Time Warner Management Discusses Q2 2013 Results - Earnings Call Transcript

Aug. 7.13 | About: Time Warner (TWX)

Time Warner (NYSE:TWX)

Q2 2013 Earnings Call

August 07, 2013 10:30 am ET

Executives

Douglas Shapiro - Senior Vice President of Investor Relations

Jeffrey L. Bewkes - Chairman of the Board and Chief Executive Officer

John K. Martin - Chief Financial & Administrative Officer

Analysts

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

Douglas D. Mitchelson - Deutsche Bank AG, Research Division

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

Anthony J. DiClemente - Barclays Capital, Research Division

Vasily Karasyov - Sterne Agee & Leach Inc., Research Division

Jason B. Bazinet - Citigroup Inc, Research Division

Barton E. Crockett - Lazard Capital Markets LLC, Research Division

David Bank - RBC Capital Markets, LLC, Research Division

Tuna N. Amobi - S&P Capital IQ Equity Research

Operator

Welcome to the Time Warner Inc. Second 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 Mr. Doug Shapiro, Senior Vice President of Investor Relations at Time Warner. Mr. Shapiro, you may begin.

Douglas Shapiro

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

Before we begin, there are a few things I need to cover. First, we 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 timewarner.com/investors. Reconciliations of our expected future financial performance are also included in the business outlook release that's available on our site. 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 the 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.

And lastly, in the second quarter, we began accounting for investment in Central European Media Enterprises as an equity investment. Due to the accounting rules, we have recast our historical financials as though we had accounted for it as an equity investment since we first invested in CME in May 2009. Because CME has historically produced net losses, this accounting change reduced full year 2012 adjusted EPS by $0.04 and our first quarter 2013 adjusted EPS by $0.06. In the second quarter, the impact was a $0.02 reduction.

Thank you, and let me turn the call over to Jeff.

Jeffrey L. Bewkes

Thanks, Doug. This was another really successful quarter for us, financially and operationally. It puts us in great position to post another year of strong growth in 2013 and beyond. In the second quarter, we grew revenue of 10%, we grew adjusted operating income 25% and we increased adjusted earnings per share almost 50%. During the first half of the year, we also generated $1.8 billion in free cash flow. That's triple the amount we generated in the first half of last year. And over the last few months, we bought back almost another $1 billion worth of our stock.

This morning, we also increased our guidance for adjusted EPS growth this year. That's a reflection of our performance in the first half and our confidence about how we're positioned for the rest of the year. John will discuss our financial results and outlook in detail in a few minutes.

I'd like to point out some of our key operational highlights this quarter, starting with the networks. At Turner, we saw a continuing evidence of the growing value of our brands and programming to our viewers, our advertisers and our affiliates. TNT and TBS finished the quarter as the #1 and the #3 networks in prime time for adults 18 to 49 on all of cable. At TNT, the story again was sports and originals. The NBA playoffs on TNT were the third most viewed in the 29-year history of the NBA on Turner, outdelivering all networks, broadcast and cable, among adults 18 to 49 during May sweeps.

And Game 7 of the Eastern Conference Finals was the highest-rating NBA game on TNT ever. As you know, we're steadily increasing the amount of original programming on TNT and we're airing originals year round. We had about double the number of original hours in prime time this quarter compared to last year and it's paying off, led by shows like Falling Skies, Rizzoli & Isles, Major Crimes and Dallas. Ratings on our prime time originals during the quarter more than doubled compared to the same period last year.

At TBS, The Big Bang Theory was again the #1 sitcom on cable and Cougar Town was the #1 original sitcom on cable. In fact, our original programming on TBS was up over 50% compared to our originals in the second quarter last year. As you know, we've recently made a number of changes at CNN and we're seeing real progress. This quarter, CNN was up almost 70% in its key demo during total day, while both of its cable news competitors were down. In fact, CNN surpassed MSNBC to finish as the #2 network of the quarter in both total viewers and adults 25 to 54 for the first time in almost 4 years. That was partially driven by a high volume of breaking news events, but we saw strength across almost every daypart and every show, even away from breaking news coverage. For instance, in June, CNN's new morning show, New Day, was up over 50% in the key demo over last year and Anthony Bourdain: Parts Unknown is an unqualified hit. Our brands and programming are resonating with our advertisers, too. We just completed negotiations for the 2013 to '14 upfront and our portfolio of entertainment-oriented networks, TBS, TNT, truTV and Adult Swim, obtained CPM increases in the high single-digits. Once again, that was at the high-end of the range for all TV networks, broadcast and cable.

Our affiliates also recognize the value of our networks. As you may recall, last year at this time, we first told you that we expect Turner's domestic subscription revenue to grow at double-digit CAGR between 2013 and 2016. Last month, we completed a contract renewal with a top 5 distributor and got the affiliate fee increases we were seeking. This gives us even more confidence that we'll achieve our long-range targets.

At HBO, our programming lineup is as strong as it's ever been, which is saying a lot. Game of Thrones finished its third season with an average of 14 million viewers per episode. That's up more than 20% from last year and firmly establishes it as the second most popular series ever on HBO. True Blood recently launched its sixth season and is averaging over 10 million viewers per episode. And in its second season, The Newsroom is averaging 7 million to 8 million viewers. Last, but not least, our made-for-HBO movie, Behind the Candelabra, starring Michael Douglas and Matt Damon, was the most-watched HBO film in 10 years. And HBO received 108 Primetime Emmy nominations this year. That's the most of any network for the 13th consecutive year and it's more than double the nearest competitor. It's also the most that HBO has received in 9 years. That included nominations for Outstanding Drama Series for Game of Thrones, Outstanding Comedy Series for both Girls and VEEP and Outstanding Miniseries Or Movie for Behind the Candelabra and for Phil Spector. We intend to build on this success.

HBO remains the port of first call for distinctive-airing television. And right now, we have more pilots in development at HBO than in any time in its history, including projects for Mike Judge, Damon Lindelof, David Milch and Ryan Murphy, among others.

We also had a fantastic quarter at Warner Bros. Warner Bros. TV wrapped up one of its most successful upfront seasons ever. It received orders for 31 shows on the 5 broadcast networks for next season, including 18 that are returning shows and 13 new shows. That's the highest number of total orders in years and it's the most returning shows in over 30 years. Importantly, we have orders for 10 comedies, which as you know, have the greatest potential value in syndication.

We also had a really strong theatrical quarter, led by the performance of Man of Steel and The Great Gatsby. Notably, Man of Steel, our Superman reboot, is on track to generate almost $700 million at the worldwide box office. That's obviously a great start to the franchise. A few weeks ago, we revealed exciting plans for a Man of Steel sequel that will bring together Superman and Batman, which is scheduled for 2015. We have a lot more plans for DC that we look forward to sharing when the time is right.

Looking out into the third quarter and through the rest of this year. The Conjuring is well exceeding our forecast. It's on track to reach $130 million at the box office domestically, putting it among the top 5 horror films of all time. We're optimistic that We're The Millers, starring Jennifer Aniston and Jason Sudeikis and opening tonight, has the makings of a sleeper hit. And we're particularly excited about our biggest remaining release of the year, The Hobbit: The Desolation of Smaug.

I want to touch on some significant personnel changes we announced recently. After leading Turner Broadcasting to great success for over a decade, Phil Kent recently approached me with a decision not to renew his contract after it expires next year. I'm very excited that John Martin has agreed to take on the CEO role at Turner, starting January 1. We'll miss John's leadership here at corporate, but he'll been in an even better position to drive Time Warner's success from that seat. Howard Averill, current CFO of Time Inc., will move over to Time Warner to replace John. Howard has been a steady hand during a period of tremendous change at Time Inc. and I'm confident he'll prove a great addition to the senior management team at Time Warner. We also announced that Joe Ripp, a veteran of Time Warner and an accomplished media executive, will return to lead Time Inc. as CEO. Having someone of Joe's caliber in place is a key component of our plan to spin off Time Inc. into an independent, publicly traded company.

I'll also update you on the timing of the Time Inc. spend. Our top priority in the spinoff is to make sure that we put Time Inc. in the best possible position to succeed. So rather than rush to complete the transaction this year, we've decided that it's prudent to give Joe some time to further refine Time Inc.'s strategic direction and as a result, we now expect to complete the spinoff early next year.

So in closing, with more than half the year behind us, we're very proud of what we've achieved. We're also very confident of how we're positioned, both for 2013 and the years to come.

With that, I'll pass it 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 our consolidated results. We're halfway through the year and we couldn't be more pleased with our performance to date. We've delivered strong results in the first quarter and even stronger results this quarter. In fact, through the first half of the year, our adjusted operating income is up 15% and we've grown adjusted earnings per share by almost 30% year-over-year. That's a result of healthy underlying trends across nearly all of our businesses.

In the second quarter, our revenues grew 10% and that included a nearly 200 basis-point drag from our Publishing division. We had a terrific quarter at Networks, which posted its highest quarterly revenues and profits ever. And company-wide, international revenues grew almost 20% in the quarter.

Adjusted operating income grew 25%, making it our highest second quarter ever for profits. Margins expanded over 230 basis points and that included margin expansion at each of our reporting segments. And that's despite double-digit growth in programming, production and marketing expenses, which we were able to offset partially by reducing other cost of revenues and other SG&A expenses. And this discipline has allowed us to produce very strong financial results even while we're investing aggressively for the future.

Continuing to move down to P&L. Adjusted EPS grew even faster than adjusted operating income, climbing 46%. And that's the 12th time in the last 15 quarters that adjusted EPS has grown double digits, along with our strong operating performance that was helped by a lower effective tax rate and our ongoing allocation of capital to share repurchases.

Since we last reported earnings, we've repurchased almost $1 billion of common stock, which is an acceleration from the first quarter, and we also paid over $270 million in dividends. So year-to-date, we returned almost $2.4 billion to shareholders, including more than $1.8 billion in share repurchases and $500 million in dividends. And as Jeff mentioned, in light of this strong performance and our confidence of our ability to execute in the back half of the year, we're raising our 2013 full year business outlook for adjusted EPS and we now expect growth to be in the mid-teens year-over-year.

Let me now turn to the specific segment highlights and let me begin at our Networks segment where each of HBO and Turner grew adjusted operating income double-digits. Advertising revenues were up 11% year-over-year and that's our highest quarterly growth rate in 2 years. And please recall that we benefited from the timing of the Final Four this quarter. But if you look through that, domestic ad growth was also around 11%. And that includes solid growth across all of our categories. That's domestic entertainment, that's kids and that's news.

International advertising declined in the low single-digits, but without the prior year closure of TNT Turkey and the impact of foreign currency movements, it would have been up mid single-digits. And that was a result of mid-teens growth at international entertainment, which was partially offset by declines at international news.

Looking ahead to the third quarter, we continue to see very solid trends here with scatter pricing up double digits over the upfront. So as of now, we anticipate mid to high single-digit growth in total Networks advertising in Q3.

Moving on. Subscription revenue growth was 4% in the quarter, which was relatively consistent with the mid single-digit growth that we saw in the first quarter. This quarter, the mix of subscribers at HBO and a stronger U.S. dollar both somewhat weighed on Subscription revenue growth. And as we look ahead to the rest of the year, we continue to believe that Subscription revenue growth will be up mid single-digits. And as Jeff mentioned, with Turner recently securing a new deal with a top 5 distributor, we have even more confidence that we'll see significant acceleration in Subscription revenues beginning in 2014.

Adjusted operating income at the Networks segment was up a very strong 13% in the quarter, with margins increasing almost 180 basis points year-over-year. And please note that growth this quarter did benefit from an adjustment through a receivable allowance, but even without that, adjusted operating income would still have been up double digits. And that reflects both of the revenue growth as well as our ongoing focus on constricting non-programming costs, as programming expenses increased 8% in the quarter. So in the first half, programming expenses at the Networks were up 4%, which is consistent with our expectation of, in any given year, programming expenses being up mid to high single-digits.

Looking ahead, we continue to anticipate margins are going to be up here at this group for the year. And that's despite continued growth in our programming investments. So 2013 should be another very, very strong year for the Networks segment. And we're positioning ourselves to grow at attractive levels for the foreseeable future here.

So now let me turn to our Film and TV production group at Warner's, which had another really terrific quarter with revenues up 13% and adjusted operating income up 34%. The increase in adjusted operating income was largely driven by the strong performance of our Film slate. And that included films such as Man of Steel, The Great Gatsby and The Hangover Part III. In Television, we faced a very difficult comparison against the domestic syndication sale of The Mentalist in the year-ago quarter. And despite this difficult comparison, the underlying trends remain really strong here. In addition to the really successful upfront season that Jeff described, we also saw higher international license fees and very healthy demand for our television product from SVOD services, both domestic and international. We recognize just under $70 million in SVOD revenue at Warner's in the second quarter and that's up significantly from a year ago.

And if you look at Time Warner, we've recognized now year-to-date about $150 million of SVOD revenues. And we continue to expect that SVOD distribution channel will be a strong contributor to our results this year. Across theatrical and TV, Warner's Home Entertainment revenue was up 3% in the quarter. And while the industry was down slightly in the quarter, it grew modestly for the first half of 2013. And we're particularly encouraged by the growth in the electronics sell-through area, which was up over 50% for the industry in the first half. And while there's still work to do on improving the consumer experience here, we think it's a very positive sign for the future of the Home Entertainment business.

Looking ahead, we expect second half results to be strongly weighted to the fourth quarter at Warner Bros. In the third quarter, we face very tough comparisons against last year's theatrical release of The Dark Knight Rises. In addition, we anticipate recognizing SVOD revenues from certain CW availabilities in the fourth quarter of this year versus recognizing them in the third quarter of 2012. And while we've already released the majority of our larger movies this year, we're optimistic about the rest of this year's theatrical release slate. And We're the Millers, which opens this evening, is a particularly funny film.

Similarly, we feel very good about our position going into the new TV season due to Warner Bros.' industry-leading performance during this year's upfront. And we have very, very high hopes for the fourth quarter games release, including Batman: Arkham Origins. So we remain confident that Warner Bros. profits this year should be at least as good, if not better, than what they were last year. And we've been saying that now for some time.

Let me move on to Publishing. At Time Inc., advertising revenues were down 5% in the quarter and that was due to declines both here as well as outside the U.S. Domestically, we saw softness at the sports and news groups. We also finally lapped the transfer of SI.com and Golf.com back to Time Inc., which contributed to advertising trends appearing somewhat worse than what they were in the first quarter. Subscription revenue fell 7% in the second quarter as we continue to see softness in newsstand sales. And looking to the back half of the year, we expect the decline in Subscription revenue to look somewhat similar to what we experienced in the first half of the year. But note, that we will see some shift of Subscription revenue to the third quarter from the fourth quarter due to the frequency of certain titles in each quarter. Despite lower revenues, adjusted operating income was up a pretty strong 28% in the quarter. And that was primarily a function of cost savings initiatives including the restructuring actions that were taken earlier this year.

As we look to the rest of 2013, our comparisons as compared to last year become somewhat more challenging. So while we remain focused on cost controls at Time Inc., we don't expect that will be sufficient to offset revenue declines in the back half of this year.

Now let me turn to the next slide, which looks at our full year 2013 business outlook. As I just said, we had a great first half of the year. And that's given us a tremendous amount of confidence to raise our full year 2013 outlook to mid-teens growth in adjusted EPS. And despite higher losses from our investment in CME than we originally anticipated at the beginning of the year, the absolute numbers implied by our new current guidance are nicely higher than our previous outlook. Clearly, our updated outlook implies that growth will slow somewhat in the back half of this year. And that's the result of difficult comparisons, particularly at our Film and TV and Publishing segments. And this is consistent with what we expected coming into this year and it certainly doesn't suggest any change to the health of the businesses. I'll also point out that our effective tax rate was a bit lower in the first half than we normally anticipate, as a result of settling a couple of audits with taxing authorities. And excluding those settlements, our effective tax rate would have been somewhere in the mid-30s, which is more in line with our longer-term expectations. So we feel good about raising guidance. We feel good about our performance. And we believe that we are set up for both a very good year and continued attractive growth in the longer term.

Let me now turn to cash, free cash. We're having a big year for free cash flow generation. We've generated, through the first 6 months of the year, $1.8 billion of free cash flow. That's more than triple the year-ago period. And that's mostly due to an improvement in working capital, which we expected, and the strong growth of profits, which I've been just discussing. Capital expenditures and cash taxes are also lower year-to-date. The favorable working capital variance accounted for more than 1/2 of the improvement in free cash flow year-to-date. And the biggest drivers there were reimbursements for prior co-financings and the timing of payments for sports programming at Networks. The decline in cash taxes was primarily a result of tax law extenders that were passed by Congress in January this year. So with our solid performance through the first half of the year, we're on track for a really, really strong year of free cash flow generation in 2013.

Turning now to the final slide which looks at our net debt. We ended the quarter with a little less than $17.4 billion in net debt. That's up about $350 million from year-end 2012. And that's largely due to the almost $2.1 billion of capital we allocated in the form of dividends and share repurchases in the first half. Providing stockholder returns remains a critical component of our capital plan. And as you can see, the amount of capital we've returned well exceeds the free cash flow we've generated year-to-date. That's consistent with how we've been allocating capital for a number of years now. And since 2008, we've generated about $13 billion in free cash flow. And over that same time period, we've repurchased almost $13 billion of stock or almost 30% of our float and, at the same time, we paid more than $4 billion in dividends. So our leverage ratio is now only 2.3x, which is a little bit below our target of 2.5x. And we still think that our target leverage ratio of 2.5x strikes the right balance of maintaining a balance sheet strength, while giving us the flexibility to invest in our core businesses, make acquisitions and return capital to our stockholders. So we'll continue to manage the balance sheet to stay close to that target over the course of the year.

And with that, let me turn the call back to Doug so that we can begin the Q&A portion. Thank you.

Douglas Shapiro

Thanks, John. Dawn, let's get the Q&A started. [Operator Instructions]

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Alexia Quadrani from JPMorgan.

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

My question is just on the affiliate renewals that are upcoming. The one you referenced to having signed last month, I believe, I assume that kicks in, in 2014 and not right away. And then just staying on that topic, the real positive move you've seen in ratings at CNN recently, is that -- do you expect -- I guess the timing of that is real good given your upcoming renewals or ongoing renewals. Do you expect as much sort of upside opportunity at CNN as you would at TNT in these renewals, given the addition of the NCAA?

John K. Martin

Alexia, it's John. I just -- with regard to the affiliate renewals, we're really not going to speak specifically. We have nondisclosure agreements with regard to the specific deals and -- but what was important and the reason why we felt like it was relevant to mention on the call is because going back to a year ago when we said we expected double-digit compound annual growth for the 3-year period ended 2016, we said that during the middle of this year, we were going to begin what was the most ambitious rate renewal cycle that the company had experienced in years. So this was the first big deal that we were entered into and we successfully completed it and the construction surrounding the agreement where quite constructive. So it not only bolsters our confidence in our ability to get that and those rates will kick in, in the not-too-distant future. As we've said before, just to repeat, the domestic Sub revenue should grow double-digit compound annual growth from '13 to '16. And the only other thing I would mention is that the way that the increases should come in over time over those 3 years, is that we're going to see the biggest impact in terms of growth in 2016. So beginning next year, we absolutely expect to see an acceleration in Turner's domestic affiliate rates off of current year levels. And if I was going to forecast right now, I would say that it will probably be close to double digits. In '15, it will probably moderate somewhat and then in '16, you'll see the biggest overall growth rates. So that over the 3-year period, you get to the double-digit period -- double-digit rates, excuse me.

Jeffrey L. Bewkes

Alexia, were you asking something about CNN rating?

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

Yes, I know that they -- I think there is a bigger opportunity, it sounds like, in terms of the potential to move up in rates at probably TNT. I was just saying that with the incredible turnaround you're seeing at CNN more recently, do you think there's also an opportunity there?

Jeffrey L. Bewkes

On CPM rates?

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

No, on the renewals, yes, the renewals.

Jeffrey L. Bewkes

Absolutely. And I think John said it well. We're not -- we do our affiliate rate renewals across our networks. And so the strength of CNN, which as we have said and we certainly believe it, it's essentially worth a lot more in affiliate rates than the current rate that it's getting. And it's not just a function of ratings. As we mentioned in the call, the ratings are up 50% in total day and we're taking share. But the ratings have moved around. That's really not the only thing. It's actually not even the main thing. It's simply the role of in-depth, trustworthy, nonpartisan global news that CNN fills. And the strength of CNN in online and mobile broadband delivery, which is the #1 source to go to for that, whether it's breaking news or not, and certainly during breaking news. So it's very valuable. We think everything at CNN is on the uptick. Really, the quality of what it's doing and also, both the ad rates and the affiliate rates.

Operator

Our next question comes from Doug Mitchelson from Deutsche Bank.

Douglas D. Mitchelson - Deutsche Bank AG, Research Division

A further clarification on the Turner affiliate renewal cycle, John. It's obviously encouraging, you signed a deal with a top 5 operator. I understand the reticence on giving too much detail, but could you tell us, are there other meaningful deals that you'll strike around this year end that will bolster confidence in the renewal cycle further? Or should we look to 2014 for the next piece of news on that? And the question for Jeff, just curious, your updated thoughts around online video distribution. Disney and Fox decided that Hulu was an interesting business to own. Do you see the appeal and value of having direct-to-consumer online video retail business? Or is remaining an independent wholesaler the right strategy? And to the extent the answer is different for international versus U.S., I would love to hear about that.

John K. Martin

So, Doug, I'll start. I think this answer's going to be pretty short. So, yes, we've got some negotiations and deals that come up for renewal before the end of this year. Some of them are big distributors. But having said that, we're not going to see the impact of those deals kick in, in 2013, which is why I'd said that we're not really going to expect to see anything in terms of the overall affiliate growth until 2014. But, yes, I mean, we've kicked off the cycle, so to speak, in terms of affiliate deals. And we've got a number of them coming up before the end of the year. But as I said, just at the risk of repeating myself, we feel good about the hand we've got, we feel good about the value that the networks have with respect to affiliates and consumers. And we have every confidence that we're going to succeed in what we're trying to do.

Jeffrey L. Bewkes

Doug, on your question, I think it's a good question. Look, it's for Disney, News Corp. and NBC to talk about what they're doing with Hulu and why. But having said that, I think our view of what they're doing, and it makes sense to us, is more about supporting the value of their networks and their programming across platforms than it is particularly about the discrete business of broadband-only delivery at Hulu. I think those things can be complementary and I think they're searching to get there. It seems like a good decision. What we're doing and to answer your question, we think that the best place for us for now is essentially emphasizing the very large wholesale networks and the packages over both the video plan and increasingly the broadband plan. Because as you know, we've been very -- well, we've said it over and over again. We think the move of television to an on-demand service on television and on broadband devices is a major move to support the value of TV networks, TV programs. We think it's huge. We see it all over the world. And as we look at the ways that we're going to distribute our shows and our networks across the world, we essentially try to optimize the distribution opportunity in whichever country. In the United States, it's a very powerful penetration of the giant packages of TV networks. In certain other countries, there are times when you're actually better off going really broadband-delivered. We did it recently in the Nordic countries. But it's this kind of a case-by-case thing at this point. I think it will all converge. And the key point, I think, is not which platform, it's essentially getting everything to be VOD with an interface that consumers love. And there should be deservedly and there is a lot of attention on the kind of excitement consumers and viewers have for on-demand programming. Some of it from broadband-delivered sources, but most of it from television network sources that are becoming on-demand programs and networks like HBO, which I think is probably the leader across the world in delivering the largest package of on-demand programming in all -- well, all the hemisphere. There's just 2 hemispheres. We're thinking of a third hemisphere, but we haven't gone there yet.

Operator

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

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

Two topics. First is on à la carte or unbundling of networks. I think most of us have assumed it's a bit of a nonstarter as long as the content companies and your distribution partners were both against the concept of unbundling the pay TV package. But in the last few days, you've had more commentary from Cablevision. Time Warner Cable offering to CBS to go à la carte. So I guess my question is -- or are, number one, do you see this as an actual shift and increasing the likelihood that we would move to à la carte, or how something like that would happen? And how do you view your network's position, would it -- does it change your strategy at all, or do you like your positioning regardless of how that plays out? And then I have one on HBO.

Jeffrey L. Bewkes

Okay. We don't think it results a big change yet. And we do think we're very well-positioned. If there is a chance, I don't think it goes to à la carte. We think it probably would move, if it does, to smaller bundles of kind of appropriately placed together kinds of networks. We do think we'd be really well-positioned in that scenario. What would happen is there would be more money for the biggest networks like ours. And in fact, of all the programming groups out there, Turner Time Warner has the highest proportion of our networks among the top 4. And that's just on the Turner side. If you add HBO, it's more. We'd also have the highest proportion of our affiliate fees from our biggest networks. We have about 85% to 90% from our top 4 networks. And those networks would be highly likely to be in any base package that anybody's going to create. So we don't believe we'd be vulnerable. It will probably, actually, increase our relative advantage. It would be good for HBO because lower-priced packages would effectively make HBO even more affordable. So that's how we look at it. We doubt that it will happen, but if it happens, it probably helps us. We do think there would be some of the weaker networks or weaker network groups that would fail, which would reduce the diversity of voices out there. It's not necessarily in the public interest. We don't really think that many legislators have shown any desire to take up this issue. And there's been a lot of misstatement and misinformation around it. So that's why we don't think it's probably going to take off. But if it does, it will probably happen in a way that helps us. You have a question on HBO?

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

Yes. And just quickly, John. You mentioned the mix of HBO subs being a little bit of, I guess, maybe a drag sequentially from the first quarter on the affiliate growth rate. My question is, as you go into these negotiations, we've been very focused on Turner, but is there an opportunity to change the terms of HBO to perhaps get a bit more of the economics in the future?

Jeffrey L. Bewkes

Yes, let me answer it. We don't think that's optimal for us. We've been -- really, the design of HBO affiliate rate structures are very much the -- our creation and very much in the interest of HBO. And as -- due to the nature of them, typically, distributors that have been performing better are more likely to have a higher proportion of non-revenue-generating subs because they've got incentive to have more subs and average down there effective per sub rate because they have higher penetration. That means we get a full ride on our rate increases, which are fairly strong. The poor-performing affiliates, once they get below that benchmark, as they lose subs, they basically lose revenue-generating subs for us. Of course, they're also losing revenue-generating subs for themselves and their average rate goes up. So we think it's the kind of an effective tool. We focus on a combination of penetration from different distributors. Remember, satellite, telco and cable distributors compete with each other in given geographic areas and we find this an effective tool to motivate or incentivize the appropriate competition between them to sell HBO. And as you know, HBO's the anchor service for all high-value packages. There are no high-value packages out there that don't have HBO in them. So we think it's working fine for us. And the way to look at it, essentially, the earnings growth at HBO, what we would do to improve it is we're always working with our affiliates. We have some things underway right now which I won't talk about specifically, because some affiliates are performing better than others that are going to, essentially, incentivize the underperforming affiliates to do better. And that's upside for us.

Operator

Our next question comes from Anthony DiClemente from Barclays.

Anthony J. DiClemente - Barclays Capital, Research Division

My question is on the new affiliate deal and how that pertains to the NBA. So I'm assuming, or presumably, the new affiliate deal extends beyond the 2016. I don't know if you can confirm that, but if we could assume that the duration of the new deal goes beyond the duration of your current NBA deal, which I think ends in the middle of the 2016 season, I guess my question is, do the affiliates see NBA as being a must-have piece of content for Turner as part of that deal? And so does that really put the onus on you guys to renew and negotiate a sooner time period with the NBA? And so for us as investors, I guess the question would be that given how crucial the NBA presumably is, how are you thinking about maintaining financial and economic discipline as you go into that renegotiation with the NBA?

John K. Martin

Anthony, it's John. You know what, unfortunately, and I hope you can understand this, I mean, we're not going to comment specifically on the duration of the deal that we did. But Jeff may have something to say about the NBA specifically.

Jeffrey L. Bewkes

Yes, which is not much more. It's one of the longest and strongest partnerships we have with any league. And we do have the right, as you said, through the 2015, '16 season. We not only license the content, but we manage both NBA TV and the NBA digital properties for the league. We're confident this relationship will continue for many years to come. And we all know, it's in your question, that sports rates are going up. We feel pretty good about our position there and our ability to pay that and continue to have the earnings growth we've been showing you. And we really don't want to, obviously, say much more about it because we're talking about significant amounts of money. And I think you would want us to just go off and keep securing the programming that we judge it wise to have.

John K. Martin

The only thing I would add to that, Anthony, just to keep in mind, and this is by design, the entertainment networks at Turner are hybrid networks, right? And the programming falls into different buckets, whether it's originals, which is getting an increasing percentage of the schedule, or sports, or acquired TV shows and movies. So I think last year, it was about 70% acquired, 20% originals, 10% sports. And it's moving much more towards originals. But just think about, sports is incredibly important, but I think the NBA represents 3% of our overall programming in terms of hours. So we have a lot of other programming that's extremely valuable to the affiliates and extremely valuable to consumers. So the NBA is important, but we're going to be okay no matter what.

Operator

Our next question comes from Vasily Karasyov from Sterne Agee.

Vasily Karasyov - Sterne Agee & Leach Inc., Research Division

I have a two-part question on margins at the Networks. I think a couple of years ago, you guys laid out at your Analyst Day, the HBO margin expansion pass where the non-programming costs will be contained and the revenue growth will lead to that. So I was wondering if HBO margins have been expanding in recent years? And then if it's still the trajectory that you see in the next 2 or 3 years? And then with the Turner affiliate fee accelerating, should we also expect an incremental margin expansion, that is -- or do you think all of the incremental revenue will be absorbed and spent into -- on programming?

John K. Martin

Thanks for the question. Look, I think if you look back over the last 5 to 7 years at the Networks group, and this would be true for each of HBO and Turner, in any given year, margins expand roughly 100 basis points a year. And that could be a little bit more in some years, a little bit less in other years. And I think the best indicator of the future is probably looking at the past because I think that's kind of a trend and that sort of a trajectory should continue. All of the elements of the HBO margin story that we laid out in the Analyst Day from a number of years ago, those are absolutely still intact. But it's not just an HBO margin expansion story, the same thing's happening at Turner. And if you look at this quarter, as just an indication, we had at the Networks group, I think 7% revenue growth, 4% expense growth. But if you look at the expense growth and decompose it, in this quarter, we had 8% programming expense growth. That means all of the rest of the expenses at the Networks group were down. And that doesn't come easily. That comes by hard work. But nevertheless, we have a lot of control over our nonstrategic expenses. And our goal is to hold those to growth in any given year of no more than low single-digits. And we think programming costs are going to grow in any given year of no more than mid to high single-digits. So that means overall expenses in any given year at the Networks should grow mid single-digits and we think revenue growth is going to outpace that each and every year.

Operator

Our next question comes from Jason Bazinet from Citi.

Jason B. Bazinet - Citigroup Inc, Research Division

I know you mentioned on the call that the timing spend is getting pushed out a little bit. I was wondering, have you guys established the capital structure that you intend to put on Time Inc. once it spins out?

John K. Martin

Jason, it's John, I'll just take it. The answer is no. There's a considerable amount of work that's going on and there's lots of different work streams associated with all aspects of the spin. With Joe just being named as a CEO and a new CFO being named, I think as recently as 2 days ago, we look forward to a collaborative process working with them and the rest of the team. One of the things I think we've said is, is we want the capital structure of Time Inc. to represent or provide Time Inc. with the best possible path to success. And we want the equity of the spun company to be attractive. So we're going to be looking very closely at the amount of debt that we think is optimal for the Time Inc. company and some sort of a dividend policy that we think will be optimal. And anything that we would likely do, because we haven't made a decision, will leave Time Warner remain co as a leverage ratio that should be similar to where we are today, is another way to think about it.

Operator

Our next question comes from Barton Crockett from Lazard Capital Markets.

Barton E. Crockett - Lazard Capital Markets LLC, Research Division

I wanted to ask just a follow-up to the discussion of the acceleration of the Turner affiliate fees, 2014 to 2016. How much of that drops to the bottom line? In other words, when you look out to this revenue acceleration, do you also in your mind think can I give this a bucket to invest more in things like programming maybe for a sports rights feed, or is it really kind of purely incremental profit?

Jeffrey L. Bewkes

Can I start? All of it, I guess, is the short answer. It's an increase in marginal revenue and so it's discretionary whether you want to spend and all of it went to the bottom line, or whether we took -- we obviously have some percentage of total revenue that goes to costs we decide to make. But you want to ask it in a different way?

Barton E. Crockett - Lazard Capital Markets LLC, Research Division

[indiscernible]

Jeffrey L. Bewkes

What did you say, I'm sorry?

Barton E. Crockett - Lazard Capital Markets LLC, Research Division

Okay. I think you answered it. Yes, I think you're saying there's no change in your expense trend as you get that boost in revenue, so it does drop to the bottom line.

John K. Martin

Yes, I mean, any of the investments we would choose to make would be discretionary. And I would just sort of mention for context, we already spend an awful lot of money on programming. So we've got meaningful scale. And so we'll make the decisions based on the competitive dynamics. But to have extra money in revenue is a nice thing to have.

Barton E. Crockett - Lazard Capital Markets LLC, Research Division

Okay. And then just one other question, if I can. I was wondering if you could comment on the discussion of new over-the-top services, like Intel has been in the press with things they look to launch. So without talking specifically about things like Intel, but the general kind of category of new multi-channel over-the-top services, how do you gauge the probability of something meaningful coming to you in revenues in terms of like minimum guarantees for these new services over the next few quarters or the next few years?

Jeffrey L. Bewkes

Well, okay. No one showed up on the horizon with anything that looks like that yet. We've had conversations across our businesses with many technology companies, vendors, others that want to be distributors, some of them over-the-top. And we'll evaluate each business and opportunity within the context, number one, of our overall business; and number two, of what we would think might be the sustainability of what some of these new entrants are proposing. We're not philosophically opposed to it. We just -- we don't see it as being viable through any of the suspects -- usual suspects yet. Take some examples, Intel hasn't launched yet. So I don't know what they're going to do or whether they're going to do that. Apple, we talk to all the time, and there's none that we know of that are interesting opportunities, in our view.

Operator

Our next question comes from David Bank from RBC Capital Markets.

David Bank - RBC Capital Markets, LLC, Research Division

So, Jeff, you've obviously made some pretty meaningful leadership changes across the business, most recently at the Turner networks. And when you gave the job to John to run the networks and, I guess, and David did work for him, what essentially were the -- like, what's the mandate to take this great business, what is it that they are supposed to do? What did you say was -- you expected of them? What is like the 1 or 2 key goals that you expect to see them execute as the new leadership team or leadership?

Jeffrey L. Bewkes

Well, I want to start by saying I'm very happy. And all companies from the top management of the divisions, the corporate, the board, we're all really excited about the team that we have across all the divisions. And I think that -- I'm personally really excited and happy about how smoothly all the transitions went, how much of a bench we've got and how we were able to promote from within in pretty much all of these cases. So there's an -- there's a body of both relationships and knowledge that are working together in a way that Time Warner hasn't had in previous years. In terms of the specifics at Turner, Phil and the management at Turner, which certainly David Levy, who's picking up some new responsibilities, working closer with Steve Koonin and Stu Snyder now and their jobs as TBS, TNT, Turner Classic Movies and truTV gets stronger and they become a bigger part of a kind of programming evolution in the entire network business, not just in our company but across the industry; but also the regeneration of momentum at CNN with Jeff Zucker. The tremendous moves and the real fast growth that Gerhard Zeiler is making in all our international businesses, including a new cooperation and level of kind of joint action between HBO and Turner and Warners all over the world. These are all the things that got under way. Phil put a lot of these people in place, not just Phil but this whole team has got tremendous initiatives under way. I think Turner is the leading company on digital transformation of its networks, to VOD and to broadband-delivered TV Everywhere. We have fuller offerings and more deals in place than anybody else. So what John is going to do is go and join that momentum and continue to evolve it as it has been. That's pretty similar to what Kevin's doing at Warner's with a great team there. The team at HBO, with Richard and Eric, has continued to just move forward. So it's really the same answer across the company. It's just a new generation that has been here, which is reaching the point in their careers where they can take the next step.

Operator

Our next question comes from Tuna Amobi from S&P Capital IQ.

Tuna N. Amobi - S&P Capital IQ Equity Research

So first question for John. The numbers you threw out in terms of the 5-year record of your return allocation between share buybacks and dividends, I think if my math is correct, that kind of forks out to north of 130% return rate, which I have to say is pretty remarkable. So I guess, the question is, is there any reason why you think that this kind of momentum or rate may not be sustainable after the spinoff? I mean, if anything, I would imagine it would probably even trend higher than that. So any kind of color around that would be helpful. And separately for Jeff, so Game of Thrones, obviously has had a phenomenal performance. But one other issue that has also come up with regard to that title is the online piracy, I think, by all accounts, one of the highest-pirated show and I'm not aware what you guys have done to kind of address that. It almost seems like you've kind of viewed that as kind of a compliment in terms of just kind of looking the other way. So I'm not sure if that's kind of the right thinking. Is that a paradigm shift in terms of how you kind of look at some -- the piracy and its impact on some of the shows that's going forward? If you can touch on that and what you've done, that would be helpful.

John K. Martin

So, Tuna, I'll start with respect to your first question. I think it's true to say that for at least 5, 5.5 years, we've had a very, very consistent policy as it relates to managing the balance sheet, capital structure and capital allocation. And we have believed and continue to believe, that having a balanced approach of delivering shareholder returns in many forms through earnings growth and a direct dividend and supplemented with share repurchases opportunistically, coupled with maintaining a balance sheet that remains strong and provides adequate strategic flexibility, that, that policy has served the company well. And we have been able to deploy a lot of capital over the last 5 years. And as you appropriately pointed out, more than 100% of what was generated. The only thing I would say, looking backwards, is we did go through a period where we took up the balance sheet leverage. When we spun off Time Warner Cable and we received the $9.25 billion dividend, the company was underlevered and we used that opportunity to more appropriately optimize the capital structure. So now, the 2.5x leverage ratio will be basically the governor, at least for the near term, as it relates to what we will do and how we'll allocate capital. And as I said in my proactive remarks, we ended the quarter a little bit below that, about 2.3x. I do think, though, as you think about Time Warner post the Time Inc. spin, the spun company will be the company that probably is the least predictable in terms of free cash flow generation over the next several years. So what will remain at Time Warner is, essentially, 90% of the company is from the TV ecosystem, which is incredibly predictable, incredibly robust. And we'll feel really good and really confident about our free cash flow generation for the foreseeable future. So we need to take that into consideration as we think about capital allocation going forward. But I don't think we're contemplating, at this point, steering away from what we've done. I think what we've done and how we've managed the company has served us well.

Jeffrey L. Bewkes

Tuna, on Game of Thrones at HBO. I have to confess, I think you're right. I admit, our first reaction to it, to how much people want to watch it -- now, first of all, it's got ratings of 14 million, 15 million. A lot of it is VOD on your TV system, a fair amount, an increasing amount of it is VOD on your GO service. So it's really strengthening not just the image and the engagement of our subs with HBO programming, it's also getting them familiar and very involved in using the Video on Demand capabilities of HBO. And don't forget the television part, the part where you go to your house and you turn on that big screen TV and you're watching it over the video plan. Also, the HBO GO service, which the Game of Thrones is the leading introduction manual for how to use HBO GO, which more and more millions of people are doing. If you then go to people watching it that aren't subs, it's a tremendous word-of-mouth thing. The issue would be if they were doing it and because they could get it, not subscribing. We don't see much of that. Basically we've been dealing with this issue for years at HBO, where, literally, 20, 30 years, where people have always been running wires down the back of apartment buildings and sharing with their neighbors. Our experience is, it all leads to more penetration, more paying subs and more health for HBO, less reliance on having to do paid advertising. We don't do a lot of paid advertising on HBO. We let the programming and the reviews talk for us. And it seems to be working. If you go around the world, I think you're right, that Game of Thrones is the most pirated show in the world. Now that's better than an Emmy.

Douglas Shapiro

All right. Dawn, I think we're actually out of time here. So we're going to have to make that the last question.

And thanks, everybody, for listening in and we'll talk to you soon.

Operator

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

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Time Warner (TWX): Q2 EPS of $0.83 beats by $0.07. Revenue of $7.4B beats by $0.3B. (PR)