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Executives

Douglas Shapiro - Senior Vice President of Investor Relations

Jeffrey L. Bewkes - Chairman and Chief Executive Officer

John K. Martin - Chief Financial & Administrative Officer

Analysts

John Janedis - UBS Investment Bank, Research Division

Benjamin Swinburne - Morgan Stanley, Research Division

Jessica Reif Cohen - BofA Merrill Lynch, Research Division

Michael C. Morris - Davenport & Company, LLC, Research Division

Anthony J. DiClemente - Barclays Capital, Research Division

Richard Greenfield - BTIG, LLC, Research Division

Alexia S. Quadrani - JP Morgan Chase & Co, Research Division

Michael Nathanson - Nomura Securities Co. Ltd., Research Division

Michael Senno - Crédit Suisse AG, Research Division

Time Warner (TWX) Q1 2013 Earnings Call May 1, 2013 10:30 AM ET

Operator

Welcome to the Time Warner Incorporated First Quarter 2013 Earnings Call. My name is Dawn, and I will be your operator for today's call. [Operator Instructions] Please note that this conference is being recorded. I will now turn the call over to your host for today, Mr. Doug Shapiro, Senior Vice President of Investor Relations for Time Warner. Please proceed.

Douglas Shapiro

Thanks, and good morning. This morning, we issued 2 press releases, 1 detailing our results for the first quarter and the other reaffirming our 2013 business outlook.

Before we begin, there are 2 items I need to cover. First, we'll refer to certain non-GAAP financial measures. Schedules setting out reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measures are included in our earnings release and trending schedules. These reconciliations are available on our website at www.timewarner.com/investors. Reconciliations of our expected future financial performance are also included in the business outlook release that's available on our site.

And 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 recent annual report on Form 10-K and subsequent 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.

Thanks, and let me turn it over to Jeff.

Jeffrey L. Bewkes

Thanks, Doug, and thanks, everyone, for listening in this morning. Before I talk about our first quarter results, I'd like to touch on the biggest news that we came forward with over the last few months. And that was our announcement in March that we intend to spin off Time Inc. as an independent public entity by the end of the year. We think it's the right step for Time Inc., for Time Warner and for our stockholders for a few reasons. As you know, Time Inc. is by far the largest magazine publisher in the world with iconic brands and massive reach. After the spin, it will have much more strategic, financial and operational flexibility, and it will be able to develop a shareholder base that's aligned with its strategy and its growth prospects. Also, it will be able to attract, retain and reward talent with equity that's directly tied to its own performance. Ultimately, we concluded that these benefits substantially outweigh the relatively smaller strategic links between Time Inc. and our other businesses. These are essentially the same reasons why we separated both Time Warner Cable and AOL 4 years ago. Back when we did those transactions, it wasn't common for large media companies to take steps to become smaller. But we did them because we believe they were in the best interest of our stockholders. And in light of the performance those companies and their stocks, I think it's fair to say that they're both in a far stronger position today as independent companies. We fully expect the same for Time Inc.

Following the spinoffs of Time Warner Cable and AOL, we quickly saw the benefits of making Time Warner smaller, more nimble and more focused. With the separation of Time Inc., we'll complete the final natural step in that process.

After the spin, Time Warner will be the leading pure-play video content company in the world, operating the largest cable networks business, the largest TV production company and the largest film studio with the largest library. We'll derive 80% of our profits from our cable networks. And when you consider that roughly half of Warner Bros. profits each year come from its TV production businesses, that means 90% of our profits will come from the broader television ecosystem. With video consumption, pay TV subs, pay TV ARPUs and television CPMs all growing globally, we think that's a very good place to be. It was certainly a good place to be this quarter, and we're off to a great start this year.

In the first quarter, we grew adjusted operating income 7%, adjusted EPS increased more than 20%, and we returned over $900 million to our stockholders through buybacks and our dividend. We also saw a number of very encouraging operational trends. At Turner, the headline this quarter was again the outstanding performance of March Madness. Across TNT, TBS, truTV and CBS, total viewers were up 11%, making it the most watched tournament in almost 2 decades. We also saw really strong digital engagement. For instance, we delivered close to 50 million live streams. That's up more than 150% over last year. Since we acquired the rights, the tournament has far exceeded all our expectations for ratings, linear ad revenue, digital usage metrics and digital ad revenue.

We also continued to see solid performance across most of our networks. TBS was the #1 ad-supported cable network in prime time across adults 18 to 34 and 18 to 49, powered by the continued strength in The Big Bang Theory and the success of some of our new series, including Cougar Town and King of the Nerds. TNT faced some difficult NBA comparisons this quarter against the lockout-affected season last year with fewer games and fewer compelling matchups. But TNT grew ratings for its entertainment programming, which included originals like Dallas and the new unscripted show, Boston's Finest.

As usual, we have the bulk of our original programming on our big entertainment networks between now and the end of summer. In June, we'll bring the biggest original shows back to TNT, including Rizzoli & Isles, Major Crimes, Falling Skies and Perception, and launch several new unscripted series. At TBS, our biggest original comedies returned to the lineup in the second quarter, Men at Work and Sullivan & Son, and we'll debut a couple of new unscripted shows. And you can expect to hear more about the continuing evolution of our original programming strategy for both TNT and TBS at our up-front presentation in a couple of weeks.

Turning to some of our more targeted networks, Adult Swim continues to a juggernaut. It posted its most watched quarter ever and again ranked #1 on all of basic cable for total day delivery of adults and men 18 to 34 and 18 to 49. And truTV saw extremely strong performance from some of its biggest hits and some of my favorite shows like Hardcore Pawn, Impractical Jokers and Lizard Lick Towing. Check that out.

At CNN, coverage of the recent tragic events in Boston and Texas reaffirmed that it's more essential than ever, reaching more viewers in the key demos than any other news network as well as experiencing record traffic levels on CNN Digital. I'm optimistic that under its energized new leadership, CNN will build on its position as the leading source of breaking news to become the destination for compelling TV all the time.

I'll shift next to HBO, which continues to perform at the very top of its game. Unless you've been hanging out with some White Walkers north of The Wall, you know that Game of Thrones has become a cultural phenomenon. So far this season, it's averaging over 13 million viewers per episode, making it the most watched series on HBO since The Sopranos. As a sign of its popularity, despite challenges in the home video business in general, the just-released second season of Game of Thrones posted the highest first day DVD and DST sales of any HBO series ever.

And Game of Thrones is only one part of what is arguably the strongest programming lineup in HBO's history. We just debuted the second season of VEEP to critical acclaim and will follow that with the return of True Blood in June, The Newsroom in July and Boardwalk Empire later this year, among others. We also have several exciting pilots in development, including new shows from J.J. Abrams, David [ph] [indiscernible] and Ryan Murphy

At Warner Bros., we're finishing up a very strong TV season. Among adults 18 to 49, we've got 4 of the top 6 comedies on the air: The Big Bang Theory, Two and a Half Men, Two Broke Girls and Mike & Molly. We've got both of the breakout new dramas this season: Revolution and The Following. And we have the #1 reality show on TV, The Voice.

With a really strong slate of returning shows and a promising crop of pilots this year, particularly 30-minute comedies, we think we're again really well positioned heading into the up-front over the next few weeks.

Our theatrical results over the last quarter were somewhat disappointing as both Gangster Squad and Jack the Giant Slayer fell short of our expectations. But our ability to post strong financial results in spite of this is a testament to the resilience and breadth of Warner's businesses. And importantly, all of our most promising and highly-anticipated theatrical releases of the year are yet to come. Next week, we'll premier The Great Gatsby, followed by The Hangover Part 3, then Man of Steel, then Pacific Rim and, at the end of the year, the second film in The Hobbit trilogy. We're particularly excited about Man of Steel, which is shaping up to be one of the biggest movies of the year, and it's a real opportunity for us to relaunch the Superman franchise. As you may have seen in the press, we recently received a few very favorable legal rulings related to the Superman IP. Those court decisions paved the way for us to be more aggressive in developing our future plans for Superman. We hope to share more on that front soon.

So all in all, it was another successful quarter for us, both financially and operationally. And although it's just the first quarter, we're really pleased about how we're starting off the year.

With that, I'll turn it over to John.

John K. Martin

Thanks, Jeff, and good morning. I'll begin by referring to the first slide, which is now available on our website, and starting with the consolidated highlights.

We're off to a terrific start this year with adjusted operating income up 7% to a first quarter record of $1.4 billion and adjusted EPS up over 20%. And if you look at the company, excluding the results of the Publishing division, adjusted operating income was even stronger, up 10% year-over-year. We were able to do that despite relatively flat revenue in the quarter as costs were down low-single digits year-over-year. That resulted in margin expansion of 140 basis points on a total company basis and around 250 basis points for the Time Warner, excluding the Publishing division. That's consistent with our expectation that we'll post a fifth straight year of margin expansion in 2013, reflecting both underlying growth in our businesses and our commitment to efficiency gains.

Moving down the P&L. We continue to leverage growth in adjusted operating income and to even faster growth in adjusted EPS, and that was mostly due to a combination of a lower effective tax rate and our ongoing share repurchase program. Coming into the year, we set a goal to once again deliver double-digit adjusted EPS growth, and, as Jeff mentioned, with the first quarter now behind us, we have increased confidence we'll achieve that goal.

We also had a great start to the year for free cash flow generation, generating over $900 million in the quarter. So we fully expect to deliver a lot of free cash in 2013, supporting our continued significant returns to shareholders. During the quarter, we repurchased about $670 million of common stock, and we paid $273 million in dividends. So we think we're set up for another great year as our investments in content, international expansion and digital initiatives continue to pay off.

Now let me turn to the segment highlights, and let me begin with our largest segment, the Networks, where revenue growth and margin expansion at both HBO and Turner resulted in record first quarter adjusted operating income for the segment. Subscription revenues were up more than 5%, relatively consistent with the trends we saw for the full year 2012. Our underlying rate increases are not changing much this year, but changes in unit growth, currency and various other factors can move the needle one way or another in any given quarter. We expect to remain in the mid-single-digit range for the balance of the year, and we fully expect to see an acceleration in subscription revenue growth in 2014 as Turner will begin to see the benefits from its upcoming affiliate renewal cycle.

Turning to advertising, revenues were down 1% year-over-year in the quarter, which is about in line with what we expected coming into the quarter. There were a number of headwinds, and let me just mention a few. These included the timing of the Final Four games, which fell into the second quarter this year. It also included the closure of certain networks in India and Turkey last year and the transfer of management of SI.com and Golf.com to Time Inc. last year. Looking through these items, domestic advertising was up in the mid-single digits with entertainment advertising, including kids and young adults, up in the mid- to high-single-digit range, while news was down about 10%. And international advertising would have been down mid-single digits due to double-digit increases at international entertainment, which was more than offset by declines at international news.

Looking at the second quarter, we expect overall Networks advertising growth to rebound and accelerate into the high-single digits. Recall that next quarter, we'll benefit from the timing of the Final Four, and we'll finally lap the transition of SI.com and Golf.com back to Time Inc. as well as the shutdown of India's Imagine. In addition, the second quarter scatter market has been very healthy with double-digit premiums over up-front pricing.

Adjusted operating income was up 7% in the quarter at the Networks with margins increasing 150 basis points. That was a result of cost discipline, the timing of programming expenses and the international network shutdowns last year. However, we continue to invest in our most important brands, including a double-digit increase in Turner's original programming spend this quarter. For the full year, we continue to expect overall programming expenses to be up in the mid- to high single-digit range. We also anticipate that margins will be up for the year at the Networks division as revenue growth should improve beginning in the second quarter. So 2013 should be another really strong year of financial results for the Networks segment.

Turning now to film and TV. Despite the somewhat disappointing box office performance start of our films this quarter, Warner Bros. had a strong quarter financially. Adjusted operating income grew 23% year-over-year, and margins expanded more than 200 basis points. That was driven by the strong performance of our carryover films, the home video sales from the first Hobbit film and lower prints and advertising spend in the quarter. The performance of The Hobbit on home video was part of a broader trend of stabilization for the industry. For the overall industry, the first quarter was particularly encouraging in that regard as both sell-through and total home entertainment revenue increased year-over-year. Growth was especially strong for electronic sell-through, which was up over 60% from a year ago. It's particularly encouraging to see these signs of stabilization even as some of the industry's digital initiatives, including UltraViolet, remain at a relatively early stage.

On the SVOD front, we recognized about $75 million of revenue at this segment in the quarter, similar to last year with significant contribution from international territories. If you include Turner as well as Warner's, we recognized about $100 million of SVOD revenue in the quarter. And we continue to expect the SVOD distribution channel to be a significant contributor to our results this year.

Looking ahead, as Jeff mentioned, over the next few months, we'll start to release our most promising and anticipated films of the year. Likewise, we're optimistic about this TV pilot season. And between a strong stable of returning shows and a great lineup of pilots, we expect to be in a very strong position again this fall in television. With a really strong film slate and continued momentum in TV, Warner Bros.' profits this year should be at least as good, if not better, than a year ago.

Now moving on to Publishing, where both first quarter revenues and adjusted operating income were down somewhat versus last year. A significant portion of the decline in adjusted operating income was due to higher restructuring expenses this year and absent that increase, adjusted operating income would have been about flat in the quarter. Advertising revenue was up 2% in the quarter, but that included the positive impact from the transfer of management of SI.com and Golf.com back to Time Inc. And without this transfer, advertising revenues would have been down modestly year-over-year. And based on our current outlook for Q2, we expect advertising to be down somewhat again in the second quarter.

Subscription revenues were down 11% in the first quarter, though that included the impact of certain weekly titles having fewer issues in the quarter than in the prior year quarter. As we look to the rest of the year, we anticipate subscription revenue declines to be more similar to the mid-single-digit declines that we experienced in 2012 at Time Inc. We remain very focused here on taking costs out of the business, both to improve efficiency and to allow for investment in growth initiatives. So as we previously announced, Time Inc. made significant reduction in its workforce during the first quarter, and restructuring costs were a little north of $50 million in Q1. This process is an important step in preparing Time Inc. to operate successfully as a stand-alone public company.

Now let me move over and provide some additional context to our 2013 outlook. As I noted earlier, we're off to a great start this year, and we're on track to deliver another year of double-digit growth in adjusted EPS. In terms of quarterly progression, we expect the second quarter to be very strong, and it could be perhaps the strongest growth rate quarter we have in a year. And if you'll recall, in last year's second quarter, we had a significant intersegment elimination resulting from the Warner Bros. sale of The Mentalist to Turner, and we also had our softest quarter of the year at Time Inc. Along with positive underlying trends in our businesses, those year-over-year comparisons set us up for a very strong second quarter growth rate. The second quarter should also benefit from an effective tax rate that will look similar to the first quarter and below our expectation for the full year. That means our growth will likely be more heavily weighted to the first half of this year, which is somewhat different from the past couple of years. But it is consistent with what we expected as we entered 2013, and we feel pretty good about how things have started this year and how things are shaping up.

I also want to remind you that we expect to begin accounting for our nearly 50% stake in Central European Media Enterprises as an equity investment during the second quarter of 2013. And due to the accounting rules associated with this, we will be recasting in the second quarter our historical financials as though we had always accounted for CME as an equity investment. Now since CME produces net losses, this accounting change will be somewhat of a drag on earnings. But based on what we know today, we're still comfortable with the absolute range of adjusted EPS in 2013 that is implied by our current guidance.

Turning to the next slide, which looks at free cash flow. We generated about $935 million of free cash in the first quarter, and that's up significantly from a year ago, and that's primarily due to an improvement in working capital as well as a decline in cash taxes. The reduced drag from working capital accounted for more than half of the improvement in year-over-year free cash flow this quarter, and that was due largely to lower production spending at Film and TV and the timing of sports payments at our Networks division. The decline in cash taxes was a result of tax law extenders that were passed by Congress in January earlier this year. Given the strong start and our expectations for the remainder of the year, free cash flow should be up nicely in 2013.

And moving over to our final slide, which looks at our net debt. We ended the quarter with $16.9 billion in net debt, which is pretty similar to where we ended 2012 as we used slightly more than 100% of our free cash flow in the quarter for dividends and share repurchases. That's almost $950 million in the quarter, and that includes about $600 million -- $670 million of share repurchases. Our leverage ratio is now 2.4x, in line with where we ended 2012. We remain comfortable that our target leverage ratio of 2.5x strikes the right balance of maintaining balance sheet strength while allowing us to continue to invest in our businesses, making acquisitions and returning capital to our stockholders. So we'll continue to manage our balance sheet to stay in that range over the course of the year.

With that, let me turn it back to Doug in order to start the Q&A portion of the call. Thank you.

Douglas Shapiro

All right. Thanks, John. Dawn, we'll get the Q&A started [Operator Instructions].

Question-and-Answer Session

Operator

[Operator Instructions] We have John Janedis from UBS online.

John Janedis - UBS Investment Bank, Research Division

Jeff, to your point on HBO, creatively it's going great. Can you talk about what you're seeing from a subscriber perspective? Any change in churn given the programming strength? And do you still think you have pricing power given the increase in lower-priced substitutes?

Jeffrey L. Bewkes

Yes, I think subs are going very well at HBO, both domestically and overseas, particularly overseas. I don't know if you're asking about first quarter, but they were pretty -- they move around in terms of the mix of paying versus not paying subs. In general, the trend is very buoyant. We think that subscribers love the program, and we got several shows that are record audience shows led by Game of Thrones. HBO GO continues to pick up users, registrations and tremendous reports from the families that are using it. Let me -- what are you asking exactly?

John Janedis - UBS Investment Bank, Research Division

I guess what I'm asking is that given the strength of Game of Thrones, et cetera, is that bringing churn lower, I guess, number one? And then number two, given some of the lower-priced substitutes for, let's say, $8 or $10, is there any kind of impact in terms of your subs as it relates to some sort of substitution effect as a result of that?

Jeffrey L. Bewkes

Okay, now I got it. No, I don't think there's any effect of other complementary services like Netflix, et cetera. Remember, both Netflix over-indexes in HBO homes and HBO over-indexes in Netflix homes. So these are not -- these are very complementary things. On the churn side, churn is certainly kind of restrained and improved by strong programming at HBO. But the churn dynamic for any pay TV service that flows on top of basic packages has a lot more to do with what the distributors are doing in terms of price offers, vigorousness of -- vigor of marketing and so forth, not that much to do with programming. But having said that, HBO has the lowest churn of any premium service.

Operator

Our next question comes from Dan [ph] Swinburne for Morgan Stanley.

Benjamin Swinburne - Morgan Stanley, Research Division

I think that's me. I guess is that me? I have 2 questions, one housekeeping just on the advertising. John, what was the actual domestic international year-over-year growth rates or declines at Networks this quarter?

John K. Martin

So in the first quarter, I think I might have even said this, we reported down 1%. The movement of the NCAA Final Four from Q1 to Q2 probably cost us about 200 basis points. And then all of the other sort of noise, whether it's the network shutdowns, the transfer of SI and Golf.com and FX, was about another 200 basis points. So overall, organic ads were up call it around 3%. And if you look at that between domestic and international, domestic was up mid-single digits, right around 5%, and international was down mid-single digits, right around 5%. And internationally, we saw particular strength in our entertainment properties, which were up double digits with a very strong rebound in Latin America, and that was more than offset by double-digit declines at news.

Benjamin Swinburne - Morgan Stanley, Research Division

Okay. And then, Jeff, I would love to hear your comments on some of the comments Richard Plepler made, I think, over the last couple of months about HBO potentially exploring kind of a broadband-only distribution plan with MVPDs. Sort of how real is that in your mind? How big of an opportunity is that? And in particular, why would you argue that's consistent with your 'TV Everywwhere' strategy at Time Warner overall?

Jeffrey L. Bewkes

I'm not sure you have. I mean, we always look at opportunities to increase the distribution, the availability of HBO. And so I think Richard was speaking to that. We have done, for example, that model in Scandinavia where you can buy HBO the traditional way on TV with HBO GO attached to it from a traditional video distributor there. But because they don't have that many multi-pay subs over there, basically we also offered it through broadband. So if you then go to the United States, I think you're asking about that.

Benjamin Swinburne - Morgan Stanley, Research Division

Yes, yes.

Jeffrey L. Bewkes

HBO has got 40 million HBO Cinemax subs here. We are vigorously offering HBO GO through all our distributors. If you then go and say, well, should we add it as a broadband-only service, which you could do through facilities-based providers or you could do it through non-facilities-based providers, which I think was the discussion Richard was having, we have the rights to do it, and we would do it if we thought it was in our economic best interest. At this point, we don't think it makes sense. We don't think the target market is sufficiently large to be attractive at this point. So what we're doing, and it is working pretty well, is we're working with the MVPDs to increase the penetration of HBO in a mutually beneficial way. We're always going to keep evaluating it depending on the country, and I think that's what Richard was talking about. I think he's right to say it that way.

Operator

Our next question comes from Jessica Reif Cohen from Bank of America.

Jessica Reif Cohen - BofA Merrill Lynch, Research Division

I have 2 questions, 2 topics. One is on SVOD. You mentioned that this will be a strong year, and I was just wondering, I wondered if you could give us your current thoughts. You've talked about it in the past. And also, how much of an opportunity do you think there is with Netflix moving away from Viacom? You guys have one of the biggest, if not the biggest, television library. So that's the first question.

Jeffrey L. Bewkes

Oh, so you're asking, Jessica, about SVOD outlook for 2013?

Jessica Reif Cohen - BofA Merrill Lynch, Research Division

Yes.

Jeffrey L. Bewkes

Like going forward? Good. It's pretty good. What we have said, I'll try to remember all the things we've said publicly, we have disclosed that we generated over $350 million in revenue from SVOD sales in 2012. We think that's near the top of our competitive set, and that does not include the revenue from the CW Network deal, which is pretty significant. As we look at this year, we feel very good. We've got some deals we've already done. We have a number of agreements that we did last year that have ongoing components. We've recently signed additional deals with both Amazon and Netflix, and we did that both at Warner's and at Turner. We're in active negotiations with all the major players, including those buyer. So we think it'll be a significant revenue stream for us again this year, and it may well grow this year. But we do want to keep it in perspective. It's a small percentage of our revenue. It's only around 10% of our TV syndication revenue last year, and we -- it's about 3% of total Film and TV. So hopefully, it'll grow. While -- I want another point, which is take the biggest SVOD buyer outside of HBO, which is the biggest. Netflix on the new basis, it's getting more selective what Netflix is trying to buy, and we thought that would happen. We think it's a good trend for us. I think what'll happen with SVOD providers' broadband is they're going to focus more on current content, especially back seasons of series that are currently on the air and some select high-value library series. We have not done -- or we've got the biggest supply in all those categories. We haven't done kind of general deals that require people to take less desired series. So we think we're in a catbird seat from that point of view with all the SVOD buyers.

Jessica Reif Cohen - BofA Merrill Lynch, Research Division

Great. And then just a completely different topic. On CNN, can you talk a little bit -- you made a lot of changes and continue to make changes, but what is the upside over the next couple of years with ratings improvement? Are the affiliate contracts from the same cycle as the Turner's or the Turner networks?

Jeffrey L. Bewkes

Yes, they are. The biggest upside is in affiliate improvement. We think there's a lot of correction there. There's certainly a lot you can do on the advertising side, but let's focus on really the strength of CNN as it comes back here. We think the new leadership is off to a great start. We feel momentum in ratings. If you look at April, it's significant progress. CNN is #2, HLN is #3. If you look at online, we had our highest day in history just last month. You can see, as you just looked at what happened in Boston last week, and we keep, all us are, saying this over and over, whenever there's a global news item of interest, CNN is the first place to go. We're getting better all the time in extending that and covering it in all its dimensions. So we have said, as having said that, that CNN can't just mean politics and wars. And we're -- we will cover those, but we don't need to start a war to have a success at CNN. We do need to be more competitive in the mornings. We're working on that. I think you can see the focus on some of our broadening of what we're doing in the hires of Chris Cuomo, Jake Tapper and Rachel Nichols. You can see it in the success of Anthony Bourdain. And so we think -- because remember, more people tune in to CNN than any other news channel, and the issue is how long do they tune in. We're making strides on the length of time that people watch CNN as we really basically deepen the program.

John K. Martin

And just a quick amplification, too. Looking at the second quarter, I talked a little bit about ad revenues strengthening. We are seeing improvements in the news category, both domestically and internationally in Q2. So that's also encouraging.

Operator

Our next question comes from Michael Morris from Davenport & Company.

Michael C. Morris - Davenport & Company, LLC, Research Division

First, just following up on that question of news. And the news ratings not just for CNN but some of your competitors' have been down pretty significantly so far this year. Now I'm curious, where do you think that audience is going? And hopefully, I mean, that does kind of tie into the comments you just made about the new programming. But I guess I want to get a little better understanding of why you feel certain that, that opportunity is there, where those people are going and how you're -- where you're winning them back from. Then I have a follow-up.

Jeffrey L. Bewkes

So remember -- okay, the reason is it's really what -- it's in your question. You have -- see, the ratings were down at all the news networks. The number of people tuning in was not down. And so what you have is a variation in either the sense of urgency people have around the country or the world as to whether they want to watch news coverage or if there's something happening of great interest to them. And then secondly, you have the question of whether news channels are delivering the kind of coverage that would motivate people to stay. So it's not an issue of reach. It's not an issue of whether people are showing up and are interested in the news. It's really a question of whether the programming is engaging and whether what the news is, is drawing audiences. We have seen Fox as one of our competitors moving more to the extreme, and NBC doing -- and MSNBC doing the same thing on the other side. We think that's a huge opportunity for us. And because we have more people tuning in to us than either of them do, we think that if we just do a job on finding the news and the coverage that satisfies them that they find relevance to stay for a little longer than just getting the headlines, that we have a great upside. And I would add one thing, which is the world, the media world, the press world covers very intensely all the developments in online or digital that are relatively, they think, small but portend the future. CNN's digital and online business is the biggest one out there. It ought to get more attention.

Michael C. Morris - Davenport & Company, LLC, Research Division

Great. And then also on the international side, on Turner International, I think you made a management change about a year ago right now. Can you talk a little bit about the progress there in terms of strategy, both any markets that you're focused on or increasingly focused on? And also, whether -- is news a focus? Is more entertainment content a focus? Just any update there will be helpful.

Jeffrey L. Bewkes

Okay, there you're referring to Gerhard Zeiler, who's the CEO of Turner International. First thing I would say is we're coordinating more, and we have more positions of strength between Turner, HBO and Warner's in various places, overseas where we've concentrated, particularly in Latin America. Secondly, I think we've said now many times and we're pretty much on track that our international business is on track to make $1 billion in operating earnings in the next few years. It'll be either '14 or '15 that we hit that. Some of the change, if you're asking for specifics, has been the cleaning up of efforts that didn't work like in India and Turkey. And a lot of the rest of the changes essentially focus on the places where we've been churning along. I think it's important to point out that the margins overseas -- we're usually the leading share player on the multichannel side where we're competing, and our margins overall are still in the 20s. They have improved 500 or 600 basis points on an underlying basis over the last couple of years if you leave out shutdowns. And so there's kind of a -- we all know there's a growing multichannel market out there. We've got tremendous position in distribution. We have channels from Turner to HBO to Warner that make a nice package. And you have basically an opportunity cause these are scale operations, of raising margins pretty rapidly because we're in that phase of growth in Latin America, Eastern Europe and Asia. So that's basically the outlook. It's pretty strong.

John K. Martin

Just one further thing, Michael, specific to next quarter and then this year. We do anticipate our international network ratings at Turner to begin to improve in the second quarter. So I think Q1 will probably be the low watermark for the year. And then because of the restructuring initiatives that have already been put in place, we think that the profit growth internationally at Turner this year is going to be really, really substantial, and we're going to experience meaningful margin expansion in '13.

Operator

Our next question comes from Anthony DiClemente from Barclays.

Anthony J. DiClemente - Barclays Capital, Research Division

I had 2 questions. At the Film and TV segment, John, you called out EST growth as 60%. Wondering, as you look at your new home video releases like Hobbit or Argo, what percentage of units sold for a property like that these days are digital versus physical? It seems like digital is accelerating. Is that -- and what is that from? Is it distribution of EST platforms? Is it pricing? Is a tablet growth? And then second question, there've been some talk out there about Turner carriage of the Final Four in your talks with CBS and the chance that, that could move up. I wonder if you could remind us strategically of the puts and takes there, Your willingness to absorb a greater percentage of the licensing costs in order to perhaps strengthen your content portfolio ahead of your affiliate renewals.

John K. Martin

Anthony, I'll take the first one. Yes, I don't know title by title specifically the differential in EST versus traditional physical sales. I mean, something like The Hobbit, frankly, across all distribution methods exceeded our expectations. If you look at EST in the quarter for us, and we probably have the lead EST share across the industry, we were up in the first quarter 20% year-over-year, and the overall EST revenues were north of $75 million. If you look at EST and VOD, which is another important form of digital distribution, it was up significantly in the quarter, and we approached -- we were north of $150 million, close to -- approaching $200 million in the quarter. And just a reminder, if you add SVOD on to that, if you add EST, SVOD and VOD, last year we were at $1 billion. So those 3 forms are already big. And frankly, that's one of the reasons why you're seeing stabilization in the overall home entertainment market in general, and it's one of the reasons why we're feeling more optimistic about the going-forward performance of the home entertainment business. So I apologize, I don't have the specifics for the newer titles.

Anthony J. DiClemente - Barclays Capital, Research Division

And so the...

Jeffrey L. Bewkes

On the NCAA question, we do have the option to start airing the Final Four next year, and that does not involve any incremental payments from us. So we have not made an announcement on that front yet, but it's something we've been discussing with CBS. So stay tuned.

Anthony J. DiClemente - Barclays Capital, Research Division

And what would be the downside to doing that if there aren't any incremental costs or losses incurred?

Jeffrey L. Bewkes

There would not be downside.

Operator

Our next question comes from Richard Greenfield from BTIG.

Richard Greenfield - BTIG, LLC, Research Division

When you look -- we love the HBO GO app, especially because of the way it curates a deep catalog experience. Yet when you look at apps like the Turner apps, the content is significantly more limited, and we've even seen you sell back episodes of things like Falling Skies to Amazon or Netflix. I forget which off the top of my head. But why not follow the HBO GO strategy with authentication to drive sub fees even higher when you force people to authenticate and really drive more usage of those apps? Basically, what are differences in strategy between HBO GO and the Turner assets? And then if you could just touch on Cinemax seems like you've had a real progress over the course of the last 6 months. You never really talk about Cinemax on your conference calls. Can you just update us on how big it is today and how big it could be over the next couple of years?

Jeffrey L. Bewkes

Yes, thanks, Rick. Let's start with Cinemax first. So Cinemax subs have been growing well in America and overseas. Cinemax original programming is a new genre over the last year or so. You have Strike Back, Hunted, Banshee. I watch them all. If any of you on the call have not seen every episode of all of those shows, go home -- well, don't go home, just turn your iPads right now and watch them all. You take the rest of the day off. They're really good. If you're asking, and I think it's a good question, about what about a more robust offering of VOD rights for basic channels, Turner or the -- ours but there's all the other ones owned by other companies, I think it's a good question, but you've said a lot when you mentioned the distributors. Well, what you have to do in basic is you have to try to figure out how to get the industry or, if you're going to do something different, have it work in a package of other channels. So up to now, we were the lead company. We did it first of putting at least 5 episodes of every series that we have on our Turner networks up there for free to subscribers on VOD and on broadband availability. We haven't been acquiring the back season rights. If you me for stacks of full seasons for the TV offering, yes. It's a big question because we're not really able to monetize them through carriage fees. If you take a show and put it on right now, it's not easy to get monetization, whereas if you're selling kind of library serialized, and I can't think of a series, to an SVOD provider, you can get monetized. And most are the natural places for consumers to find those shows and look deeply as 10, 20, 30 episodes. So kind of a video on-demand is the best way to watch serialized series. It can be VOD, as it is on HBO, as it could be on TNT, but it's essentially a model that has to evolve. So we're keeping an eye on the balance of how to make all of these networks, TBS, TNT, truTV, along with HBO, stronger and be things that viewers know they can go there and watch their favorite series and whichever episode of that. It's easy to do in pay TV, as you saw actually us do with all our shows on HBO, than it is on basic.

Richard Greenfield - BTIG, LLC, Research Division

And Jeff or John, is there any way to just quantify what percentage or even like the size of Cinemax in the portfolio relative to HBO just as it keeps growing? It seemed like a big opportunity that -- trying to get my arms around that size potential.

John K. Martin

Domestically, I think we ended 2012 with about 41 million HBO Cinemax subs. We don't break out the specific numbers, but HBO generally has twice the number of Cinemax. Cinemax, just to echo what Jeff said, has been growing very, very healthily. And then outside the U.S., I don't even know how many we have. I mean, if -- it's -- we have 71-plus million HBO Cinemax subs outside of the U.S., they grew like 35% last year, a big chunk of that growth was Cinemax, particularly in Latin America.

Jeffrey L. Bewkes

I just want to clear, we -- in domestic, we -- the relation, HBO to Cinemax, well, we don't -- it's more than 2x HBO. HBO has a bigger share than Max.

Operator

Our next question comes from Alexia Quadrani from JPMorgan.

Alexia S. Quadrani - JP Morgan Chase & Co, Research Division

Just looking at The WB, the TV studio business, are you seeing any change in demand for more the traditional syndicated programming domestically as more networks are focusing on original programming? And if so, maybe that's more than offset by international demand. And then just a second question, just to follow up on your earlier comments on the SVOD business that you made, I -- is there a way you can sort of quantify how big of an opportunity there is for potential revenues outside of Netflix if Netflix were to really pull back on the syndication programming?

Jeffrey L. Bewkes

All right, so you're asking about demand in syndication first or -- is that what you're asking?

Alexia S. Quadrani - JP Morgan Chase & Co, Research Division

Yes. Just demand by...

Jeffrey L. Bewkes

Increased demand by regular syndicated buyers?

Alexia S. Quadrani - JP Morgan Chase & Co, Research Division

Exactly.

Jeffrey L. Bewkes

Okay. It's up for A titles, and it's up around the world as well. So it's a very strong market for A titles. The B titles are tending to go more and more to either some cable or some SVOD players. And it's not a divide, as we've said many times, between serialized things versus non-serialized things. The serialized are of more use to subscription VOD players. What was the other question?

John K. Martin

On SVOD?

Jeffrey L. Bewkes

SVOD.

John K. Martin

Yes, I mean, look...

Jeffrey L. Bewkes

[Indiscernible].

John K. Martin

Yes, we've been doing deals with other SVOD providers outside of Netflix actually all along. And if you just look at the first quarter, about 30% to 35% of the deals that we did that we recognized and revenue were non-Netflix and a considerable portion of those are outside the U.S. And so I just want to also reiterate and repeat what Jeff said a little bit to your earlier -- to an earlier question because I think your question somewhat assumes that we have a lot of risk should Netflix pull back and change its buying patterns. We don't really see that. And as Jeff said a little bit earlier, we haven't really sold these huge blanket library deals perhaps as some of our -- other media companies have had. So we think, if to the extent that a Netflix or, frankly, all of SVOD providers become more selective, we've got the best shows that we think demand is going to go up.

Alexia S. Quadrani - JP Morgan Chase & Co, Research Division

So that $350 million that you saw last year, that could potentially grow this year, in 2013?

Jeffrey L. Bewkes

Yes.

John K. Martin

Yes. I mean, yes. Yes.

Operator

Our next question comes from Michael Nathanson from Nomura.

Michael Nathanson - Nomura Securities Co. Ltd., Research Division

I have one for John and one for Jeff. John, can you give just me some help? On programming cost growth, I know the shutdowns of the networks internationally have helped you. What is -- what are the like-for-like programming international [ph] growth be in the first quarter? And when you gave your guidance for the full year, how are you factoring in the shutdown within your guidance?

John K. Martin

Well, if you look at programming costs, which were basically essentially flat in the quarter, I think they were down 1%, they were lower than they ordinarily would be for really 3 reasons: it's the NCAA shutdown -- or excuse me, the NCAA move from Q1 to Q2; it was also the shutdowns, as you said; and it was also we had a pretty big write-off for a series at HBO last year. So on a normalized basis, programming costs would have been call it mid-single digits, which is consistent with our plans to grow programming mid- to high single digits over time. And I think even said that in my proactive remarks in 2013 that's the expectation. But I just want to remind everybody that, that does include significant investments in original programming and sports. So in other words, we're already factoring that into the mid- to high single-digit outlook and, because we know that we've got several components of programming expenses that are growing more slowly than that, are either flat or low single digits. So we do expect overall programming costs to increase, but we think they're going to be at a very measured and controlled pace. And obviously, beyond programming costs, we are looking to restrain growth in all non-revenue-generating expenses, and you saw that again and again this quarter, so.

Michael Nathanson - Nomura Securities Co. Ltd., Research Division

And John, that's on a reported basis. Your guidance, as reported, mid-single-digit programming expense growth?

John K. Martin

Correct, on a [indiscernible].

Michael Nathanson - Nomura Securities Co. Ltd., Research Division

Okay, okay. And Jeff, can you just go back to...

John K. Martin

And so Michael, just to qualify, it's going to -- basic -- over an annual period, it's going to basically be about the same, reported and normalized.

Michael Nathanson - Nomura Securities Co. Ltd., Research Division

Okay. And Jeff, the last question is about the value of A titles going up in the world [ph], and that's totally true. But the question I had, though, as as a buyer of syndicated content at Turner, does your definition of A titles change over time? Like what was considered an A title 2 years ago? [Indiscernible] do you believe now [indiscernible] anything about that?

Jeffrey L. Bewkes

[Indiscernible] So company A titles, let's take Two and a Half Men. I mean, Two and a Half Men, Big Bang -- Two and a Half is on Fox, Big Bang is on FX, Big Bang is on TBS. Clearly, extremely successful and valuable, holding up well on whichever networks they go to. So that's a very healthy ecosystem. It's a very good part of your programming mix for our basic channel. That's comedy. So as we know, they've been resilient for decades. Dramas are kind of interesting. It's a bigger field. We certainly think titles like Mentalist, Hawaii Five-0 are A titles. There are plenty of buyers for them. The question that's going to emerge over time is that as cable networks, TNT, USA, FX, et cetera, move into drama production, it started at HBO, now everyone's doing it, you end up with a kind of a continuum of successful cable originals that, depending on the kind of niche appeal of a show on AMC versus a show on TNT, et cetera, that then starts to proliferate production into those cable-hour drama originals. It's -- then you still have the power and value of hit hours that come off of the big networks like Mentalist, like NCIS, but the relative performance of those kind of off-network-hour drama hits, still A titles, may change just because you have more and more kind of fragmentation and focused appeal of cable hours. So it's a moving spectrum. We feel very happy about our position at Warner's as the biggest producer and seller of those across the 5 broadcast networks. So we have a lot of them to put into syndication or cable networks or SVOD. And then on the Turner side, we have such an advantaged schedule of kind of -- we've got a very healthy schedule of both originals and acquired. We have great access to acquired hits. So as we figure out what the optimal mix of acquired dramas is versus cable original produced dramas, we're going to be able to dial it up and down on both sides. So that's essentially how we see it. And we've got a pretty good position and flexibility.

Operator

Our last question comes from Michael Senno from Crédit Suisse.

Michael Senno - Crédit Suisse AG, Research Division

Two quick ones, if I could. One, in terms of international, if you were to look at any M&A opportunities, would you provide some context on what attributes, what type of assets you may be looking at and what areas of the globe you're interested in complementing the current portfolio? And then second, just in terms of Time Warner being one of the more aggressive TV Everywhere early adopters, do you think a virtual MSO is the catalyst that's needed to really accelerate the adoption of TV Everywhere in its ultimate form?

Jeffrey L. Bewkes

No to that question, but we don't have theological views about it. On your international first question, we've said this a lot. And certainly, we can remember that. I'm not sure you should. But the areas that we focused on are ones where we think there are -- there is basically high secular growth, both in the underlying economies and in the video habits of the population; and then secondly, where there is reasonably hospitable rule of law and acceptance of nonlocal media network operators, full-on ownership. So basically, what we've said and still say is let's ask America, Central America, that's all of Latin America, it's been a very strong market for us. We have the leading network position of any nonlocal broadcaster network operator across all of Latin America. We've said Eastern Europe -- and while the Eastern Europe economic macro situation is a bit difficult, we've got an interesting position at CME that we're optimistic about, and we're in the midst of helping to strengthen the financial resources of CME. So we think that's going to be a great long-term network across numerous countries in Eastern Europe. And we think Eastern Asia -- we think Asia, South Asia and Southeast Asia, where we've got a lot of -- we're #1 actually in all of our HBO territories, including the Asian ones, and we've got some good positions with our Turner networks there, we think that's the other obvious growth area, so we're going to put more emphasis there.

Douglas Shapiro

Well, that's it. Thank you very much for listening in.

Operator

Thank you. Ladies and gentlemen, this concludes today's conference. Thank you for participating. You may now disconnect.

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