answer the first question first.

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Philippe Dauman - Viacom, Inc. - President, CEO Okay, Ingrid. It is only one month into the quarter, so it is fairly early on to project the entire second quarter. From everything we see -- that includes the strengths of our ratings, the momentum that we have, the buzz that we have, the strength in the scatter -- taking into account the overall economic environment, which certainly does not seem to negatively impact in any significant way our major categories of advertisers, which include motion pictures, which include quick service restaurants, games and the like, all of those categories seem to be, whether you want to call it recession-resistant, slowdown-resistant, whatever you want to call it. So that is why at this early point in the quarter, we continue to expect our domestic ad sales growth in the second quarter to be comparable to the first quarter.

Ingrid Chung - Goldman Sachs - Analyst Okay, great. Thanks.

Operator Spencer Wang, Bear Stearns.

Spencer Wang - Bear Stearns - Analyst Thanks, good morning. I just wanted to also follow up on the second-quarter advertising outlook. Philippe, you said it would be comparable to the 7% growth in the first quarter, and I think you referenced 5% ratings growth in the first quarter. I guess according to Tom's comment about affiliate revenue growth, it sounds like subscribers grew 4%. So if there's pricing increases, shouldn't at some point advertising growth be greater than 7% or is there something going on with sellout? I have one follow-up, if that's okay.

Sumner Redstone - Viacom, Inc. - Executive Chairman As you know, we're heading into the upfront season for the selling market, which will dictate pricing and the like as we get into the late part of this year and into next year. So what we are -- the way we look at it right now, it's just a continuation of the trends that we've seen in the first quarter, early second quarter. And that is why we have come out with our comparable forecast.

In terms of the reach of our networks, of course, is good. A lot of our subscriber growth is in our smaller digital networks as opposed to the big fully-distributed networks, but there is some growth just because of population growth. But we see this as a normal progression in our business.

Spencer Wang - Bear Stearns - Analyst Okay, and then just my follow-up was, Tom, do you know how much cash you're going to contribute to the pay TV channel venture, if any? Thank you.

Tom Dooley - Viacom, Inc. - CFO, CAO Over the life of the venture, we do not expect it to be more than $100 million.

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Spencer Wang - Bear Stearns - Analyst Great, thanks.

Operator Jessica Reif-Cohen, Merrill Lynch.

Jessica Reif-Cohen - Merrill Lynch - Analyst First on the advertising, as you --.

Tom Dooley - Viacom, Inc. - CFO, CAO You got cut off there. Could you start again?

Jessica Reif-Cohen - Merrill Lynch - Analyst Just two follow-ups. As far as advertising, you mentioned the ratings growth is -- you both mentioned ratings growth. I was just wondering since several other cable network companies reported midteens growth, is the difference attributable to the move to C3? Do you think it's different demographics?

And the second follow-up was also on the pay TV service. Do you have any plans to tie your affiliate contract renewals on MTV Networks to the new service?

Tom Dooley - Viacom, Inc. - CFO, CAO Hi, Jessica. As far as advertising goes, in terms of how you look at the different networks in the universe out there, C3, we're holding up very well. The transition to C3 has gone very smoothly for us, and thanks to a lot of the measures that -- some of which I described in my remarks -- we're doing quite well on viewer retention through the commercial pods, and we think that performance will continue to probably improve actually as we roll out some of the methods that we are using.

The different levels of ratings growth you see across the various networks really is probably more demographic driven. As you see, broadcast ratings suffered tremendously this season. You have a lot of the spillover going to the older skewing networks, and we are seeing some of that benefit in our own TV Land, as well as Nick at Nite.

But most of our networks, as you know, reach the young demos. So our growth is probably more steady-state in the demos that we serve, and I think just reflects the fundamental strength. It is not really impacted by writers' strike or anything like that.

As far as the pay TV, or premium service, as we call it, window, the Affiliates services are being provided for the joint venture, separate and apart from MTV Networks. We happen to have a great Affiliate organization, so it made a lot of sense for the joint venture, which is not wholly ours -- we have other partners in it -- to contract out to the MTV Networks group, since we probably have the best team in the business. So why not go for the best? And so the joint venture has an agreement with MTV Networks to provide, wholly apart from the Viacom efforts, Affiliate services and other services.

Operator Michael Morris, UBS.

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Michael Morris - UBS - Analyst Thank you. Can you talk briefly about the decision to release your films on iTunes on the same day as the DVD release? I guess specifically how do you view the risk of cannibalization of the current DVD sales and rental cycle? But at the same time, what is the opportunity?

And also, what are the key factors that you look for as demand on iTunes or other things like that ramp up?

Also on HD-DVD, I think you said this is a conclusion of that agreement, the $29 million payment. Should we be looking at, I guess, comps from any payments that you received in the latter half of 2007? Is there something we need to be taking into account there as we look at the rest of 2008 in Film? Thank you.

Philippe Dauman - Viacom, Inc. - President, CEO On iTunes, really we had been supplying some of our movies to iTunes, primarily our library product, at price points that made sense for us. So with Apple, as you know, leaving Disney aside, the other studios had not agreed to distribute current releases on iTunes because their terms had to be negotiated so that the pricing would be consistent with the pricing that we use for DVDs that we sell to Wal-Mart, Best Buy, and other outlets.

So this just reflects our selling. And again, this is a sale window, download window we're talking about. It is totally consistent with the other efforts that we have made in distributing, at the right price points, DVDs or equivalents during the DVD window. I will let Tom answer the --.

Tom Dooley - Viacom, Inc. - CFO, CAO As far as the impact, the $29 million was sort of an acceleration of a deal that closed sort of earlier than we had anticipated closing. So the impact in this quarter was worthy of mention. The impact in previous quarters last year I don't think will be significant, and there will be other items that will more than offset that decrement.

Michael Morris - UBS - Analyst Great, thank you.

Operator Tuna Amobi, Standard & Poor's.

Tuna Amobi - Standard & Poor's - Analyst Great, thank you very much. I think you guys have staked out a pretty good claim in the videogame world, online games. But as I think about the social networking universe, I just believe that perhaps -- it seems to me that you were a little -- the company was a little slow getting started in the music-oriented social networking space, which seems somewhat at odds with the history of MTV.

So my question is, as you look at entities like Last.fm, CBS, and imeem, as well as my space MySpace actually attacking this area very, very aggressively, what are you doing to capitalize on this fast-growing market, which would seem to fit nicely with your music background at MTV?

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Philippe Dauman - Viacom, Inc. - President, CEO You are quite right. It is a core part of our content (technical difficulty) space, and we have made tremendous strides which we're very pleased with over the last year or two in developing functionality, content, number of sites, social networking across our sites with Flux platform, Virtual Worlds. We have been innovators with Virtual Lower East Side, as an example of a very interesting Virtual World experiment our music group is doing.

We have online plans relating to our Rock Band franchise. Again, music based, tied into our core competency. We think we are really setting the pace in music, as we always have. We are -- we have the opportunity again in this case to reinvent how music is enjoyed and experienced, and you will see us grow from there.

In addition, because a lot of our activities tie into the very successful way we brand what we do, when it comes to getting advertising dollars, we enjoy higher CPMs, by far, than some of the other entities you mentioned in your question.

Tuna Amobi - Standard & Poor's - Analyst Just to follow-up on that same theme --.

Tom Dooley - Viacom, Inc. - CFO, CAO Just to add to that, our efforts are focused on efforts where we will see a path to profitability. We are very focused on return on invested capital for our businesses and our investments will reflect that focus.

Tuna Amobi - Standard & Poor's - Analyst Are you likely to do all this organically, or would you look at imeem and some of these upstart players as possible acquisition candidates? Are you just going to try to build this off of what you have at Flux?

Philippe Dauman - Viacom, Inc. - President, CEO Our primary focus throughout our company, because we have so much to do, is organic growth. We have great breadth in franchises. We've only begun to monetize virtually all of our brands throughout the company.

There is a lot of opportunity there. It is a good opportunity. As Tom mentioned, it has the best return on invested capital, and that is our primary focus.

Now, we have, during our tenure here, made a few very selective smallish acquisitions, the most notable of which of course was Harmonix, which brought us Rock Band -- again, because it tied in very much to our core. But we are completely focused on executing on our organic growth, where we see a lot of opportunity.

Tom Dooley - Viacom, Inc. - CFO, CAO We'll be a major player in the music space, both online and on-air.

Tuna Amobi - Standard & Poor's - Analyst All right. Thanks a lot.

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Operator Benjamin Swinburne, Morgan Stanley.

Benjamin Swinburne - Morgan Stanley - Analyst Thanks, good morning. There's been some third-party data suggesting your commercial retention has been cut in half year-over-year because of what you -- I should say the commercial fall-off level. So you had a big improvement there, Philippe, in the last 6, 9 months. I am wondering how much of that, if any, is due to lower ad units, if you have actually reduced the inventory level on some of your networks to improve the retention levels, or it has really all been more moving the pods around and restructuring them. Any color there would be very helpful. And I have one follow-up.

Philippe Dauman - Viacom, Inc. - President, CEO Yes, our commercial retention has really been quite positive. We took a leadership position in last year's market to delay full implementation of C3 to the first quarter this year, giving us time to prepare. So we've used a combination of methods in those networks where there is falloff. Some of our networks, like Nickelodeon, there really is no falloff, and several of our networks are in that category.

But in those networks where there is falloff, we have used scalable retention devices such as increasing and shortening the number of pods. We have provided integrated marketing solutions that include pod takeovers by some of our advertising clients, and that enhances viewer retention. And we have used videoscreen, advertised videoscreen on the commercial pod, or showing content from our shows, quizzes or program-related elements inside our pods. All of those things have made our viewer retention really probably better than we anticipated, and we see room for improvement. So we feel extremely comfortable with how this moves forward.

Benjamin Swinburne - Morgan Stanley - Analyst Great. And if I could just ask one follow-up. One area there has been a lot of M&A activity in this space over the last year has been in ad networks, online ad networks. And vertical networks are really popping up a lot, if you look at what SOAPnet did and Martha Stewart. It would seem with your brands, MTV, VH1, Nickelodeon Online, that might be a logical extension for you to try to create partnerships with other sites and then resell their inventory. Are you guys doing that or is that interesting to you at all?

Philippe Dauman - Viacom, Inc. - President, CEO Yes, we are doing that. ET is doing it at the American sites. Nickelodeon is doing it in connection with kids'- and parents'-oriented sites. So yes, that is something that we are doing. Again, with the primary focus being on the now well over 300 sites that we have that are directly connected to our brands. But with the platform we have and the great advertising sales force that we have, naturally we are extending our reach in this way. But the best and most productive dollars we have come from our own sites, which are related to our own brands.

Benjamin Swinburne - Morgan Stanley - Analyst Thank you.

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Operator Imran Khan, JPMorgan.

Imran Khan - JPMorgan - Analyst Thanks for taking my question. Two questions. One, Tom, I was trying to get a better sense of how foreign currency may or may not impacted your operating margins. You talked about foreign exchange impact on the revenues. Can you give us some color how did it impact operating profit side?

Secondly, Philippe, you talked about improving international market sales as one of your key focus. What kind of international markets improvement do you have from here on? So that would be two questions. Thank you.

Tom Dooley - Viacom, Inc. - CFO, CAO It was just a slight benefit, like less than 1%, on the operating margins on the foreign side due to the current currency translations because of the way impacted expenses in a market-by-market basis.

Philippe Dauman - Viacom, Inc. - President, CEO As far as our international margins, we made tremendous structural improvement through the restructuring that we effectuated last year. We now have a very effective international platform.

We are continuing to look at opportunities to improve efficiency, to further improve those margins. And of course growing our revenues is an important component of it.

In terms of looking at it from a long-term point of view, we will continue in our international business to have a mix of established channels like we have in the UK, which are performing very well. And the opportunity where we have it to expand some of our franchises so that we can startup mode as we expand Nickelodeon and others, which are really creating tremendous long-term value for us.

So we operate the right mix with a combination of driving the margins in our established channels, while at the same time launching new channels that extend our brand in the right markets.

Imran Khan - JPMorgan - Analyst Got it. Thank you.

Jim Bombassei - Viacom, Inc. - SVP-IR We want to thank everyone for joining us on our first-quarter earnings call.

Operator Thank you. That will conclude our conference call today. We appreciate your participation. You may disconnect at this time.

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