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Time Warner (NYSE:TWX)

Q4 2008 Earnings Call

February 4, 2009 10:30 am ET

Executives

Douglas Shapiro – Vice President, Investor Relations

Jeffrey L. Bewkes – President and Chief Executive Officer

John K. Martin – Executive Vice President, Chief Financial Officer

Analysts

Douglas Mitchelson - Deutsche Bank

Michael Nathanson - Sanford Bernstein

Spencer Wang - Credit Suisse

Michael Morris - UBS

Jessica Reif-Cohen - Bank of America/Merrill Lynch

Benjamin Swinburne - Morgan Stanley

Tuna Amobi - Standard & Poor’s Equity Group

Tom Eagan - Collins Stewart

Operator

Hello and welcome to the Time Warner fourth quarter 2008 earnings call. (Operator Instructions) Now I would like to turn the call over to Mr. Doug Shapiro, Vice President of Investor Relations. Sir, you may begin.

Douglas Shapiro

Thanks and welcome to Time Warner’s 2008 full year and fourth quarter earning call.

This morning, we issued two press releases, one detailing our results for the full year and fourth quarter, and the other providing our 2009 business outlook. Before we begin, there are a few items I need to cover.

First, we refer to certain non-GAAP financial measures. Schedules setting out reconciliations of these historical non-GAAP measures to the most directly comparable GAAP measures are included in our earnings release, our trending schedules and the investor portion of our website. A reconciliation of our expected future financial performance is also included in the release that’s on our website.

Second, today’s announcement includes certain forward-looking statements which are based on management’s current expectations; actual results may vary materially from those expressed or implied by these statements due to various factors. These factors are discussed in detail in Time Warner’s SEC filings, including its most annual report on Form 10-K and quarterly reports on Form 10-Q. Time Warner is under no obligation, and in fact, expressly disclaims any obligation to update or alter its forward-looking statements, whether as a result of new information, future events or otherwise.

With that, I will now turn it over to Jeff.

Jeffrey L. Bewkes

Thanks, Doug and thanks to everyone listening in today. We are entering 2009 and I think we all know it, with the most economic uncertainty and the least visibility in most of our memories. But, as I’ll explain, we are well-positioned relative to the rest of industry and we’re positioned well to push ahead with the strategy that we’ve outlined to you over the last year.

To remind us, put simply, our goal is to be the word’s leading content company and to deliver increasing stockholder returns. Last year we set an aggressive agenda towards those goals, primarily rationalizing our structure and improving operating performance. The economy clearly affected some of our businesses, particularly advertising at AOL and publishing, but we achieved most of what we set out to do.

In 2009, we intend to build on what we accomplished, and it is helpful to think of our priorities in three buckets: operational, structural and balance sheet management. So let’s start with our operational priorities.

First, we are streamlining the overhead in our businesses to make them as efficient as possible.

And then second, we are reallocating those resources to invest more in the production of high-quality content that defines our brands and makes the brands stand out as consumers face more media choices. In fact, excluding the cable company we’ll reduce our aggregate operating expenses and we’ll hold capital spending flat in 2009, but we’re going to invest more on content development this year than we did last year.

Through these steps we intend to emerge from this period in an even stronger competitive position. Let me walk you through the key initiative for this year which build on the foundation we put in place last year. I’ll start with our content businesses: networks, film and publishing.

At our networks, we continued to expand our original programming line up and enhanced the brands. This strategy drove primetime ratings up 16% at TBS last year and up 4% at TNT in the key demos that account for TNT last year. In 2009 we will air 13 original series, ten on TNT and three on TBS, and this includes six new series on TNT including Trust Me, which some of you I hope saw last week; Men of a Certain Age, Ray Ramano’s first foray back to TV since Everybody Loves Raymond.

Moving to news, CNN had an outstanding 2008 with record-setting coverage of the political campaigns across TV, online and mobile, and it culminated with CNN’s election night ratings victory over all broadcasts and cable networks. This year we’re expanding our news-gathering resources domestically and internationally across TV, mobile and broadband platforms to capitalize on CNN’s momentum. Consider that on Inauguration Day 27 million people watched video on CNN.com; this was an internet record for a live event on video.

Last year, HBO also launched its most aggressive original programming drive ever, putting more pilots in development than in any other time in its history. As a result it has more original series on tap for 2009 than in any prior year.

HBO’s programming continues to excel, both measured by critical acclaim and by ratings popularity. Just last month it won more Golden Globes than any other network and its new fall series, True Blood, became the third-highest rating HBO series of all time. Despite all this investment, we’ll hold total operating expenses essentially flat at the networks this year.

So let’s move to our film studio. At Warner Bros. we keep looking for ways to improve operating efficiency while at the same time pushing to extend our leadership position. Warner’s had a great year in 2008, finishing #1 at the box office worldwide and posting a record $1.8 billion in domestic ticket sales. It also finished #1 in home video, both for new releases and catalog for the eighth consecutive year. Warners is leading the push to digital, ending the year #1 in the fastest-growing parts of the home video business: Blu-ray high definition, video on demand and sell-through. We plan to maintain this momentum in 2009.

The slate of tent poles this year includes the sixth installment in the Harry Potter series which is called Harry Potter and the Half-Blood Prince. It has Terminator 4: Salvation, which if you couldn’t tell, was the fourth Terminator; it has a new Sherlock Holmes which we’re very excited about, and the Watchmen film coming out. Looking out further, we are deep in development on a number of extensions of our existing franchises as well as projects that leverage additional DC Comics characters.

The studio had a great year in TV last year too. It produced the #1 comedy on network TV, Two and a Half Men; the #1 new network series among total viewers, The Mentalist; the #1 new series for 18 to 49 demo, Fringe; and the #1 ad-supported cable show in history, The Closer, for its sister network TNT.

For 2009, Warner Bros. TV has already secured several pilot orders for new projects from producers such as John Wells, Josh Schwartz, David E. Kelly, McG, Kelsey Grammer and Jerry Bruckheimer among others.

Warner Bros. is also investing to expand its interactive games business with plans to release substantially more titles in 2009 than it did last year. Warner’s did all this while completing the reorganization of New Line Cinema as well as the closure of both Picturehouse and Warner Independent Pictures, moves that are now saving us more than $140 million annually. And two weeks ago, it announced a major outsourcing and cost reduction initiative that will ultimately eliminate about 800 jobs or 10% of our workforce there. And this will require a restructuring charge of approximately $100 million this year which we believe will pay for itself within two years of completion.

Publishing, moving to Time Inc., we are similarly focused there on improving operating efficiency. Our publishing company is clearly feeling the extremely difficult print ad market and this may continue for some time; but even as advertisers pulled back, consumers stepped up. Time Inc.’s readership grew 4% for the year compared to about 1% for the industry and it continued to be the most successful publisher transitioning its magazine content online, where average unique visitors to Time Inc.’s sites were up 24% over the year before, and that puts Time Inc. sites among the top 20 most-visited sites on the internet.

As you all know, Time Inc. also just completed the most aggressive reorganization in its history, moving from being highly decentralized to putting its operations into three groups. This should pay off in 2009 and beyond, as we now expect that this move will generate savings of about $175 million in 2009.

Move now to AOL, which continues to balance efforts to improve efficiency with targeted investment spending. Last year AOL felt the brunt of soft online advertising markets, as well as sales integration issues that we have discussed before. But AOL still made important progress. Over the past year, even as dial-up subs continued to decline, AOL’s page views increased 12%, powered by a 69% increase in page views in its publishing unit. More than a dozen of its sites rank in the top 4 in their respective categories and in 2009 we plan to launch 30 more.

Last year, in 2008, AOL further reduced its cost structure by more than $600 million and last week it initiated a restructuring that will better align the audience business into three groups: Platform-A, People Networks and its Media Globe publishing unit. This step should reduce AOL’s headcount by 10% and allow us to close some facilities. As a result, we’ll incur a restructuring charge of about $150 million this year, but we expect the run rate annual cost savings from that to exceed $250 million when the process is completed.

Moving now to our structural initiatives, our top priority is to finish what we started last year, namely complete the cable separation which will bring us much closer to our goal of being an even more content-focused company. As you know, the chief hurdles to completing the deal have been regulatory, but we expect to get IRS and FCC approval soon, which should allow to us close the deal by the end of this quarter.

Last, I’ll turn to our balance sheet. With the pending $9.25 billion dividend from Time Warner Cable, we’ll be operating from a position of strength. We have three goals in the balance sheet.

First, we always want the ability to make high return, organic investment in our businesses and we will have plenty of capacity to do that. As I mentioned, our plan is to increase the amount we’re investing this year, particularly at the film and networks division.

Next we want a strong balance sheet to support the businesses and provide access to the capital markets at attractive rates, regardless of the environment. And to that end, we’ll likely take a portion of the cash dividend and reduce debt. We are also lowering our long-term target leverage ratio from 3 times OIBITDA to 2.5 times. We think this is the right thing to do given the change in our overall asset mix. In the near term, we expect to keep leverage even lower than that until there is more visibility of a stable economy.

Our third goal is to return value directly to shareholders in the form of both dividends and share repurchases. To that end, our current intention is to maintain the same quarterly dividend even after the cable separation. This represents a meaningfully higher payout commitment and it underscores our confidence in our businesses. Our hope is to increase this dividend over time as free cash flow grows.

We’ll also look to restart our stock buyback under our existing authorization when we can. We’ll certainly have a lot of capacity for strategic M&A, but we will be disciplined about that. We are well aware of our industry’s poor track record of acquisitions, particularly deals that were supposed to be transformative. So we’ll continue to look at any opportunity that can improve our competitive position in our existing businesses as you’d expect us to.

But any potential acquisition faces a high hurdle. It would need to be compelling strategically, and we’d carefully evaluate the execution risk and potential return against the alternate use of our capital, including purchasing our own stock.

In closing, 2008 was a challenging year and we’re prepared for 2009 to be challenging too. In particular, as we said at the outset, we do have limited visibility into the ad market. But as you saw in our outlook release this morning, excluding cable we think we can deliver adjusted EPS in 2009 about flat with last year. At the same time, we’re focused on continuing to drive efficiencies in our businesses while also pressing our competitive advantages. By doing both, we expect to emerge from this period in an even stronger competitive position and our strong balance sheet gives us substantial flexibility and positions us to deliver a consistent return of capital to our shareholders.

Thanks for listening and now I’ll turn it over to John to go through more detailed financial projections.

John K. Martin

Thanks, Jeff and good morning. As usual there are slides that are now available on our website that follow along with my comments. And getting right into it, beginning with the first slide that highlights our fourth quarter and full year consolidated results, as many of you know we updated our full year 2008 business outlook in early January and the results that we’re reporting today are essentially right in line with the expectations that we previously laid out.

To begin with, we predicted adjusted OIBITDA growth of 1% which is where we ended up. The fourth quarter included certain items that were particularly noteworthy which we highlighted in the January outlook release and included nearly $200 million, $280 million, excuse me, legal reserve at Turner; nearly $60 million of expenses tied to a large tenant in the Time-Life building which was Lehman, that declared bankruptcy; and an increase of about $75 million in reserves related to potential credit losses.

Not including these, adjusted OIBITDA growth in the fourth quarter would have improved by 12 percentage points and we would have actually been up 4% year over year in the quarter and for the year.

Next, our free cash flow actually ended up a little bit better than we had predicted, up $500 million higher than we said in our outlook. This was due to stronger than anticipated year end cash collections at several of our divisions. And in 2008 we delivered $6 billion of free cash flow, that’s a record for us. It is $1 billion higher than in the prior year and our conversion rate of 46% was also a record for our company.

Moving to the next slide which provides EPS details, the 2008 fourth quarter and full year diluted EPS figures include a $24 billion pretax non-cash charge taken in accordance with FAS 142. Excluding that and the other items affecting comparability, adjusted diluted EPS was $0.23 in the fourth quarter, and that compares to $0.29 last year.

In addition, the roughly $400 million of notable pretax fourth quarter charges and reserves that I just mentioned reduced EPS $0.09 so it would have actually been $0.32. And for the full year, adjusted diluted EPS of $0.99 was $0.03 higher versus 2007 and excluding those same charges in reserves, EPS would have been $1.10, which is up 15% year over year.

Turning to free cash flow quickly on the next slide, this shows the details. As I just mentioned, we generated $6 billion. That’s up $1 billion or 20% over 2007. It was even more impressive when you consider that this was net of almost $800 million in 2008 pension contributions and compared to 2007, in addition to higher adjusted OIBITDA levels, free cash flow benefited from favorable working capital changes due to lower TV and film production spending and in part, that was tied to the writer’s strike. And we also had lower interest expense resulting from lower rates and higher cash balances. And as I mentioned, we saw our conversion rate rise to 46% last year, and with more than 80% of the company’s capital expenditures at the cable segment, conversion at the rest of the company was considerably higher than that.

Next slide, moving forward updates where we ended the year in terms of net debt. We had $33 billion on a consolidated basis at year end and that was about $2.6 billion lower than where we began last year. Our consolidated leverage ratio ended up at around 2.5 times and after giving effect for the $9.25 billion dividend we expect to receive from Time Warner Cable shortly, that would lower Time Warner’s leverage ratio to about 1.7 times.

Let me move now briefly to discuss each of our divisional results. Let me begin with the networks where we really had another very, very strong quarter capping off a very strong year. In the fourth quarter advertising was up 7% driven by both domestic news and entertainment. This was due to higher CPMs and audiences, higher political spending at CNN and the broadcast of additional Major League Baseball playoff games on TBS.

The 20% profit decline in the quarter includes the nearly $280 million legal reserve that I previously covered, and excluding this, networks adjusted OIBITDA would have been up about 11% in the quarter and 12% for the full year, a very strong result at the division.

As for the current advertising scatter market, we’re seeing pretty limited volume right now with pricing flat to up slightly above upfront levels. First quarter cancellations ran at normal levels. I would point out that we do have tough first quarter comparisons at Turner, due particularly to the scatter strength that we saw a year ago. For example, in last year’s first quarter ad revenues were up 13% so as a result right now, we expect advertising to be about flat in the first quarter of 2009 at the networks division, which wouldn’t be a bad result.

Our visibility into the ad environment for the rest of 2009 is somewhat limited, but due to Turner’s operating momentum, we expect it to outpace the industry in terms of advertising performance and while we expect to see some headwinds related to FX translation at Turner, its subscription revenue growth should be very, very solid and overall expenses will be essentially in the flat range, as Jeff highlighted a few minutes ago.

Focusing on HBO for a moment, HBO just completed a great year and had double-digit adjusted OIBITDA growth in both the quarter and the full year. It also ended the year with its highest subscriber base ever. Their 2009 results will benefit from the consolidation of HBO Latin America, which closed recently. This, plus solid ongoing business trends and strong attention to costs should once again allow HBO to post healthy year over year profit gains this year.

Moving to film, where Warner Bros., as Jeff said, posted another solid quarter of OIBITDA growth, capping off a really terrific year. Profit in the quarter rose 6% as reduced theatrical and home video release schedules led to a decline in costs, including lower P&A expenses, and the combination of lower costs plus growth in gains more than offset the revenue decline.

Revenues were lower in the quarter because of fewer theatrical and home video releases, as well as softer DVD sales. In the quarter, theatrical releases included New Line’s Four Christmases and Warner Bros. Yes Man and Gran Torino; and video releases included The Dark Knight, Get Smart and Journey to the Center of the Earth.

In 2007, by way of comparison, the fourth quarter film releases included I Am Legend, The Golden Compass and Fred Claus; and in video in Q4 last year we had Harry Potter and the Order of the Phoenix, Ocean’s 13, Hairspray and Rush Hour 3.

Looking ahead at the key 2009 drivers in film, we’re optimistic about the film slate, particularly Harry Potter and the Half-Blood Prince and as Jeff said, our TV business is coming off a strong year last year and we expect another strong year in 2009. Keep in mind, we didn’t really have any significant new avails of syndicated programming in 2008 and we don’t expect any again in 2009, so at least there aren’t any negative comparisons there.

Our film results this year will also be helped by the 2008 integration of New Line into Warner’s. As Jeff said, this eliminated about $140 million in annual costs and we only achieved about a third of that benefit in last year’s results. And we will also benefit from lowering restructuring charges here this year, although we do expect Warner’s to record the roughly $100 million in pretax restructuring charges related to the major MIS and accounting-related cost savings initiatives.

We remain cautious regarding current DVD trends and we expect the industry to stay challenged as long as there is broader softness in consumer spending in retail. The division will also be impacted by FX translation and higher pension expenses, which taken together, may be a drag of about $150 million or more in operating profits based on current exchange rates.

Focusing on the first quarter for a moment, we have difficult home video comparisons and as a result, we expect to be down considerably in the film line in the first quarter. To give some context, we only have about five key new home video releases in the first quarter of this year and that compares to 13 in the same quarter of last year and as I mentioned a little earlier, last year included the very successful title I Am Legend.

Moving on to AOL, where despite strong growth in usage and engagement, advertising declined 18% year over year in the quarter due to the tough online ad environment. And as a reminder, advertising consists of display, paid search and third party, and each of these represent roughly about a third of the total and I’ll quickly walk through the pieces.

Display advertising on the AOL network was down 25% year over year to about $188 million. There was continued softness in certain categories including personal finance, technology, telecom, autos and retail, which saw a much smaller seasonal lift in the quarter than usual. Also, as in recent quarters, yield declined as a larger proportion of inventory was monetized through lower price sales channels.

Paid search revenues were flat at $172 million as higher cost per click was offset by fewer queries and third-party network ad revenues in the quarter decreased 25% to nearly $150 million. Keep in mind, consistent with what we were talking to you about all last year, this reflects the absence of a large customer, Apollo, but the results do benefit from small year over year increases in contributions from acquisitions that were made in 2007. So Apollo’s contribution declined $52 million and that was offset by $21 million of acquisition-related contributions. So that means that the remaining third-party network advertising revenue declined 13% and this was due to softness, again in key categories such as autos and retail as well as lower conversion rates on performance advertising.

AOL’s Access business lost 573,000 subscribers in the fourth quarter. This is the smallest quarterly subscriber decline since the company moved to free in 2006. So this does suggest the difficult economic environment, at least for now, is not lifting churn.

Turning to the AOL profit line, in the quarter adjusted OIBITDA was up 6%, but that was primarily due to the absence of a large restructuring charge that was taken in the fourth quarter of 2007. As for this year in the Access business, we expect subscribers to continue their recent declines. Assuming that monthly average revenue per subscriber stays roughly flat or steady, access revenue should be down this year between $500 million and $650 million and we expect to offset about a third of the revenue decline through access-related cost reductions. But even with the expected decline in adjusted OIBITDA, Access is going to continue to remain a very large business and it’s still going to generate significantly more profit than the audience business this year.

And in advertising, it’s fair to say we really have little visibility here. We can’t predict right now how this year is going to play out. Currently advertising is pacing down almost 20% in the first quarter as we continue to see lower demand, particularly from retail and personal finance advertisers.

We also expect search to be somewhat challenged from a growth trend standpoint this year. Revenue per search, or RPS, may come under pressure due to lower cost per click growth and some algorithmic changes that have been made by Google. And query volumes may remain under pressure from users migrating to aol.com and away from the AOL Client where queries per user tend to be higher. This is a trend that we’ve seen, we’ve talked to you about before and we expect that to continue.

To address these top line challenges, as Jeff mentioned, AOL has a plan to aggressively reduce its cost base, taking steps to better align the audience business into its three groups; it is going to eliminate some products and it’s going it to reduce headcount by about 10%. And we’ll incur about $150 million in restructuring charges and we expect about one-third of that to one-half of that to be recognized in Q1.

I will also point out that at the end of last week Google sent us a request to exercise their demand registration rights that it has for its 5% ownership stake in AOL. We’re reviewing what we received and we’re evaluating our options. Those options include proceeding with the request, delaying the decision for some time or we can move ahead to potentially buy back Google’s stake at an appraised value, which would obviously be well below the value that was placed on it at the time of the original investment.

Turning to publishing on the next slide, although Time Inc. has been able to grow its readership and maintain share in print advertising, it’s also being impacted by the tough ad environment. Advertising was down 20% in the quarter, as we expected. This reflects a 22% decline in domestic print, offset by a modest gain in online advertising. Nine of Time Inc.’s top 10 advertiser categories were down year over year in the fourth quarter, most notably financial, pharma, home entertainment and auto.

Subscription revenue was down 9%, although this was largely due to unfavorable currency translation. Adjusted OIBITDA fell considerably in the quarter, but this reflected in part some of the large previously disclosed charges. Just a quick recap, the division took about $100 million restructuring charge associated with significant reorganization efforts. They recorded the $57 million charge related to the Lehman bankruptcy and the results were also negatively impacted by an increase of almost $35 million in bad debt reserves.

As we look ahead, the ad environment remains challenged. In the first quarter, print advertising is pacing slightly worse than the 22% decline we saw in the fourth quarter and while the year over year comparisons will clearly improve as we move ahead into the year, we really can’t predict at this time when the environment is going to begin to look better.

Our 2009 results will benefit from the roughly $175 million in lower costs that we expect to achieve related to these restructurings. And this year’s reported results will also benefit from the absence of the actual restructuring charges themselves, but a good portion of this is going to be likely offset by higher pension expenses as well as negative FX translation.

I’m going to turn to cable for a minute, but I’m going to actually be quite brief here. Hopefully all of you have had a chance to listen to the Time Warner Cable call that was held earlier this morning where the management team there discussed their fourth quarter and full year results. I have no intention to repeat that.

Revenues in the quarter were up a solid 8%. Adjusted OIBITDA grew 6% and Time Warner Cable added 175,000 net RGUs in the quarter, which admittedly was considerably below the net adds from a year ago, but as Glenn Britt, their CEO explained this morning, the year over year decline in net adds was partially due to the macro environment and the competitive environment, but also partially due to management’s decisions to prioritize profitability over subscriber growth.

Lastly, let me just discuss corporate expenses for a moment on the next slide. Corporate expenses in the fourth quarter declined 28% year over year. That means that we reduced corporate expenses by more than $60 million in 2008 and that was somewhat better than what we had expected and the goal that we set for ourselves. This year, despite incurring a nearly $20 million increase in pension costs, we expect corporate expenses to once again continue to decline.

Now let me just move briefly to talk about, from a consolidated standpoint, our expectations for 2009. I was hitting briefly, division by division, some of the key drivers in ’09 but when you pull it all together for Time Warner on a consolidated basis, we really thought it would be helpful to give you some context for the year. And we’re doing it for Time Warner without Time Warner Cable. As you can see, adjusted EPS in 2008 was $0.66 and that excludes cable. Although it’s clearly tough to make any predictions right now, we are right now expecting this year’s figure to be somewhere around flat to 2008, which means it could swing a few pennies in either direction.

Let me just tell you what’s included in that prediction, though. To begin with, we’re considering that the tough advertising environment continues and it considers that it’s essentially the tough ad environment that we’re in. And while it doesn’t assume any considerable improvement, it also doesn’t assume that things are going to get much worse, and it doesn’t assume further bankruptcies from major customers which we obviously can’t predict. But I would say that fortunately as a company we really don’t have any overwhelming exposure to any one counterparty but obviously more of our customers could run into financial troubles this year.

The outlook assumes that adjusted OIBITDA for the AOL Access business declines somewhere between $350 million and $450 million this year. The outlook also includes the roughly $250 million of anticipated restructuring charges at AOL and Warner Bros. It reflects that our earnings will be negatively impacted by both higher pension expense and negative foreign currency translation, I have been talking about that throughout the discussions of the divisions but the two taken together could aggregate to at least $400 million of a drag on adjusted OIBITDA growth this year.

For modeling purposes I would just add that we expect our booked tax rate to remain at around 38% and we also expect to be a full cash taxpayer in 2009, though we don’t yet know if there will be any impact if a stimulus bill passes.

In terms of our quarterly results, I suspect like most companies our comparisons are going to be meaningfully more difficult in the first half to three quarters of the year so our assumption of around flat adjusted EPS reflects expected declines in the first few quarters of this year, offset by growth, particularly in the fourth quarter.

Lastly, I would just mention that we intend to effectuate a reverse stock split. At the time of the cable separation, we previously disclosed this and obviously the full year outlook numbers here have been presented on a pre-split basis for now.

So that’s it, thanks for listening. Let me turn it back to Doug and we’d be happy to answer your questions.

Douglas Shapiro

Okay, thanks. Shirley, we would like to turn it over to the Q&A and please, if you could just keep yourself to one question so we can accommodate as many callers as possible. Thanks.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. Our first question comes from Doug Mitchelson. You may ask your question; please state your company name.

Douglas Mitchelson - Deutsche Bank

Thanks very much, Deutsche Bank. So the broadcast landscape is extraordinary challenging, both domestic and international. You don’t participate directly with a broadcast network or TV stations, but you’re still part of that ecosystem with sales of TV shows into that marketplace. So I guess in that light, are you concerned at all about the future profitability of your TV production businesses or any other impact on film? Thanks.

Jeffrey L. Bewkes

Thanks, Doug. No, basically. We feel very good about the TV production business. It’s a high profit business, it’s actually lower risk than the film side of the business for most participants in both of those businesses. And even though the business has changed, the dynamics are still favorable for us. We’re basically the supplier of second choice to all four broadcast networks after they buy from themselves, and this enables us to attract the best talent and make the best shows, because the talent knows that they have a shot at essentially being seen by all the four main network buyers.

So Warner Bros. TV produced a total of 21 primetime series this current year; six of them are new, 15 are returning and Warner TV had five of the top 20 shows in primetime. So due to that, and the essential advantage position we have selling into the four American networks. And due to the strength in the international markets where for us, for example, our average series, the production is profitable just with the domestic fees we get from U.S. broadcast first run and international first run, before you even get to home video or syndication revenues.

And increasingly, on that base and given the solid set of shows we’ve got at each network in the pipeline, we’re now able to build more using some of those formats in terms of local language and local production overseas, which we are moving into, we have done the last couple of years and we’re picking that up.

Finally, production of original series for cable like Nip/Tuck for FX, like The Closer for TNT, is an increasingly attractive business for us and one that because of our position and scale of our big hits off-network and the cable TV networks we own that have such broad reach, really puts us in a very eager business when it comes to producing series for television.

Douglas Shapiro

Thanks. Shirley, can we take the next question, please?

Operator

Thank you. Our next question comes from Michael Nathanson. You may ask your question and please state your company name

Michael Nathanson - Sanford Bernstein

Thanks, Sanford Bernstein. Jeff, I have two quick ones. Following up on Doug’s question on TV, your TV DVDs were actually down about 24% in the quarter and I wonder, given the widespread availability of some of these titles either online or on my DVR, are you concerned that TV DVDs may be more than cyclical? That’s one.

Jeffrey L. Bewkes

Short answer, no. Basically the high end, new release, hit DVD sales have been holding up very well for Warner’s, that’s how they achieved such #1 positions in all of the various home video markets including the new high def markets and VOD rental and all of that.

It is true home video sales were down in the fourth quarter for us and the industry. We think the A titles and the catalog do pretty well; catalog meaning the lasting hits. The B titles have not done as well so it will probably be a bit of a challenge for everyone this year, but because of our lead position with a bigger slate, more tent poles and more of a catalog, we think we will outperform everybody else, as we have been doing. I should add we were down a little bit in the fourth quarter. Some of the numbers, if you’re looking at the trending schedules, are looking at wholesale and you may be referring to declines in retail sales.

Michael Nathanson - Sanford Bernstein

Okay. One comment about there’s some chatter about AOL selling Bebo. Do you just want to update on if that’s true or not? What’s the thinking around there?

Jeffrey L. Bewkes

Chatter on Bebo?

Michael Nathanson - Sanford Bernstein

There’s been some talk.

Jeffrey L. Bewkes

Do you mean the excitement about the new – all the new Bebo product launches?

Michael Nathanson - Sanford Bernstein

No, the potential that AOL would actually sell Bebo? You know, that would divest Bebo?

Jeffrey L. Bewkes

No, we don’t plan to sell it. In fact, since the Bebo acquisition was completed, we’ve been focusing at AOL on integrating all of its social networking and communications products, launching new products with it and consolidating under Bebo everything that we’re putting in the People Networks division. And just to remind everybody what that is, there is AOL’s IM, AIM, ICQ, Bebo’s IM and mail. So we’ve got product integration underway, we have a product launch for a social inbox at Bebo that we launched in early December. That includes integrated email, aggregated fees, leveraging the Socialthing! Acquisition.

And as we have announced, we’ve changed the organization and created a new unified management team for People Networks at AOL with AIM, Bebo, ICQ, Yedda and Goowy all in there that reaches over 90 million uniques worldwide.

That’s one of the areas, the whole social networks part of AOL and Bebo where we have really been able to hire top talent from Google, Yahoo! and RealNetworks in key positions and we’ve been able to keep all the key management and engineers from Bebo.

So over the next few months, you are going to see the second phase of the Bebo roll out with an introduction of products in the United States, a new Bebo homepage, a new timeline experience that will help consumers live stream their events in a graphical way and a very important integration of AIM profiles into Bebo. So if you can hear all that, you can see pretty clearly Bebo’s very much integrated, it’s not going anywhere in relation to AOL.

Douglas Shapiro

Can we go to the next question please, Shirley?

Operator

Thank you. Our next question comes from Spencer Wang. You may ask your question and please state your company name.

Spencer Wang - Credit Suisse

Credit Suisse, thanks and good morning. Jeff, staying on the structural theme, I was wondering if you could just update us on your thoughts regarding your ownership of AOL? Specifically, have you or would you consider spinning off AOL directly to shareholders, and would a spin off structure address the Google demand registration rights? Thank you.

Jeffrey L. Bewkes

Thanks. That is -- your suggestion is certainly one option to increase the value and benefit and scale of AOL so yes, it’s a scenario where we could spin off all or either of the parts of AOL. It has also as you know, been discussed and been in discussion as to whether AOL would combine any of its assets with some other operating companies to increase scale on all sides.

I’m just not able, for obvious reasons, to tell you which of those courses we may end up taking and a third… or not a third as there are probably more than three… possibility is AOL can take the audience business even on its own inside of Time Warner. So I think while we’ve been pretty clear that we are, and AOL management is, pretty flexible and aggressive about looking at any opportunity to strengthen their position whether it’s in combination with somebody or not, and whether it would entail independence for some or all of that operation or not, we can’t or won’t announce it until we make the decision and do it.

Spencer Wang - Credit Suisse

And just a quick follow-up, Jeff. Do you have a timeline in terms of how long you are willing to, I guess, wait before changing your ownership structure of AOL, or is it just open ended?

Jeffrey L. Bewkes

I am not going to give a timeline for the changes that we’re considering.

Spencer Wang - Credit Suisse

Thank you.

Jeffrey L. Bewkes

Thanks.

Douglas Shapiro

Shirley, can we have the next question please?

Operator

Thank you. Our next question comes from Michael Morris. You may ask your question and please state your company name.

Michael Morris - UBS

Hi, I’m with UBS, thanks. On the network side, 7% advertising growth in the quarter was obviously very strong relative to peers. Can you share with us how much of that did come from political? And then also you mentioned that cancellations in the first quarter you characterized as normal. What are you seeing heading into the second quarter there? Thank you.

Jeffrey L. Bewkes

In terms of your question of how much was political and what are the quarterlies, before -- I’m going to get John to answer some of that detail on quarterly ads. Just in general, though, I would say that in first quarter the scatter market has been essentially, we’ve been keeping pricing flat to slightly up over the upfront. You remember that we were the highest gainer in the upfront. Business is booking closer to air date; also the first quarter cancellations are running at normal levels.

It was a good year last year for political bookings due to the strength of CNN, but as I hope was clear as we were going through the ratings and ad growth at Turner Entertainment, networks plus news, there was so much strength at Turner in ratings really across both the news and entertainment sides, and so much strength in its ad sales pricing position that I think that question is very much a subset of the general buoyant position of Turner Networks but John, you might want to go to a few specifics.

John K. Martin

Hi Michael. Just with respect to the fourth quarter, obviously a terrific quarter for CNN and the news company. If you look at the overall advertising growth, CNN was up strong double-digits. I’m not going to give the specific number. If you think about the overall growth in terms of dollars, it was roughly the same contribution that news contributed to the growth as did entertainment. And because entertainment is coming off of a bigger base, it’s a lower percentage growth rate, but we saw growth across all of our properties in general entertainment and kids, and news. News was stronger, but in part it was underscored by the fact that we had ratings growth virtually across the board, so hopefully that helps.

Douglas Shapiro

Shirley, can we go to the next one please?

Operator

Yes, the next question comes from Jessica Reif-Cohen. You may ask your question and please state your company name.

Jessica Reif-Cohen - Bank of America/Merrill Lynch

It’s Bank of America/Merrill Lynch. This is question really for John. 2008 had so many one-time and restructuring charges. I just want to review the impact on ‘09 if we can and I guess it’s a three parter. The timing of the $250 million of ‘09 restructuring charges, I know you said one-third to half of the AOL charge, but when does the charge come and when do we see the cost savings? Will there be an ‘09 cost savings event? And then of the $344 million of restructuring charges in ‘08 excluding cable, what are the cost savings from that? I know you said $175 million from publishing in ‘09. Can you just remind us what else there is?

The final part to this last charge was the $217 million, the separation from cable. How much of that gets repeated in 2009?

John K. Martin

Let me see if I can address the parts and if I miss something we can come back and we can revisit it again. Let me start with ‘08, if we can, just to ground ourselves in the base and let me go through the biggest charges. We had $140 million of charges in ‘08 related to the integration of New Line into Warner’s and we’re estimating that the run rate savings annually is about the same amount beginning in ‘09.

So we should achieve about $140 million of savings in ‘09, although keep in mind year over year that we did get about a third of the $140 million benefit in ‘08 so you only have about two-thirds year over year from a comp standpoint.

If you look at Time, Inc. where there were a number of restructurings, but the one I think you’re referring is about $100 million that we took in the fourth quarter related to the human resource downsizing. We expect a run rate savings there and actually we expect to achieve all of that in ‘09 to be about $175 million. It may even be slightly in excess of that, but I’d be a little bit hesitant to commit to that given that we still are in the execution phase.

We had about $12 million of restructurings at corporate in ‘08, a smaller amount, but our corporate run rate savings is probably pushing $75 million plus at this point in time. I think those are the biggies. The other things that were in the restructuring line was Lehman, which obviously is not a cost savings item but more of just a noteworthy item in terms of a bankruptcy-related thing.

If you think about ‘09 and if you think about the film line, Warner’s is going to benefit from the fact that it won’t have the New Line restructuring charge and it is going to benefit from the two-thirds year over year growth in savings from the New Line integration. It’s going to take roughly a $100 million charge this year related to all the initiatives that Jeff referred to, and because a lot of that is going to happen throughout the year we’re not anticipating seeing a lot of the benefit come through in ‘09. That’s going to come in ratably over two years and we would expect the combination of the next two years to more than pay for the investment that we’re making.

AOL, the restructuring charge that they’re likely going to take this year, which is about $150 million, that should result, believe it or not, in about $250 million of annual savings that we expect to achieve in year. And that’s due to a variety of factors including the reduction in headcount, the reduction of other initiatives that they’ve invested in in the past and frankly, just a new approach to certain areas of the business. I think that I might have hit it all.

Jessica Reif-Cohen - Bank of America/Merrill Lynch

The $217 million from cable, how much of that gets repeated in ‘09?

Jeffrey L. Bewkes

$217 million from cable?

John K. Martin

What are you referring to?

Douglas Shapiro

That might be the interest expense?

Jessica Reif-Cohen - Bank of America/Merrill Lynch

No, it’s not the interest expense. I think it’s like, page 22 of your press release.

Douglas Shapiro

Jessica, it might make sense for me to get back to you, if you don’t mind. Shirley, can we go on to the next question please?

Operator

Yes, the next question comes from Benjamin Swinburne. You may ask your question and please state your company name.

Benjamin Swinburne - Morgan Stanley

Hi, Morgan Stanley, good morning guys. John, you ran through a number of assumptions underlying the ‘09 guidance. I wanted to just go back to networks and two questions. HBO, obviously the content there has been very strong. We’ve heard some anecdotal evidence from the distributor that pay units are down, or at least under pressure. Do you still expect HBO to grow? I think you said strong growth in ‘09 again. Do you think that is a base case or maybe more of a bull case given the power of the content, or are you factoring in some kind of economic pressure to that business?

On the Turner side, just to go back, I think you said that OpEx would be flat there. My sense is programming costs are probably growing pretty healthily. Is the rest of the cost base actually declining? Is that headcount driven? Maybe a little bit of color there would be helpful.

Jeffrey L. Bewkes

I can’t resist on the HBO question. It’s not a bull case, it’s a baseline.

Benjamin Swinburne - Morgan Stanley

Okay.

Jeffrey L. Bewkes

I think they will be so [inaudible] and wide because so far, even though everyone has an eye out for pay TV theoretical erosion, it hasn’t come through to HBO yet. While it is true, since it’s only January, that the lag in receivables going through that system is a few months and so perhaps you could see if there is cutting back that consumers do on subscriptions to cable and satellite companies it could end up eventually at pay TV companies. Probably HBO will benefit relatively, or hold better than the Showtime, Starz and other competition that is likely to be the thing subscribers economize on.

Secondly, there are a lot of features to HBO’s affiliate revenue contracts with affiliates that essentially insulate them from moderate downturns in consumer subscription levels for reasonable periods of time. That’s not to say that in the long run if you had a longstanding reduction in pay TV levels it wouldn’t eventually hit HBO. But we don’t see, nor does HBO management, a particular problem there for this year. Some of it does come from the strength of the programming and the position.

Remember that we had the most subs ever at the end of 2008 and without getting too much into the structure of HBO’s wholesale contracts with affiliates, it’s just not likely to be a big problem in 2009.

Do you remember what the Turner question was?

John K. Martin

I’ll just jump in on that one. Ben, it’s John. There are a few things going on at Turner. Yes, you’re right. Programming costs are likely going to be up, but they will likely be up modestly because there’s sort of, and I think we’ve talked about this before, from an accounting recognition of sports programming rights, we expect in 2009 to recognize considerably less cost relative to what we recognized this year because there was a new contract involved this year. And when I say this year, I’m sorry, I meant 2008.

Despite the fact that there’s going to be more aggressive investment in 2009 related to original programming, essentially it’s going to offset the decline in the recognition of sports programming costs and it’s not going to give rise or put a lot of pressure with respect to programming cost increases.

And to answer your other question, which is offset the programming cost increases, the Turner management team is in the process of putting through a number of cost reduction initiatives to try to manage that and offset that.

I think before we go to the next question, if I might just go back to Jessica’s question and I apologize, I misunderstood the question. The $217 million that was referred to on page 22 in the release isn’t a restructuring charge, but rather it’s a cost that we identified as a separation cost for TWC. Essentially it relates to the negative carry on the cash that we had on the balance sheet this year. And so no, that shouldn’t recur in 2009. In fact, it will get re-classed down in the income statement into a discontinued operation. So hopefully that clarifies that.

Douglas Shapiro

Shirley, can we move on to the next question please?

Operator

Yes, our next question comes from Tuna Amobi. You may ask your question and please state your company name.

Tuna Amobi - Standard & Poor’s

Great, thank you very much, Standard & Poor’s Equity Group. My question is on filmed entertainment business. Jeff, it looks like Dark Knight actually, given the performance of Dark Knight in the DVD window, it seems like the industry was looking at that as a bellwether and it came through big time on the Blu-ray as well as in units sold.

So I guess my question is, could you comment on the strategy for that title vis-a-vis as you look forward to your future release slate? Also any kind of trends that you are seeing after your conversion to the day and date release strategy? How did all that play into Dark Knight’s strategy and how do you think that is going to play out this year?

Jeffrey L. Bewkes

Dark Knight was the second most profitable film in history, close to Titanic and so the obvious thing we’re going to take from it is more Dark Knight.

In a related way of thinking, and you’ve seen it in Harry Potter which we’re proud, even though we know there are seven Harry Potter books and there will be eight Harry Potter movies, it’s fantastic to have franchises that not only last that long, but where and I think Warner’s you should stop and consider that Warner’s has been able, with a number of these franchises and we want to do it with Batman, Superman and Sherlock Holmes perhaps, as you go along the sequels as they used to call them, are performing as well and are as original and good in terms of storyline with new characters added and new, very important actors added as were the originals, which didn’t used to be the case in the old sequel business years ago.

Warner’s really did make a distinguishing choice several years ago when it moved toward an emphasis on having more big tent pole, high cost franchises. Not to the exclusion of other films. If you look at Benjamin Button and Gran Torino that are up for Oscars this year you can see the emphasis on character-led and director-led films too. But Warner’s has more tent poles as an ongoing strategy, usually three or four a year that very much affect and lifts its distribution consistency and performance and that’s why Warner’s has been able to earn more than other studios so consistently on the film side.

If you go to VOD and windows that come after films like The Dark Knight and tent poles generally are increasingly important and valuable around the world through all the physical DVD release, the electronic VOD, Blu-ray and so on.

So we think that’s going to hold up our slate in the 09-10 period because we have such a strong slate of successes that we just came off of, as we talked about in my formal remarks, we’ve got four more big tent poles at least coming this year to hold up that slate.

The last point is the strength of Warner’s TV slate, which increasingly also goes through home video, DVD and VOD simply adds to that distribution scale and the power of Warner’s titles and the ability to get them all across the world.

Tuna Amobi - Standard & Poor’s

A quick clarification, you said the four tent poles that you have coming up they are all going to go day and date?

Jeffrey L. Bewkes

On day and date, so far the results moving to day and date have not cannibalized sell-through of physical DVD. And while we, I’m not in a position to exactly tell you on the four tent poles because it may be that in one case or another we move it a little bit. Basically to answer your question, I think most of the studio titles will be released day and date in the U.S. this year.

Tuna Amobi - Standard & Poor’s

That’s helpful. Real quick still on Dark Knight, maybe this is a question for John. I was a little surprised the financial impact of that title wasn’t as big as I had expected, even despite the tough comparison. I guess the logical question is, do you still expect a major pull through into Q1 from Dark Knight?

John K. Martin

I mean Dark Knight was, as Jeff said, it was clearly our most successful theatrical release and our most profitable title. The fourth quarter did benefit from Dark Knight. Without Dark Knight, obviously, things would have been worse and frankly, you can can’t underestimate the difficult comparison when you’re up against Harry Potter in the prior year fourth quarter.

We were quite pleased with where we were. It’s one of the reasons why Warner’s continues to stay at the same level of scale of profitability that it’s been able to do for so many years and Dark Knight will continue to benefit us in 2009, but the big title in addition to the other new tent poles that’s going to really help ‘09 will be Harry Potter.

Douglas Shapiro

Shirley, can we just have one last question before we wrap up?

Operator

Yes, the next question comes from Tom Eagan. You may ask your question and please state your company name

Tom Eagan - Collins Stewart

Great, thank you. This is Tom Eagan from Collins Stewart. Just a follow up on Google’s request. So does that mean that their search deal expires in the first half of ‘09? Secondly, are you guys talking to any other search deal providers? Thanks.

John K. Martin

The two are not linked.

Jeffrey L. Bewkes

No, it doesn’t mean that. The search deal continues aside from their rights at a given point and this point they’ve taken to trigger that right. So we don’t link it. And as to what we may do with our search business, we reserve all options on that.

Tom Eagan - Collins Stewart

Thank you.

Douglas Shapiro

Thank you very much for joining us. I’m around if anybody has any questions and we’ll talk to you next quarter.

Operator

Thank you and this does conclude today’s conference. We thank you for your participation. At this time you may disconnect your lines.

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Source: Time Warner Q4 2008 Earnings Call Transcript

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