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Time Warner Inc. (NYSE:TWX)

Q2 2006 Earnings Conference Call

August 2, 2006 8:30 am ET

Executives

James Burtson - VP

Dick Parsons - Chairman, CEO

Wayne Pace - EVP, CFO

Jeff Bewkes - Chairman, Entertainment & Networks Group

Analysts

Spencer Wang - Bear Stearns

Anthony Noto - Goldman Sachs

William Drewry - Credit Suisse

Jessica Reif Cohen - Merrill Lynch

Doug Mitchelson - Deutsche Bank

Lowell Singer - Cowen and Company

Douglas Shapiro - Banc of America Securities

Aryeh Bourkoff - UBS

Rich Greenfield - Pali Research

Gordon Hodge - Thomas Weisel Partners

Jason Bazinet - Citigroup

Michael Kupinski - A.G. Edwards

Presentation

Operator

Hello and welcome to the Time Warner second quarter 2006 earnings call. (Operator Instructions). At this time I would like to turn the conference over to Mr. James Burtson, Senior Vice President of Investor Relations for Time Warner. Thank you, sir, you may begin.

James Burtson

Thanks, operator. Good morning, everyone. Welcome to Time Warner's 2006 second quarter earnings conference call. This morning we issued three press releases: the first detailing our second quarter results, the second announcing our new 2006 full year business outlook, and the third updating AOL's business strategy. Before we begin there are a number of items I need to cover with you.

First, we refer to non-GAAP measures including operating income before depreciation and amortization, or OIBDA, and free cash flow. We use these measures when we analyze year-over-year comparisons. In order to enhance comparability we eliminate certain items such as non-cash asset impairments, gains or losses from asset disposals, and amounts related to securities litigation and government investigations. We call this measure adjusted operating income before depreciation and amortization, or adjusted OIBDA.

Schedules setting out reconciliations of these historical non-GAAP financial measures to operating income and cash provided by operations are included in our trending schedules. These reconciliations are available in today's earnings release and on our Company's website at www.TimeWarner.com/investors. A reconciliation of our expected future financial performance is also included in the press release that is now available on our website.

Second, as a result of the purchase of the 50% interest in Court TV that we did not own, the Company has presented the financial condition and results of operations for this business as of January 1, 2006, but not in any prior periods.

Third, due to the July 31 closing of the Adelphia and Comcast transactions the Company has issued a new business outlook which includes the net impact of these transactions. The cable systems acquired from Adelphia and Comcast are reflected as of August 1, 2006 but not in any prior periods. The Time Warner Cable systems transferred to Comcast as part of the redemption of Comcast's interest in Time Warner Cable and Time Warner Entertainment Company LP are accounted for as discontinued operations in both 2005 and 2006, which excludes their impact from the business outlook.

Fourth, today's announcement includes certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are based on management's current expectation or beliefs and are subject to uncertainty and changes in circumstances. Actual results may vary materially from those expressed or implied by the statements herein due to changes in economic, business, competitive, technological and/or regulatory factors. More detailed information about these factors may be found in Time Warner's SEC filings including its most recent annual report on Form 10-K and its quarterly reports on Form 10-Q.

Time Warner is under no obligation to and, in fact, expressly disclaims any such obligation to update or alter its forward-looking statements whether as a result of new information, future events or otherwise.

Finally, let me remind you that we're conducting a second conference call this morning starting at 11 am to update you on AOL's business strategy. So we'd appreciate it if you could please hold all your questions on that topic until the next call. Of course, we'll be happy to address any questions about AOL's second quarter performance during this call. In the same vein, neither Dick nor Wayne will speak to AOL's plans in their prepared remarks.

With that covered I'll thank you and turn the call over to Dick.

Dick Parsons

Thanks, Jim and good morning, ladies and gentlemen. We appreciate your joining us today on our second quarter earnings call. As Jim mentioned, we've got a very busy agenda today which includes a separate call later this morning to update you on our business strategy for AOL, so we'll do our best to stay efficient on this call.

I'll start off by sharing my perspective on our Company's progress in the quarter and then ask Wayne Pace to briefly take you through the results. We'll leave plenty of time for your questions at the end of our presentation; and during the Q&A session, Jeff Bewkes is going to join Wayne and me.

Now, looking at the quarter, the Company delivered solid results that position us well to meet our full year financial expectations. We posted healthy 7% growth in adjusted operating income before depreciation and amortization or, as we call it, adjusted OIBDA. Once again we generated impressive free cash flow, converting 49% or $2.6 billion of our adjusted OIBDA to free cash through the first six months of this year. Our adjusted diluted earnings per share in the quarter were $0.20, up 25% from the prior year.

This performance drew strength from across our businesses, led by stand-out results in our cable, Filmed Entertainment network segments as well as better than expected results in AOL.

As you saw on one of this morning's press releases, we provided a new full year outlook for adjusted OIBDA, reflecting an increase to low double-digit growth. This outlook now includes the impact of the Adelphia and Comcast transactions that we closed on Monday. Without those transactions, however, we would have remained on track to achieve our previous business outlook of high single-digit growth. We continue to expect to convert 35% to 45% of our adjusted OIBDA to free cash flow.

That said, the Adelphia and Comcast transactions may push us towards the lower end of that range as we absorb integration costs and work aggressively to upgrade the infrastructure of our newly acquired systems.

Looking briefly at the individual performance of the divisions, Time Warner Cable delivered another really great quarter. The second quarter represented the 22nd in a row that subscription ARPU grew at double-digit rates. The triple play bundle continues to drive customer satisfaction up and churn down. 11% of our customers are now in triple play bundles. In this typically seasonally weak quarter, Time Warner Cable had its best second quarter ever with impressive net additions in every subscriber category.

Basic subscribers increased both year-over-year and sequentially. Annual subscriber penetration at the end of the quarter was 53% per basic subscriber. High-speed data net additions were over 200,000 for the sixth consecutive quarter, despite the current penetration levels 27% of eligible homes passed.

Digital phone continues to grow at a rapid pace. With this quarter's net additions we ended the quarter with over 1.6 million phone subscribers and we're approaching 10% penetration of eligible homes.

With Time Warner Cable's continued excellent performance we were very pleased to have finally closed the Adelphia/Comcast transaction this past Monday. Our focus is now on integrating the newly acquired systems. First on our list of priorities is upgrading the infrastructure as soon as possible. This is an important step because doing so will allow Time Warner Cable to execute its already proven strategy of selling advanced digital video, data and voice services. In addition to upgrading the infrastructure, our other near-term priorities include ensuring that the level of service to existing customers only gets better after Time Warner Cable takes over.

In addition, as you may have seen this morning, we're preparing for the dissolution of our cable joint venture with Comcast. For those of you who are not familiar with the composition of this joint venture, we currently own jointly with Comcast approximately 1.6 million subscribers that are clustered in two pools, one being Houston, Texas; the other being a combination of systems located in Kansas City, Southwest Texas and New Mexico. Last month Comcast initiated the process to dissolve that partnership.

After carefully evaluating the benefits and trade-offs of both pools we have selected to receive Kansas City, Southwest Texas and New Mexico. As a result of this transaction Time Warner Cable will consolidate the results of those systems and receive a cash payment of approximately $600 million.

Switching now to AOL. In the second quarter AOL's advertising revenue grew a stellar 40%, which leads us to believe that AOL took share domestically for the first time in a long time. With the refinements to AOL's strategy that we'll be announcing later today, we believe that AOL will be able to continue to improve its industry positioning.

Without getting too far ahead of the presentation Jeff Bewkes and AOL's CEO, John Miller, will give on a separate call later this morning, I will say that I believe the strategy is quite sound. By giving AOL's valuable numbers the ability to stay with us free of charge as they shift to broadband, we will finally position AOL to fully take advantage of very compelling online trends. AOL's advertising results this quarter only serve to bolster our confidence in AOL's business prospects and potential to produce incremental shareholder value.

Touching briefly on our other segments, we're very pleased with the performance at our studios and networks, both of which posted results that put them squarely on track to meet their respective full-year expectations. Please note that both Turner and HBO had strong double-digit adjusted OIBDA growth in the quarter which, as Wayne will detail, was offset in our segment results by the costs associated with the shutdown of the WB Network. This shutdown expense was the result of the merger of the WB with UPN to form the CW.

In addition, during the second quarter we were pleased to close on the purchase of the remaining 50% of Court TV that we did not already own, which Turner is now working to integrate fully into their operations.

The one disappointment in the quarter was Time Inc. whose results were once again less robust than we had expected. Nonetheless, this shortfall is not meaningful enough to cause us significant concern as we look out at the rest of the year. We continue to believe that Time Inc. will generate adjusted OIBDA growth for the full year.

Before I ask Wayne to do his normal detailed review of the quarterly results, let me update you on our share repurchase program. To date we've repurchased approximately $11.7 billion worth of our stock including $3.7 billion of it since we last reported earnings on May 2nd. In totally we've bought back over 14% of our outstanding shares since we began the program and we remain on track to complete at least $15 billion of our $20 billion program by the end of this year.

With that, I thank you and I'll turn the call over to Wayne.

Wayne Pace

Thanks, Dick and good morning, everyone. The slides that I'll refer to this morning are now available for you on our website. We'll begin with an overview of our second quarter consolidated results. Revenues increased 1% over the prior year to $10.7 billion; adjusted OIBDA grew 7% to $2.7 billion, and our second quarter margin increased by nearly 130 basis points to 25%.

Moving to EPS, which was $0.20 per diluted share in the quarter compared to a loss of $0.09 in 2005. As a reminder, the prior year included a $3 billion legal accrual related to our securities litigation offset in part by certain other items that are detailed in the press release and trending schedules for you. Adjusting for those items, EPS increased $0.04 or 25% from a revised $0.16 per share in 2005.

Looking at free cash flow, through the second quarter we generated $2.6 billion in free cash flow and converted 49% of our adjusted OIBDA into free cash. The slide that you now see shows the usual detail that we give to you each quarter.

Moving next to an update on our capital structure, we ended the second quarter with net debt of just over $22 billion, that's up about $6 billion from year end. Reflected in this increase are year-to-date share repurchases and dividend payments offset partly by the free cash flow that we generated so far this year.

In addition, during the second quarter we purchased the remaining 50% interest in Court TV and we received proceeds from the sale of a 5% interest in AOL to Google as well as the previously announced sale of Turner South.

As Dick mentioned, we completed the Adelphia and related Comcast transactions earlier this week. These transactions resulted in an increase in net debt of about $11 billion and a net addition of about 3.3 million basic cable customers. And as a result Time Warner increased its equity ownership of Time Warner Cable's common stock from 79% to 84%.

This next slide is the share repurchase program; Dick already updated you on that. This shows the highlights and we'll move on I think from that to our business outlook.

As you heard, we're issuing new guidance today to include the impact of the Adelphia and Comcast transactions as well as the consolidation of Court TV and the impacts of the shutdown of the WB Network. With the combined impact of these items our full-year adjusted OIBDA outlook is now low double-digit growth. As noted in our business outlook release, the net impact of the Adelphia and Comcast transactions raised our adjusted OIBDA outlook by low single digits.

As Dick mentioned, without the impact of the Adelphia and Comcast transactions we believe we're firmly on track to deliver our previous outlook of high single-digit growth. You should also note that while we're not providing specific expectations for Court TV, the Court TV network contributed $127 million in revenue and $25 million in OIBDA during the first six months of this year.

We'll next go through the results for each of our segments and then go to the Q&A part of the call. Starting with cable, where, again, we had strong second quarter revenues, grew 15% led by subscription revenue growth for high speed data, digital phone and enhanced digital video services. Average monthly since subscription revenue per basic subscriber for the quarter grew 14% to $91 marking the 22nd consecutive quarter of double-digit year-over-year growth. OIBDA increased 16% benefiting from higher revenues offset partially by a 9% increase in video programming costs and higher operating expenses.

Cable's second quarter OIBDA benefited from the net effect of several items which we have detailed for you in the earnings release. Without the impact of these items, OIBDA growth would have been closer to 14% on a year-over-year basis.

Looking at subscribers within cable, we did have a strong second quarter despite the typical seasonal trends that negatively affect the second and third quarters. In fact, we added 665,000 revenue generating units, that's a 12% higher number than last year's quarter. Basic subscribers increased 18,000 representing the fourth consecutive quarter of growth and it's the largest second quarter increase since 2002. We added 171,000 digital video customers, that's 19% more than in the prior year, increasing our penetration to 53% of our basic subscribers.

DVR customers grew 157,000 in the quarter bringing DVR penetration of digital subscribers to 32%. Residential high-speed data subscribers increased 230,000 representing the sixth consecutive quarter of more than 200,000 net additions. Penetration of eligible homes was 27% at the end of the second quarter.

We added 234,000 digital phone subscribers this quarter, the fifth straight quarter of more than 200,000 net adds for our fastest-growing service. This brings our total voice customers to 1.6 million or 9% of service-ready homes.

Turning to Filmed Entertainment, revenues here declined 10% primarily due to lower revenues from home video and theatrical product available for television viewership compared to the prior year. OIBDA improved 10% against that revenue decline, primarily associated with higher television contributions related to better margin product mix and the second cycle syndication of Friends.

In addition, the second quarter included the off-network availability of the first three seasons of Without a Trace, which had been expected previously to occur in the third quarter of this year. These contributions were offset in part by theatrical declines primarily related to the distribution costs associated with the successful late June release of Superman Returns and also the underperformance of Poseidon.

On to networks. Revenues increased 9% as a result of higher subscription and advertising revenues. Revenue growth for the quarter included $65 million from the consolidation of Court TV. Subscription revenue grew 9% led by higher rates and subscribers at Turner and at HBO. Ad revenue growth of 8% was due primarily to an 11% increase at Turner, some of that benefit coming from revenues related to the consolidation of Court TV offset partly by a 9% decline at the WB Network. OIBDA increased 9% driven by higher revenues and $13 million related to Court TV offset in part by higher programming expense.

Please note that this quarter's results also reflected $81 million in shutdown costs for the WB Network. That number is before the impact of inter-company eliminations of $29 million. This inter-company elimination relates to the impact of programming sales to the WB from our Filmed Entertainment companies. As such the net impact of that $29 million elimination is not shown in the network segment but is reflected in the overall consolidated Time Warner results and the total impact is therefore $52 million on our consolidated results.

At AOL, revenues for the quarter were down 2% reflecting a decline in domestic AOL brand subscribers offset partly by a 40% increase in advertising revenues. Ad revenue growth exceeded 30% across all advertising product categories. Adjusted OIBDA declined 4% which was less of a decline than we expected as lower subscription revenues were offset partially by higher advertising revenue and by cost reductions. Second quarter results also included $15 million in restructuring costs related to the closure of one member services center and the scaling back of two others.

This next slide shows AOL's audience metrics for the second quarter. Domestic ad revenues less traffic acquisition costs, or TAC, were $295 million, a 7% increase from the first quarter. Unduplicated monthly domestic unique visitors across AOL's web properties averaged 113 million, up 6% from the first quarter. Total domestic page views of nearly 52 billion were down 2% sequentially, reflecting a decline in AOL members while domestic ad revenue less traffic acquisition costs per 1,000 page views was $5.71, an increase of 9%.

Turning for a moment to AOL's membership base. In the second quarter domestic AOL members declined 976,000 to 17.7 million. Monthly ARPU for the total membership base rose to $19.42 compared to the prior quarter and prior year.

Looking at publishing, revenues were down 2% compared to the prior year, advertising revenues increased 2% primarily from higher online revenues as well as growth at Time magazine and at People. This was more than offset by a decline in subscription revenues due to an unfavorable impact from changes in foreign exchange rates at IPC in the UK and declines at certain domestic titles including Southern Living, which had one fewer issue.

OIBDA declined 11% reflecting $22 million in restructuring costs and losses at certain non-magazine businesses and domestic magazines. Margins declined, as you see, 2% to 21%. That is the end of our prepared remarks and Jim will now start the Q&A part of our call for us.

James Burtson

Thanks, Wayne. Before we begin I'd like to remind everyone on the phone asking questions if you could limit yourselves to one question each so we can get as many people to ask questions throughout the call. Operator, we're ready to start when you are.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Spencer Wang – Bear Stearns.

Spencer Wang - Bear Stearns

Good morning. Just a quick question on the cable systems segment. The programming cost growth was 9% in the second quarter which is pretty comparable to the first quarter, and that seems to be a bit of a deceleration from the double-digit growth historically over the last couple of years.

Can you give us a sense of what you expect programming cost growth to be in the second half and the full year? Any sort of update on pending reaffiliations with ESPN and the Viacom channels would be helpful. Thank you.

Jeff Bewkes

Hi, Spencer, it's Jeff. We think that the programming costs for video channels for the remainder of 2006 will increase at a rate somewhat higher than the 9% we experienced in the first half of the year. This basically reflects the continued expansion of the service offerings that we have in our line-ups; some of it has to do with sub growth; and some of it has to do with contractual rate increases across the line-up, mostly in the sports area.

Wayne Pace

Spencer, the second part of your question was on the specific negotiations and, as usual, I don't think we're going to refer to any contract negotiations we have going on.

Spencer Wang - Bear Stearns

Thank you.

Operator

Our next question comes from Anthony Noto – Goldman Sachs.

Anthony Noto - Goldman Sachs

In the prepared remarks you talked about the trend in AOL advertising domestically, and I think the numbers you had quoted were a 9% sequential increase in revenue per 1,000 page views and a 7% sequential increase in domestic revenue less TAC.

I was just wondering if you could separate out for us the sell through component of that sequential increase versus the price component?

Your ability to continue to improve sell through last quarter despite the page view decline and again this quarter is fairly significant to the growth rate of the overall company. Just wondering if we could get a sense for what the sell through improvement is versus price, so we can think about the opportunity longer-term. Thanks.

Jeff Bewkes

We're not going to specifically address the components of that in this call, but I think that you will get a very much clearer idea of how that's going to work in the 11:00 outline of all that we're doing. Because what you'll see is that you won't have to worry about declines in page views. So the components are going to become pretty powerful. I think the best way to deal with that is to put it in the context of the new strategy.

Anthony Noto - Goldman Sachs

Great, thank you.

Operator

Our next question comes from William Drewry – Credit Suisse.

William Drewry - Credit Suisse

Just wondering, Jeff, if you can give us an update on the advertising upfront for the cable networks, and also maybe some comments on the scatter market as well? Thanks.

Jeff Bewkes

The scatter market for the broadcast networks, as all of you know, is a little weaker this year than it has been in recent years. I think everyone in the television business, whether in the cable networks or the broadcast networks, is increasingly coming to the point of not thinking that the upfront from year-to-year tells you the story of where the actual year is. Because everyone is now managing their inventories as they always did, but with more intent towards the opportunities in scatter.

Having said that, we think our Turner networks are going to end up at the high end of the cable upfront performance. So we are quite happy about where we stand. We haven't fully released, we will shortly, how we are doing. I think we're looking forward to making that announcement, and we do think that our revenues in ads for the year are going to be quite strong competitively in the cable business.

Operator

Our next question comes from Jessica Reif Cohen – Merrill Lynch.

Jessica Reif Cohen - Merrill Lynch

A cable question. The voice adds were down a bit year-over-year and sequentially. Just wondering if you could break out how much your footprint increased in those time periods? On the CapEx, it was up a bit. Is it Adelphia related? What is going on?

Jeff Bewkes

The first question was voice?

Jessica Reif Cohen - Merrill Lynch

Voice adds.

Dick Parsons

They were down slightly, but almost flat.

Jessica Reif Cohen - Merrill Lynch

Is there something going on with the footprint increase?

Jeff Bewkes

Not really. The second quarter voice numbers are always seasonally down and have been most years. This year, as Dick said, was basically the same as last year in absolute numbers. We have basically 90% of our homes passed VoIP enabled; 75% of our subs are triple plays. That is the fastest-growing product for us, and if you look at our VoIP numbers, our phone numbers this quarter, on an MSO footprint adjusted basis they are the highest in the industry.

That is true even though we are coming off of a higher penetration base than any of the other cable operators. In some of our old VoIPs, longer-enabled systems like Albany and Syracuse and San Antonio, we are getting out penetrations in the 15% to 20%, actually closer to 20%, with our overall penetration around 9%. With new additions like adding second lines and in-state calling, , because we are ahead of the others we think we can continue to stay ahead of everyone else that is trying to catch us in VoIP in the cable business. We really don't see a problem at all in continuing to increase our penetration the way we have been.

Wayne Pace

CapEx is up, and you are specifically looking at cable. None of it relates to Adelphia yet. It is all our legacy Time Warner Cable, if you will, and over three-fourths of it is what we refer to as variable capital or success-based capital that comes with a new revenue generating unit. So these are high return. Again, they come from new revenue generating units, and we're happy to have that increase in capital and it is at the very high return.

Having said that, with the closing of Adelphia earlier this week, we will rapidly begin to integrate those systems and where there are upgrades needed, we will start spending some capital there. So you'll start seeing CapEx going up compared to prior years because of the impacts of Adelphia in the third and fourth quarter of the year.

Once again, it is to tee us up to provide the advanced services. So these are good things.

Operator

Our next question comes from Doug Mitchelson - Deutsche Bank.

Doug Mitchelson - Deutsche Bank

As Time Warner Cable goes on the path of pursuing an IPO of, I think, at least one-third of the 60% ownership stake now in the hands of the bankruptcy process, is Time Warner considering offering its own primary shares as part of any IPO? If so, can you give us some insight as to why that would or would not be a good idea?

Dick Parsons

Just to bring everybody to the same starting point of your question, we completed the acquisition of Adelphia; that's closed. Time Warner Cable is obligated to file a registration statement with the SEC to use best efforts to have that filed by no later than January 31, 2007. Adelphia is then required to sell at least a third of its Time Warner Cable stock in a public offering within basically three months after that registration statement becomes effective.

Now that's unless Adelphia completes -- it's a complicated situation -- if they complete the plan of reorganization that involves the distribution of Time Warner Cable common stock that they own to a broad group of creditors, then we won't have the offering because effectively we'll become a public company in that fashion, as a succession to Adelphia.

All that said, your question is do we intend to add some of the remaining 84% of the Company that we own to an offering, assuming there's going to be an offering? We've been focused on getting Adelphia closed and getting, as Wayne has talked about, those systems integrated and doing the work we need to do to get the offering statement out there. We haven't made any judgments regarding whether we would add anything to it and so I have nothing really to say beyond that.

Operator

Our next question comes from Lowell Singer – Cowen and Co.

Lowell Singer - Cowen and Co.

I want to ask a question about the cable systems. You're now well into the second year of the triple play offer in some of those early markets. So I'm wondering if you could provide some detail on what you're seeing with regard to both ARPU deltas for those early triple play subs and also any changes in churn that you're seeing. Thanks.

Dick Parsons

I'll start and then Jeff will give you more detail. We're certainly seeing, as I indicated in my remarks, subscriber uplift across the board. I think the opportunity to go back to all the homes passed with a new product offering, namely phone, gives us an opportunity to sell in other cable products -- high speed access, basic service, digital service -- to folks who weren't taking it before. So we're seeing an uptick in all the subscriber categories.

As I indicated, I think for the 22nd quarter in a row we've seen double-digit increases in our ARPU. We're seeing churn come down because people who now have yet another relationship with Time Warner Cable are stickier folks so that both sides of the triple play are working. By that I mean we now have a new product to sell so we're getting broader subscriber outreach and uptake and it's stickier, the churn is going down. Subscribers are up, churn is down. Jeff, do you want to add something to that?

Jeff Bewkes

I think Dick covered it. On the ARPU side we see a combination in triple play of bringing stability to the ARPU. I wouldn't say what the separate contributions are. We just think our triple play ARPUs have been very stable. It hasn't changed much other than the general increase that Dick announced earlier.

One of the big success factors of our cable company has been that robust increase overall in ARPU and the triple play adds to it. The churn is steadily going down in all the components and it goes down more in triple play homes. So it's contributing to the overall reduction and it is even lower in the triple play homes versus those that have single packages.

Operator

Our next question comes from Douglas Shapiro – Banc of America Securities.

Douglas Shapiro - Banc of America Securities

Just on the AOL margins, I was wondering if you could provide a little bit more color on the source of the cost control in the quarter, specifically what the moving pieces are on network costs and on marketing and the customer support cost cuts you might have made in the quarter?

Jeff Bewkes

We've been continuing to actively reduce network costs and basically the marketing costs are essentially variable scaled to the sub base kinds of costs are declining and we are making them decline as we move down along the sub base curve. We're investing on particularly those things that relate to the rapid add growth. I do think that when you hear what we're going to do at 11:00 there's going to be a gigantic discussion of a huge change in realignment of the cost structure that you'll get the answer to that question.

Operator

Our next question comes from Aryeh Bourkoff - UBS.

Aryeh Bourkoff - UBS

Thank you, good morning. I just had a question on the overall wireless strategy. Obviously Time Warner has filed with the AWS auction this week and you have this ongoing Sprint relationship. Can you just talk about plans for that auction and your overall wireless plans? Thank you.

Jeff Bewkes

We have announced we're going to participate and we signed to go into that wireless auction, that's not happening for a few weeks. We're not going to comment on what we're doing there while that process is ongoing.

I would remind you that we've got a Sprint deal along with a number of other cable MSOs including Comcast, Cox and Brighthouse which is a co-marketing agreement to add Sprint wireless service to our existing suite of video, voice and data. That gives us a quadruple play to compete more effectively and it serves as a third screen beyond just the television and the PC screen.

So we think we can work to develop co-branded, next generation wireless in that agreement and with those partners and we'll see about how things come out and what we decide to do in the spectrum auction.

Operator

Our next question comes from Rich Greenfield – Pali Research.

Rich Greenfield - Pali Research

One question and then a data point. Could you just give us a sense of why you're giving up Houston? It seems like a market that was really one of your focus markets for a long time at Time Warner Cable. Why give that up to Comcast versus the collection of other markets that you're going to be getting?

Just housekeeping, Wayne, can you just give us what the AOL Europe profitability loss was in the quarter? Thanks.

Dick Parsons

Rich, I'll start off and then let Wayne finish up. It's about value. That joint venture, we had two pools. The way the joint venture worked, if Comcast chose to pull the dissolution trigger they essentially place a value on each of the pools and then we get to evaluate which one we think carries the greatest value from our perspective and for our shareholders. As we looked at it, with the transfer of virtually all of the debt to the Houston pool, we liked the systems in both pools. We simply concluded that the greater value from our shareholders' point of view was to take the Kansas City, Southwest Texas and the New Mexico pool. Had they made different allocations we might have made a different judgment, but we're focused primarily on driving value as opposed to other considerations.

Wayne Pace

AOL Europe was around $30 million U.S. for the quarter.

Rich Greenfield - Pali Research

Of profit?

Wayne Pace

Profit.

Jeff Bewkes

I just want to echo Dick. The Kansas City pool was significantly more valuable given the structure that was offered to us.

Operator

Our next question comes from Gordon Hodge – Thomas Weisel.

Gordon Hodge - Thomas Weisel Partners

Just a question going forward on Adelphia. I gather this year will be something of an investment year. Wondering if we look at the bankruptcy filings, I think they have low 30% margins or so. I'm wondering if that's expected to increase or decrease this year as you invest? And then we would look for expansion next year or would you expect increases in margins right away given some of your most favored nation programming agreements and so forth? Thanks.

Jeff Bewkes

We've been able to say in our guidance, and we don't think we can give more than that. I guess just conceptually I would say Adelphia is a great opportunity for Time Warner Cable to extend its strategy. As you look at the performance and penetrations and the capability of Time Warner Cable, historically to integrate systems and acquisitions and to cluster them, it's a really promising outlook.

Dick Parsons

Let me just add one other thing at the central level. Because this whole Adelphia/Comcast thing has been so long in the making that it's conceivable that some of you and indeed some of us may have forgotten what's happening here. It really is I think a quite transformative transaction for Time Warner Cable because we're not only acquiring the bulk of the Adelphia subs, and we've been working side by side with their management to make sure that we could quickly pick up this ball and begin to integrate it. But it places us wonderfully in Los Angeles and now we've got New York and Los Angeles, two of the largest media markets in the country.

We're also unscrambling the egg with Comcast. This is, I have to say, to find a place to put this in because I've been working on this for at least a dozen years. This is the final unraveling of the old TWB. This is the last piece, it's now gone. So we've gotten Comcast interest in Time Warner Cable extinguished and done.

Plus the third thing we did was we've done a number of swaps with Comcast to sort of strengthen our clusters and strengthen their clusters. So it's a good deal for us, a good deal for them and I think the Adelphia thing is going to be essentially all positive going forward.

Operator

Our next question comes from Jason Bazinet - Citigroup.

Jason Bazinet - Citigroup

A quick question on the publishing division. If I understood your comments, it sounds like you're slightly more optimistic towards the back half of the year, and I was just wondering if you could talk tactically a little bit about why you have optimism for the back half of the year? Then a little bit longer term, is there anything strategically that you think you need to do to improve the operations there?

Jeff Bewkes

This is Jeff. Yes, as we all know, you all know, there's a soft print advertising environment. We do expect Time Inc. to grow its profits in the year overall because we think that we're going to have some improvement in the advertising climate and we're starting to see that at a few of our key titles, particularly Time and People.

We are getting increased traction online, most notably at SI.com and at CNNmoney.com which we've talked to you about that before.

There's some recent additions to the digital world and they've got some pretty high traffic that they've already accumulated. And the third thing is that we continue to put a pretty keen eye on cost control and we are working on that all the time. That will be a continuous event in the magazine industry or the publishing industry.

It's really a combination of moving our powerful titles into digital and continuing to perform well in the print advertising business.

Operator

Our final question comes from Michael Kupinski – A.G. Edwards.

Michael Kupinski - A.G. Edwards

A.G. Edwards. Thank you for taking the question. Just following up on Gordon Hodge's question on the Adelphia margins. It seemed like the Adelphia management has been successful in getting those margins to about 32%. But in cutting costs they seemed to may have moved to more of a centralized management structure versus a decentralized structure that I think that Time Warner Cable might have.

I was just curious, would you expect then that the margins would take a little bit of a dip as you try to integrate and maybe unwind some of the strategies the Adelphia management has versus yours? If we should look for a little dip in the margins before getting the benefits of the clustering? How quickly do you think that you'll get the Adelphia margins up to the Time Warner type cable margins, what timeframe do you think that it will take you to get there?

James Burtson

Just before Jeff tries to get your question, you know there's a limitation to how much, particularly on a forward-looking basis, we're comfortable giving on Adelphia having just closed the transaction two days ago; and two, you're entering a process where we are, as Dick said, you're going through a process where you're going to bring the Company public. There are specific rules that surround that and we don't want to get out in front of that and talk about setting specific expectations outside of that process.

So we have included what we think is the net financial impact of the Adelphia transaction in our business outlook and I don't think there's much more specificity that Jeff can give beyond that other than if you're talking about the operating --.

Jeff Bewkes

I heard the question and if that's the theory you are asking as to whether such a deal should happen for the reasons you say I would say no.

Michael Kupinski - A.G. Edwards

Okay, all right. Great, thank you.

James Burtson

Thanks, everyone, for being on the call, for joining us.

Dick Parsons

Hopefully most of you will be able to come back at 11 and hear the story on AOL, it's quite interesting. Thank you all. Bye-bye.

Operator

This concludes today's conference. Thank you so much for joining. You may disconnect at this time.

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Source: Time Warner Q2 2006 Earnings Conference Call Transcript (TWX)
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