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Time Warner (NYSE:TWX)

Q2 2010 Earnings Call

August 04, 2010 8:30 am ET

Executives

John Martin - Chief Financial Officer and Executive Vice President

Jeffrey Bewkes - Chairman and Chief Executive Officer

Douglas Shapiro - Head of Investor Relations

Analysts

Michael Morris - Davenport & Company, LLC

Spencer Wang - Crédit Suisse AG

Richard Greenfield - BTIG, LLC

Anthony DiClemente - Barclays Capital

Jason Bazinet - Citigroup Inc

James Dix - Wedbush Securities Inc.

Douglas Mitchelson - Deutsche Bank AG

Thomas Eagan - Collins Stewart LLC

Operator

Good day, ladies and gentlemen, and welcome to the Time Warner Second Quarter 2010 Earnings Conference Call. [Operator Instructions] I would now like to turn the presentation over to your host for today's call, Doug Shapiro, Senior Vice President of Investor Relations. Please proceed.

Douglas Shapiro

Thanks and good morning. This morning, we issued two press releases. One, detailing our results for the second quarter and the other, updating our 2010 full year business outlook. Before we begin, there are two items I need to cover.

First, we refer to certain non-GAAP financial measures, schedules setting out reconciliations of these historical non-GAAP measures to the most directly comparable GAAP measures are included on 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.

And second, today's announcement includes certain forward-looking statements, which are based on management's current expectations. Actual results may vary materially from those expressed or implied by these statements due to various factors. These factors are discussed in detail in Time Warner's SEC filings, including its most recent annual report on Form 10-K and quarterly report 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.

Thank you, and I'll turn the call over to Jeff.

Jeffrey Bewkes

Good morning, everybody. Thanks for joining us. We just completed another very strong quarter, capping off a good first half of the year.

Our revenue grew 8%, and that's our highest rate in two years, with advertising revenue up 11%, its highest rate in almost six years. Adjusted operating income rose 15%, and our adjusted earnings per share climbed 35%.

As you saw in this morning's release, we've raised our outlook for the year. We now expect adjusted EPS to increase at least 20% in 2010, up from our prior guidance of at least mid-teens growth. And please keep in mind that, that's after growing adjusted EPS by 29% last year.

Our results this year have benefited from an improved ad environment, from our continued cost controls and more than anything else, the appeal of our content and the strength of our brands. As I've told you before, one of our key objectives is to leverage our scale and brands, to invest in and create the highest-quality concept. That, in turn, strengthens our brands, attracts audiences and increases our scale. It's a virtuous circle and a key competitive advantage for Time Warner. Across the company this quarter, you can see our commitment to this strategy, and you can see the payoff. I'll start with our Networks.

There's no doubt that the quality of Turner's content and the appeal of its brands helped drive its 14% advertising growth this quarter, and that's the highest in years. Discounted market was healthy in the quarter, which helped our performance. But our advertising growth was so strong, in large part because advertisers increasingly want to associate their brands and products with ours. Our success at this year's upfront also showed the appeal of our content and brands.

Turner's Entertainment Networks (sic) [Turner Entertainment Networks] led both their broadcast and cable competitors in pricing gains. And they increased volumes by double digits. In particular, we saw extremely strong demand for Conan O'Brien. In fact, we were able to achieve parity with the broadcast EPS for the show.

Also, we're especially encouraged by the performance of truTV. As you know, tru recently broke into the ranks of top 10 cable networks. In the second quarter, it delivered more adults, 18 to 49, than MTV, Spike, Sci-fi and Lifetime. And tru was treated like a top 10 network at the upfront, achieving CPM increases comparable with our other large entertainment networks for the first time.

So advertisers are recognizing the growing value of our programming and brands. We're confident that our affiliates will also recognize this increasing value over time. As we head into the back half of the year, we're feeling very confident about Turner's slate of original programming. One of our new shows, Memphis Beat, premiered in June as the top-rated new cable series of the quarter.

And last month, in July, another new series, Rizzoli & Isles, launched as the highest-rated, ad-supported premier in the history of cable. And we just brought back The Closer, which remains the number one show week-after-week on cable, and it's up over last year. Other hit shows returning in the next couple of months included Dark Blue, which is premiering tonight, and Ray Romano's, Men of a Certain Age, which is coming back in the fall. And then, of course, we'll launch Conan's show in November.

This team focused on content and brand as the driving force at HBO. As you know, HBO not only has the best slate of recently released movies, but it also has the best original programming on TV. Just a few weeks ago, for example, HBO received 101 Emmy nominations, the most in any network for the 10th year in a row. Viewers agree with the critics.

For instance, we recently debuted the third season of True Blood to a 40% bigger audience than last season's premier. It's now averaging about 13 million viewers per episode, rivaling the final season of The Sopranos. HBO subscribers love our unmatched selection of movies as much as ever. But our consumer research shows that original programming is an increasingly important factor in their decision to subscribe. We're working hard to build on this momentum with more new series in development now than in anytime in HBO's history.

Next month, we'll debut Boardwalk Empire, produced by Martin Scorsese, which we think will be HBO's next breakout hit. And we just greenlit Luck, that's a provocative look at horse race from Michael Mann and David Milch and starring Dustin Hoffman and Nick Nolte.

Turning from HBO to our Studio. Last week, Warner Bros. became the first studio to cross the $1 billion market, the domestic box office for the 10th year in a row, another validation of our strategy. And we'd expect to extend this success with a strong slate in the second half and next year.

We're off to a great start. Our seller blockbuster, Inception, has led the domestic box office for three straight weeks, and is easily on track to exceed $0.5 million of the global box office. Another major releases planned for the rest of the year include: Harry Potter and the Deathly Hallows-Part I; Legends of the Guardians from Zack Snyder, who gave you 300; Bill Gates from the writer and director of Hangover, Todd Phillips; Hereafter from Clint Eastwood; Life As We Know It with Katherine Heigl and Josh Duhamel; and Yogi Bear in 3D.

As we outlined in our recent Investor Day, we plan to release six event films again next year in 2011 including: Green Lantern, The Hangover 2, Happy Feet 2, The Next Sherlock Holmes, and last, but not least, the final in the Harry Potter series.

Warner's Television Production business again delivered an industry-leading upfront with orders for 15 returning series and 11 new series from the broadcast networks. That makes us the number one provider of network TV programming for the fourth time in the past five years. And we're experiencing extremely strong demand for our products in the syndication market.

We saw very competitive bidding and a record price for the off-network rights to The Big Bang Theory in May. And that was coming on the heels of last year's record sale of The Mentalist. Demand for these shows is a great indicator about the value of our syndication pipeline over the next couple of years.

Time Inc. is also outperforming its competitors. Again, a testament to the strength of its brands and to its editorial content. Time Inc. widens its industry leadership and advertising revenue during the first half of the year, gaining more share than any other publisher. And the growth was broad-based, with 15 of our top 20 titles showing increases.

Looking ahead, these brands will continue to lead the industry as it expands into evolving digital platforms such as tablets, and the richer online environments that is enabled by HTML files. I hope you've had a chance to see the TIME, Sports Illustrated, FORTUNE and Entertainment Weekly apps for the iPad.

Overtime, and very shortly, we anticipate that our subscribers will be able to enjoy the same amazing experience on every tablet. So in short, we're committing more resources than ever to strengthening our content and our brands. It's paying off in our results. And it's a big part of the reason why I'm so confident about how we're positioned for the rest of this year and the years after that.

And so with that, I'll pass it off to John Martin.

John Martin

Thanks, Jeff, and good morning. There are slides that are now available on our website that will follow along with my comments. And let's begin, by the way, on the first slide, where there were a few high-level takeaways from the quarter.

As we discussed with you before, our goal is to deliver superior shareholder returns through a combination of operational growth and direct returns of capital. In this quarter, we continue to execute on that plan. As Jeff described, we delivered our fastest revenue growth in two years, led in large part by the strength of our content.

At the same time, we remain focused on operational efficiencies, which enabled us to grow both adjusted operating income and EPS at considerably faster rates than revenue. Our performance so far this year had given us the confidence to raise our full year outlook again. Growing at least 20% this year comes on top, as Jeff said, on top of the 29% adjusted EPS growth in 2009, think about that we're on track to deliver north of 50% adjusted EPS growth in just the last two years.

Of course, this is in the face of what has been clearly an extremely challenging recession and what continues to be somewhat of an uncertain recovery.

Turning to capital appointment for a moment. Our free cash flow generation in the first half, as well as some recent refinancings that we've done, have further strengthened our balance sheet and we've used some of its flexibility to increase our return to capital. We've spent over $1.5 billion on dividend and share repurchases during the first half of the year, and that's more than twice the level of what we returned in the first half of last year.

Moving to the next slide, which shows consolidated second quarter financial highlights. Revenues were up 8% with Subscription, Advertising and Content revenues all up over last year. Advertising was particularly strong, increasing 11% in the quarter. Adjusted operating income was up over 15%, with margins increasing 120 basis points year-over-year. This was the sixth consecutive quarter of year-over-year margin expansion.

And as we've talked to you before, we continue to try to get the keep a lid on SG&A, where we can so that we can reallocate resources toward more productive areas like Programming, TV and Film Production and Marketing.

Continuing to lock down the P&L, we grew adjusted EPS by 35%. And these strong results was helped by our operational growth, a lower effective tax rate and a lower share count as compared to last year.

Turning now to the segment highlights, and let me begin with our Networks, where we achieved another strong quarter of revenue and operating income growth.

Advertising revenues here were up 14%. We're still above 10% if you eliminate the impact of international transactions, and this performance was driven by growth across our networks. Our Domestic Networks continue to benefit from strong scattered demand, with pricing up 20% to 30% in the quarter, as well as ongoing yield management.

Gaming Networks including kids and young adults grew advertising in the high-single digits. And there was a high demand for the NBA playoffs on TNT, despite four fewer games than last year due to shorter series. And domestic news posted double-digit year-over-year advertising growth.

At our International Networks, organic advertising growth was more than 30%. And I'd also point out that adjusted operating income for our consolidated International Network businesses grew by more than 50% in the quarter. And we achieved a 200 basis points of margin expansion here year-over-year.

Looking ahead, domestic scatter pricing remains robust and it's still up more than 20% over the upfront. And trends internationally look relatively consistent with the second quarter. So, while it may be difficult for us to maintain quite the pace of this quarter's growth, we do expect another quarter of strong advertising growth in the third quarter. So we feel pretty good about that.

Subscription revenue growth here of 9% primarily reflected higher rates and international expansion. Remember, that this is a very big revenue stream for us and we continue to receive Subscription revenues as being one of the largest growth opportunities for the company. We are continually investing to increase the value of our networks through our viewers and distributors, and we expect this value to be recognized over time in our affiliate views.

Operating income was up 14% in the quarter and margins expanded approximately 100 basis points year-over-year. Consistent with our plan, both marketing and programming costs grew more quickly in the second quarter than in the first quarter and that was tied to the timing of new and original programming. As you know, increased investment in originals is a key element in our strategic plan for both Turner and HBO, and we have a particularly strong lineup of originals running during the third quarter, and it's the shows that Jeff mentioned just a few minutes ago. And those include both returning and new shows, shows such as The Closer and Leverage on TNT, a new series Are We There Yet? on TBS, Rizzoli & Isles and Memphis Speed on TNT and Boardwalk Empire on HBO to name a few.

Due to this large slate of originals, we expect our third quarter margins to compress somewhat compared to last year's third quarter, but they should once again expand in the fourth quarter. And for the year, we continue to expect relatively modest programming cost growth in and around the mid-single-digit area. So given strong topline performance to date and encouraging trends that we've experienced, we think that this will all translate into very strong profit growth at our Networks division this year.

Let's turn now to Film. Adjusted operating income in the quarter was relatively flat, but it's still up significantly year-to-date and we saw significant increases in both the optical and television revenue in the quarter, but we also have higher film costs and P&A due to a larger number of high-budget theatrical films and the shift towards international sales distribution for new line releases.

In addition, a greater percentage of our television revenue came from lower margin new series. Overtime, we're confident we can continue to push margins higher at this division by focusing on operational efficiencies and accelerating the transition to digital consumption, particularly in home video.

Our Home Video revenue was down 8% year-over-year in the quarter, but that was mostly a function of a previously disclosed return-reserve adjustment, which helped last year's results. Industry trends have shown some improvement in recent months, with home video sales for the industry close to flat in the second quarter. And digital growth remained quite strong. Warner Bros. grew video and electronic sell-through over 50%. And on a combined basis, these revenues are now quickly approaching 20% of our total Home Video business. As you know, that revenue have a much higher margin attached to it so that's both important and encouraging.

So let's continue to move ahead and look at free cash flow for a minute on the next slide. Year-to-date, we've generated about $1.2 billion of free cash flow. That's down a little year-over-year due to primarily higher cash taxes and an increase in accounts receivable tied to higher revenue growth. However, it still represents a meaningful amount of free cash flow and a high conversion ratio. So let's move to our final slide, which looks at net debt.

We ended the quarter with a little more than $12 billion in net debt, and that's up about $800 million compared to the end of last year. And that's a result of us spending more than 100% of our free cash flow year-to-date, or about $1.5 billion on share repurchases and dividends. And we've also spent about $0.5 billion year-to-date on acquisitions, and about 80% of the acquisitions have been on international cable networks, with the majority of that related to our acquisition of additional interests in HBO's international operations. It also includes our acquisition of Turbine, which is an online gaming studio, to further enhance Warner Bros.' capabilities in the video game space. So with half the year now complete, we're on track to achieve our capital plan priorities and objectives.

So let me remind you quickly what those are. First, we're going to continue to invest in our businesses to improve the strategic position and drive long-term growth, and that's evidenced by the increased investment in programming production and marketing that we've talked to you about.

Second, we're committed to providing direct returns to stockholders through dividends and buybacks, and as I previously mentioned in the first half of the year, we spent $1.5 billion, including about $1 billion in share repurchases. And we still have about $2 billion outstanding under our current share repurchase authorization.

Third, we're focused on our capital structure and carefully managing debt maturities. This year, for example, we've taken full advantage of the current credit markets to effectively extend the maturities of $5 billion in debt, including $3 billion just last month. This has allowed us to improve our maturity profile at very, very attractive interest rates. We now have no more than $1 billion in debt coming due in any year through the end of the decade, so that's good. We consider this strategic flexibility that we have to be a real competitive advantage.

Our leverage ratio is now about 2x, and that's somewhat closer to our long-term target of 2.5x, but yet still leaves us with plenty of flexibility. So thanks for listening, and let me turn the call back over to Doug to start the Q&A part of the call.

Douglas Shapiro

Thanks. Let's get the Q&A started. [Operator Instructions]

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Doug Mitchelson from Deutsche Bank.

Douglas Mitchelson - Deutsche Bank AG

On the home video market improving, is there any measurable benefit from the Netflix and Redbox yields, where you pushed back their home video window? Now that was for the second quarter and maybe there's more experience there and that was part of it. And then separately, Jeff, you mentioned affiliates will recognize increasing value over time, and John emphasized it as well. Can you help us out with the timing part of that increasing value over time? I mean, typically these deals are five years or so, so a fifth comes up every year. Is that the layout, which you just expect 20% of the deals a year? Or is there a bigger year in '11 or '12 that we should think about?

Jeffrey Bewkes

Basically, the results from the Netflix-Redbox window moving back has been quite good. As I think you all know, the intent of the move of the window is to boost demand for DVD sell-through and for VOD. And while it's early, as the results indicate, but that strategy is working quite well particularly, on big titles. Two that I would cite, which are the biggest ones since we moved there, Blind Side is one and Sherlock Holmes is another. We saw considerably higher sales and the weeks, say two to four that we used to see in that kind of week-by-week distribution of sales. The joint cable and studio marketing program to promote Video-on-Demand helped. And one other thing that, I think, we're going to see as we move along, you still have a fair amount of upside room for activity and effort in VOD. The VOD marketing effort, the kind of ability that cable, satellite, telco infrastructure to do VOD is still increasing pretty fast. And so we think that this is working already and it's going to work better as we go along. We have seen other studios following that plan in terms of that window. And we've seen the titles that come from studios that are not using that window structure underperform. So that's what we know so far on those windows. In terms of the affiliate fee, we are extremely confident of our outlook for affiliate fee growth. Obviously, in the premise of your question, the majority of what the revenue that we have is under multiyear contracts, and it's not quite right to say that it rolls over at the rate linearly that you were saying. I'm sorry, I'm not going to give exactly the timing of our maturity. But as you've been watching what we've been doing, not just this Turner, [indiscernible] its original programming success, which we mentioned in our prepared remarks, but also the big programming deals, whether it's for the sports, the basketball, Conan deal, some of the strength of new shows at HBO. We really think that we're improving our position in our future outlook on the affiliate side.

Douglas Mitchelson - Deutsche Bank AG

Are you willing to say at all, whether we'll start to see some of those benefits soon? Or should we think about that as a long-term driver?

Jeffrey Bewkes

Soon.

Operator

Our next question comes from the line of Spencer Wang from Crédit Suisse.

Spencer Wang - Crédit Suisse AG

One question for Jeff and one for John. For Jeff, just to follow up on Doug's question, can you just talk a little bit about how you're thinking about Netflix since it's a customer of Warner Bros., but also potentially, a competitor to HBO? And then for John, could you just update us on your thoughts on capital allocation in terms of potentially accelerating returns of capital to shareholders versus potential acquisitions like say, MGM?

Jeffrey Bewkes

On Netflix, you're quite right. It's a customer for our output and it is a potential competitor to Networks like HBO. Although, so far, it's been more of a complementary service to HBO than a competitor. So one thing I would tell all of you is to actually look at that and any of these companies, Netflix not being the only one, we are quite organized at the job [ph] between Warner and HBO and Turner, how we look at those. And so what you see us doing is something that comes out of a fairly coordinated approach. In terms of HBO's view, we at HBO is very used to competition, and does it by providing a great product, which you can focus either on a superior movie supply that they've got, that got us major releases out many year, or on the original programming, which is unique to HBO. Really, in both respects, both the movies, the Hollywood movies and the originals are unique to HBO and exclusive when you're on HBO. Where Netflix has gone essentially, everywhere Netflix has sub [ph], HBO out-indexed it in terms of its penetration, retention and performance. As you look into the future, I'm not going to really clarify exactly how the programming strategy will work over time. But suffice it to say, I feel very good about that, both on the movie side and the original programming side. And I really would call everyone's attention to what you're about to see, and you already see it with our biggest distributors, Verizon and Comcast, which is HBO On Demand, not only on your TV set, which is already a huge success in ratings and in competitive relative position for HBO versus all other networks. But you're still going to see HBO on all your broadband devices because you're a subscriber to HBO. And if you take the show lineup that HBO's got on originals and movies and you put it available On Demand on all broadband devices, which you're already seeing at Comcast and Verizon, that's going to be the big news for this next year.

John Martin

Spencer, on capital allocation, we don't have a specific target level for our returns. But I think our actions would suggest that we clearly believe that direct returns to shareholders should be a significant component of total return. And it's an important part of our capital plan, and we continue to believe in a balanced, consistent approach, and we believe in using a combination of dividends and share repurchases. And obviously, our share repurchase activities suggest that we have a lot of confidence in the value of the stock and the company. So we've been repurchasing shares around $500 million a quarter. We did raise our dividend 13% this year. And as I mentioned in my proactive remarks, our returns on a year-to-date basis are basically at double the levels they were a year ago. I don't know, Jeff, if you want to make a comment specific about MGM?

Jeffrey Bewkes

Yes, I do. From what we read in the papers, it sounds like we're moving in a different direction and it sounds pretty inept to us. All along, we've said that we didn't need this. We feel comfortable, of course, with our strategic positioning. And MGM could have made attach [ph] when we went, and as everyone knows, because we announced it before they did, we made what we thought was a bid based on what information we had at the time. We haven't really had the kind of discussions that would enable us to confirm whatever the value of MGM is because you just have to go into a more constructive process than has been the move [ph] we've been invited into, and so I don't know. We don't know whether that is in fact worth the full bid that we gave it at the time. And at this point, it does look like they're going off in another direction. We'll see how they do. I think it's pretty widely known that some of their key movie assets, one, which is The Hobbit is something that we may be quite involved in. And so we have an interest in them having some constructive course going forward. But it's not clear whether they do have that.

Operator

Our next question comes from the line of Michael Morris from Davenport.

Michael Morris - Davenport & Company, LLC

First, as some of your broadcast competitors are becoming more vocal and more active in generating retransmission fees to their owned and operating stations, can you just share what your outlook is for the competitive environment for content going forward, whether you anticipate that they'll become more aggressive, both as competitors, also maybe in terms of demand for Warner Bros. content? What's your expectation there, and how are you positioning yourself? And then on the Syndication side, you mentioned robust Syndication pipeline in the back half of the year. Can you be a little more specific with respect to what's in that pipeline? And as a point of clarification, you did have a slide on your Investor Day, in the Warner Bros. section, showing some titles coming up in 2010. It included Entourage and Curb Your Enthusiasm. I was curious, do they make a contribution to Warner as well as HBO? Or will that completely be in HBO?

Jeffrey Bewkes

Starting with -- what was the first question? Retran, okay. We think the retran situation is developing in the way we actually thought it would. I mean, we think it's, on whole, desirable. We do think broadcasters as competitors of our Cable Networks. They've always received a form of retran, usually not in cash for the broadcast network, but in other kind of ancillary networks. And so to the extent that as they get it more direct on their broadcast network and to the extent that they get additional cash, we still think that the stronger cable network, which will be the group we're at, will prosper as they, in the broadcast side, spoke their economics. We think that all our Networks are multi-task [ph] networks with multi-task [ph] programming. The originals, part of that. [indiscernible], the movie line ups as well. So we're actually kind of happy that broadcast has revitalized their programming because there's really two reasons. The easy one to see is that we have a very healthy leading business at Warner, making TV series for the broadcast networks and then bolstering their health going forward is actually good for that business. But the second fact that was related to that is that the successful shows that come off broadcast networks, many of which we made at Warner, are then available for the leading cable networks like TNT and TBS. And they're pretty important part of the ecosystem. And as we've said before, that kind of synergy relationship in terms of Warner supplying hit shows, broadcast across all broadcasts nets, and then having those hits shows available to the highest bidding cable network, which happened to be ours, due to their lead position, is a very beneficial kind of a cycle for the industry and for us. If you go now to the Syndication question, we think that, I think John mentioned in the second quarter, the sale of The Closer to TNT was already in there. It's not that large. We think the pipeline is very strong for the rest of the year. For the rest of this year, we have Two and a Half Men for cable. We have The Closer coming for cable, and we can broadcast. We have The New Adventures of Old Christine. And then looking after 2010, into next year, we've already sold Big Bang Theory for 2011 and The Mentalist for 2012. We've got Gossip Girl and Chuck coming in 2011. Fringe is available in 2012. And the shows you mentioned on HBO, Entourage...

John Martin

Yes, Entourage and Curb, which from an accounting standpoint, that gets reflected in HBO's line of business. The DVD sales get distributed by Warner's but the Syndication licensing is of HBO.

Operator

Next question comes from the line of Anthony DiClemente.

Anthony DiClemente - Barclays Capital

John, with a lot of the conversation around growing demand for TV Syndication content, I'm just wondering if structurally, as you smooth out your Filmed Entertainment division over time, is the composition of revenues and EBITDA from TV versus Film changing over time? I know you don't report them separately within Filmed Entertainment, but just wondering.

John Martin

We don't report them separately, Anthony. And one of the strength of Warner's and one of the reasons why they're probably less volatile than most of the competition, in terms of earnings performance is because we have a very, very big and very, very stable source of profits from our TV Production business, which includes licensing, syndication, border and its global. And I think we had mentioned that with the growing Syndication pipeline, that we would expect to see growth on a go-forward basis from that Television business beginning this year. And so I mean, the mix, sort of, can go up and down at any one particular year, but we have a very, very big component of profits coming from each of the Theatrical and the Television side. And I think we've disclosed in the past that TV, in any given year, can represent nearly half of the profitability of Warner's. And I think it's a strong business, I think secular trends are moving in its direction, which is good, and we expect to be very successful going forward.

Anthony DiClemente - Barclays Capital

And a related question for Jeff, which would be the deal that Warner Bros. announced with Netflix on TV content. I just thought I would ask, on the face of it, this looks like a really good deal because it seems like these are incremental dollars that are flowing to WB for TV content. I'm just wondering if there's a trade-off between these dollars from Netflix that you're getting and the value that you're accruing in the syndication window that you're speaking of? And I know those are not exclusive deals, but I'm just wondering, is there a balance that your syndication division has passed away, in terms of whether or not the deal with Netflix trades off with the deals for TV Syndication and domestic market?

Jeffrey Bewkes

Yes, well, we always look when we're scouting a product in a window. I won't say to it anybody, in this case, Netflix, of whether it conflicts with anything that's more interesting to us. In this case, what we're talking about is a fairly small deal with some programming Nip/Tuck series, which wasn't picked up in syndication. So frankly, had there been anybody buying it in syndication, we would've sold it to the syndication market. The same is true. There was a small movie package in there that's quite old movies, which is really the kind of movies Netflix has. So basically, we don't see so far, and we haven't seen too many other cases where other companies have sold things to Netflix, but essentially, there are a few where it cannibalizes business that's actually better than what Netflix was able to represent. And we basically traded a lot, whether it's with our current networks or with our syndicated files. And remember that the syndication market, generally, is very, very strong, which I think John mentioned. And so what you're talking about here is the only product that nobody wants.

Operator

Our next question comes from the line of Jason Bazinet. [Citigroup]

Jason Bazinet - Citigroup Inc

Definitive decision on HBO GO to make that only exclusive to existing HBO customers, your Pay TV distributors as opposed to...

Jeffrey Bewkes

Jason, would you start over? We didn't hear anything for 10 seconds. We've had, like, long lapses of silence on our side. So we apologize, but if you could start the question over, that would be helpful.

Jason Bazinet - Citigroup Inc

I have two questions on HBO GO. Have you made a definitive decision to limit the availability of HBO Online, if you will, to existing customers of HBO via the Pay TV distributors as opposed to making it available to non-HBO subs over the web? And second, have you made a definitive decision regarding the content that would be available online? In other words, is it only the content that's available on the multiplex channels of HBO as opposed to the deeper library content that you have access to?

Jeffrey Bewkes

Let me do the second part first. HBO GO, as you can all read in the press releases, we'll have to give you more [indiscernible] give it to you. HBO has considerably more products from HBO -- HBO GO's programming from HBO is even more programming than what is available -- so HBO GO's programming from HBO is even more hours, considerably more than what is available on HBO VOD. And so that's how substantial and more and it's quite a bit more. So it's going to be a very impressive product. I do think over time what you'll see on the VOD side, the television streaming side is a more robust product as the Cable, Sat, Telco operators beef up their VOD, but basically think of it as eventually, as much as what it has coming to you as a subscriber, go to your first question, which is what are we doing with subscribers? At the present time, what we're doing is, we basically are launching HBO to our subscriber base. You have 30 million subs that deserve to get HBO On Demand on every platform, including on broadband. You paid for it, you should have it. And we're going to have our distributors, who are very important partners in doing this and putting up the plant that allows you to do this, be part of the equation. The question of whether we should that bask in the future, offer a subscription separately from that, is not something that we're ready to do now. Of course, we could do it, if and when it would become reasonable, but the one thing that we're quite interested in -- and I think every content company should be, is in supporting the economic infrastructure of video streaming, video delivery and broadband ISP delivery. Because if you think carefully about the broadband-video distribution infrastructure, it needs to become more robust. It needs investment and the companies that do that are the ISPs. So you have to think carefully about keeping those economics related as you take products like HBO, Turner Network and you make them available on broadband devices. So I think we're working quite progressively to have the whole system function optimally. And the key to it all is to get our subscribers, not just for our TV Networks, but on ad events to be able to enjoy their products overall all these devices as soon as possible because they already subscribed.

Operator

Our next question comes from the line of James Dix from Wedbush.

James Dix - Wedbush Securities Inc.

If you can give any more color on the outlook for growth at WB and Proactive Entertainment, especially with the strong performance of LEGO titles. I mean, do you have a sense that the games division is somewhat outperforming your expectations for the beginning of the year? And then, secondly, on costs, I was just wondering if you can give any more color on the increase in SG&A in the quarter at the networks? Were there any components to that growth related to acquisitions, or any stuff that's not organic? And what's your expectations be for that growth for the full year there of the networks?

Jeffrey Bewkes

On games at Warner, we're basically now up to more than $0.5 billion in revenue and growing reasonably fast with healthy margins. And we're really doing two things: We've brought in some, in terms of acquisition, we brought in some companies like Midway, Rocksteady, [indiscernible] et cetera. It's bringing us IP. It's bringing us titles like the Lord of the Rings, Arkham Asylum, Mortal Kombat. And then secondly, we have, as you all know, a pretty big titles in our IP inventory in the Warner and Time Warner Characters in some strategy. So we're essentially building from our position of both distribution related to DVD and all that, and IP that we have in our programming. And we're working towards the global video infrastructure, which goes adjacent in gains. So we think that we're making steady progress. We've moved into the top 10. We see it a growing percentage of the Warner Bros. 'revenues. It's actually one of the fairly high growth areas inside Warner Bros., and we believe the margins should improve as we increase our sales and further leverage the infrastructure.

John Martin

On the cost side, I think your question was specific to Networks SG&A. One of the bigger year-over-year increases in SG&A in the quarter was marketing. And marketing around, obviously, supporting new programming launches. So that's one of the more meaningful components of that. And just to put a little bit more context around it, this is the sixth quarter in a row where we had a year-over-year margin expansion at the networks division. And I think if you look at the absolute margin in networks in the second quarter and if you go and compare that to history of the second quarters of all the prior years, I think it's the highest margin at the Networks for as long as our data goes back for. So my point being is that we are carefully managing the investment in the cost space. We are trying to be more efficient where we can, and I often mentioned that we're trying to keep a lid on SG&A, but marketing is a component of that. That is directly tied to revenues because of supporting the investment that we're making our programming. So we're working hard and we continue to see positive margin attributes as we go forward.

Operator

Our next question comes from the line of Richard Greenfield from BTIG.

Richard Greenfield - BTIG, LLC

Can you comment on your thoughts related to the actual pricing? Jeff, if you went down to the AMC Lincoln Square right near your offices, you would pay $13 to see Inception. You would pay $17 for Cats and Dogs 3D, just wondering how you think about that, and whether that makes sense from a pricing standpoint? And then two, you talked a lot about HBO GO. There's been a lot of questions about it. I'm just wondering, your deal with Comcast forces everything in broadband to go through their Fancast interface which seems, at least from consumers I've talked to, to be vastly inferior to your beautiful HBO GO interface, and just wondering whether that will change going forward or whether that's something that's set in stone forever?

Jeffrey Bewkes

On the pricing, I'm not sure if I get your question. I mean, it's a long-standing question about whether the ticket priced for movies that people think are being hit, should be the same as the ticket price from let's say, are controversial as to whether they're hits. And I believe you mentioned what could fall into that category. And then your related question is what do you think of the GAAP between 3D pricing and regular pricing. Revenues in theatrical box office has been reasonably healthy. Admissions, have stayed flat. I don't think the industry, meaning the distribution retail field industry, they don't believe really believe that the it's all about elastic in terms of volume of ignitions. It's ticket prices. And I think they believe that the place to have some kind of revenue growth to keep inflation is on ticket pricing, whether it's for standard stuff or whether it's for 3D. It's clear that 3D represents a bit of an opportunity for higher ticket prices and that probably will remain a question of legitimate interest as to whether this title in 3D justifies whatever that ticket price is versus some other type of 3D. And I think it really gets down to the whole issue of ticket pricing, whether it's standard or 3D experience. The fact that it's been standard across really good titles versus weaker titles is the source of the question. I think the question will remain and I think even I can't answer it satisfactorily that the fruit is in the eating of the pudding. Revenues in theatrical are quite healthy. And one of the things I wouldn't underestimate is that in the help of the box office, even coming from 3D price before, what does that is it develops a real interest for ancillary viewing, whether you actually see the movie in your home on a standard basis or you may watch it a theater on 3D or in the future maybe you'd get a 3D for your home viewing. So I think its all positive in terms of the industry on the film economics, at least for the producing sector. If you go-to-go and you're flying on Comcast or on the view on -- I agree with you on something. I agree with you on actually a lot of what you're seeing here. I think the interface for HBO GO, the HBO develop is superior to, basically, any interface outfits. And so we are encouraging everyone, all our affiliates, whoever they are, to take advantage of that interface and use it, which they could. I think that what will happen is any distributor who has an interface, who's really not able to perform as well as what the HBO one does, you can end up adopting it. And if your question basically asks, okay; that's what; your question has with the premise shouldn't they, do that quickly? I agree with you, yes, they should.

Operator

Our next question comes from the line of Tom Egan. [Collins Stewart]

Thomas Eagan - Collins Stewart LLC

Just a question on international cable networks, I guess if you provide maybe some more color, if I missed it, I apologize. But on the top line, on results and then on the outlook, how much of it is coming from increases in ad spending same store, so to speak, and how much of it's coming from expansion, whether it's new channels or new markets? And then on the margin, what was the actual margin on the international side and how high can that go?

Jeffrey Bewkes

I mean, as we discussed in some detail on Investor Day, international is now and is going to continue to be a key driver of growth, including our unconsolidated HBO branches. Our International Cables Networks business had very close, very constant sales, generates over $400 million of adjusted operating income just in year 2010. And we think that there's tremendous growth going on, both in ad side and the affiliate side. In both Turner and HBO International, it's growing faster than domestic. I will just emphasize before John gives some of the numbers on it, we do not have a plant-the-flag strategy. What we have is a strategy where we try to identify the right growth markets for secular growth demographics on our attractiveness, rule of law hospitality to what we're doing, and an ability to build through a reasonable scale, so we can have good marketing, distribution efficiency and reasonable infrastructure decisions.

John Martin

I'll just add a couple of numbers. Our international reported growth was north of 80%, but that did include the impact of some acquisitions, which I said, which sort of contributed close to 400 basis points in the quarter. On an organic basis year-over-year, International was still up over 30%. And there, if you look at back at last year, International underperformed Domestic. And we've seen a stronger recovery in almost all territories where we've got meaningful presence as it relates to advertising. So that's very, very encouraging. We don't specifically disclose the absolute margins, but in my proactive remarks, I mentioned that margins were up 200 basis points year-over-year and we have said in the past that international margins are still meaningfully lagging our domestic margins. So we think we've got one way for improvement as we move ahead.

Douglas Shapiro

Thanks, everybody for tuning in and we look forward to talking to you in a couple of months.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. Have a great day.

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Source: Time Warner Q2 2010 Earnings Call Transcript
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