Time Warner's (TWX) CEO Jeffrey Bewkes on Q2 2014 Results - Earnings Call Transcript

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Time Warner (NYSE:TWX)

Q2 2014 Earnings Call

August 06, 2014 10:30 am ET


Michael Kopelman - Senior Vice President of Investor Relations

Jeffrey L. Bewkes - Chairman and Chief Executive Officer

Howard M. Averill - Chief Financial Officer and Executive Vice President


Michael Nathanson - MoffettNathanson LLC

John Janedis - Jefferies LLC, Research Division

Benjamin Swinburne - Morgan Stanley, Research Division

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

Richard Greenfield - BTIG, LLC, Research Division

Douglas Creutz - Cowen and Company, LLC, Research Division


Welcome to the Time Warner Inc. Second Quarter 2014 Earnings Call. My name is Joe, and I will be your operator for today's call. [Operator Instructions] Please note that this conference is also being recorded.

I will now turn the call over to Mr. Michael Kopelman, Senior Vice President of Investor Relations. Mr. Kopelman, you may begin.

Michael Kopelman

Thanks, and good morning, everyone. Welcome to Time Warner's Second Quarter Earnings Conference Call.

This morning, we issued 2 press releases. One detailing our results for the second quarter and the other reaffirming our 2014 full year business outlook.

Before we begin, there are 2 items 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 www.timewarner.com/investors. Reconciliations of our expected future financial performance are also included in the business outlook release that's available on our website.

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

Time Warner is under no obligation and, in fact, expressly disclaims any obligation to update or alter its forward-looking statements, whether as a result of new information, future events or otherwise. Thank you. And I'll turn the call over to Jeff. Jeff?

Jeffrey L. Bewkes

Thanks, Mike, and thanks for listening in this morning. We had another great quarter. Revenues grew 3%. Adjusted operating income increased 17%, and adjusted earnings per share was up 29%.

We also generated $2 billion in free cash flow in the first half of the year. That's up 16% from a year earlier.

The other highlight in the quarter was the completion of the spinoff of Time Inc. into an independent publicly-traded company on June 6.

This really marked the beginning of a new and a very promising era for Time Warner. As you know, we started a process several years ago that focused the company on video content, emphasizing the very best storytelling. We've strived to make that content available to consumers all over the world and across every technology platform and device. We've also maintained an intense focus on our operational and capital efficiency with an unwavering commitment to maximize value for Time Warner shareholders.

Our strong results both this quarter and the last several years are evidence that our strategy is working. By focusing on the right set of leading brands and assets, on operational excellence and on disciplined capital allocation, we've been able to achieve the highest total shareholder returns of any company in our peer group over the last 6 years.

And we think the future of the company is even brighter. We've only just begun to reap the benefits of being a nimbler and more focused video content company with iconic assets, including the world's leading premium television brand, the world's strongest ad-supported cable network group and the world's largest film and television studio. The combination of those assets and a management team that I think is the strongest in the industry, positions us for continued attractive growth in the years to come.

Today's call is about our operating results and performance. We're not going to comment on the proposal from 21st Century Fox or its withdraw except to say that the board and our senior management team appreciate, very much, the continued support of our shareholders. We're committed to continued delivering substantial and sustainable returns into the future, and we saw ample evidence of what we can accomplish during the second quarter. And that's just the beginning.

So let me start with HBO, which in a world with so much great content and so many ways to access that content, continues to define the word premium.

HBO remains at the top of its game. Recently receiving 99 Primetime Emmy nominations, which is the most of any network for the 14th year in a row. It's also more than double the nominations of its closest competitor for the second straight year.

Nominations included Outstanding Comedy Series for Veep and Silicon Valley, as well as Outstanding Drama Series for True Detective and Game of Thrones.

Both Silicon Valley and True Detective are freshman hits for HBO. That underscores HBO's unrivaled ability to incubate and provide a platform for groundbreaking storytelling.

Now speaking of groundbreaking, the fourth season of Game of Thrones, which concluded in June, averaged 19 million cumulative viewers, making it the most watched season of an original series in HBO's history, surpassing even The Sopranos.

What are you going to do? With all this, HBO is not easing up on the gas. It introduced 2 more shows this quarter that are off to solid starts. John Oliver's Last Week Tonight; and our new drama, The Leftovers from showrunner and writer, Damon Lindelof.

The Leftovers is the first show Warner Bros. has produced for HBO, and Leftovers is averaging 8 million viewers per episode to date.

And 2 days from today, The Knick, from executive producer Steven Soderbergh, will premiere on Cinemax, which has been steadily building a slate of original hits.

We think The Knick could be a signature show for the network, and we've already renewed it for a second season.

I mentioned using technology to enhance the user experience. And HBO GO continues to set the standard for how audiences enjoy the content they love across devices and platforms.

HBO GO active users grew 35% year-over-year in June and is now available in 24 territories around the world. And as we've told you before, we're making investments in the next-generation HBO GO that will be even more powerful and will put us in a strong position to take advantage of consumer demand for multiplatform viewing options here and around the world.

HBO's investments in programming and technology continue to translate into solid subscriber growth. In the first half, we added more than twice as many domestic subs as we did in the same period a year ago and we're confident that, that will translate into even stronger subscription revenue growth over time.

Of course, HBO's success has not been limited to its domestic business. HBO's international subscriber base, including unconsolidated joint ventures, grew almost 15% in the past 12 months. And we think there is substantial additional opportunities to grow internationally in the years to come.

Now let's look at Turner, which has the strongest portfolio of ad-supported cable networks in the industry. That includes 2 of the top 5 networks in the U.S. and the highest percentage of its U.S. networks in the top 30 of any operator.

And Turner's 4 most important networks, TNT, TBS, CNN and Cartoon Network accounts for 85% of its domestic affiliate fees. That concentration is the result of a deliberate strategy of focusing our investment on a small group of top-tier networks to ensure that they are must haves for both consumers and distributors.

In a world where consumers are becoming more discriminating in what they watch and where distributors are looking to create smaller bundles of networks, we think that's the right strategy, and it puts us in a great position to increase share over time. We saw that play out in this year's [indiscernible], where we once again garnered price increases at the very top of the industry.

To stay on top, Turner's investing even more in content, building on a strong platform that's already home to more top-rated original programs than any of its peers and a portfolio of top-tier sports that includes the NBA, Major League Baseball and March Madness.

Those investments are paying dividends. During the quarter, TNT ranked as ad-supported cable's #1 prime time network among total viewers and adults 18 to 34, adults 18 to 49 and adults 25 to 54. We've told you about TNT's efforts to refresh and take more creative risks with its programming, and we're already seeing positive results.

The Last Ship and Murder in the First, which both launched during the quarter, are the 2 most watched new series on ad-supported cable this year so far. We expect that momentum to continue with the August rollout of Legends, which stars Sean Bean and comes from Howard Gordon. He's the creative force behind 24 and Homeland.

TBS was close on TNT's heels, finishing the quarter as the #3 ad-supported network in primetime among adults 18 to 49 and adults 25 to 54, with The Big Bang Theory on TBS remaining the #1 comedy on ad-supported cable among total viewers for the 10th consecutive quarter.

And we're excited about the launch of all new episodes of American Dad on TBS this fall.

We also continue to see strength at Adult Swim, which was, again, ad-supported cable's #1 network in total day among adults 18 to 34 during the quarter, and it won the day in adults 18 to 24 and 18 to 49 as well.

At CNN, we're making significant progress on our original programming strategy with current seasons of Anthony Bourdain: Parts Unknown; and Morgan Spurlock: Inside Man, both registering solid double-digit gains over the prior season.

The Sixties was tripling CNN's time period average from a year ago and The Hunt with John Walsh, another new show, won its time period among cable news networks.

Outside the U.S., Turner is also a leader, particularly in Latin America. The strength of Turner's international position was evident this quarter as international revenue was up around 10% and adjusted operating income grew 25% on a constant currency basis with growth across all of our major regions.

Our kids business remains a cornerstone of our international operations. In fact, Cartoon Network is the #1 kids network in many areas outside the U.S.

While already a very good business for us, we've got plans to significantly increase the size of our kids business as we focus on global franchise management and growing consumer products revenue.

Turner is also investing to expand its lead in multiplatform with properties like Bleacher Report, which was the #2 stand-alone sports site in the second quarter and CNN Digital, which is significantly ahead of its peers, leading all news outlets with over 30 million monthly mobile uniques.

CNN recently extended its multiplatform capabilities with a national rollout of its next-generation TV Everywhere product, which is now available to subscribers in over 85 million households domestically. So go check it out.

Now I'd like to turn to Warner Bros., which is on track for another great year, underscoring its continued industry leadership. In what is widely considered a volatile and mature business, Warner has grown its adjusted operating income at a double-digit CAGR over the past 5 years by leveraging its industry-leading distribution capabilities, its unique IP and its very strong relationships in the creative community to produce content with global appeal.

The strength and diversity of its revenue streams was evident again this quarter. On the theatrical side of the business, we anticipated a softer summer compared to last year, which remember, included Man of Steel, The Hangover Part III and The Great Gatsby.

But despite those comparisons, we're #2 in the domestic box office year-to-date, benefiting from the strong performances of The LEGO Movie and Godzilla. And along with the release of with the second Hobbit installment, The LEGO Movie also helped us to maintain our #1 position in home video in the quarter.

It's just the latest example of Warner's unequaled ability to create franchises with 2 additional LEGO titles already in development.

That adds to an already strong pipeline of franchises built around DC Entertainment and the new series of films from J.K. Rowling based in the world of Harry Potter. Our franchise pipeline gives us great confidence Warner Bros. will continue to lead the film industry, building on a track record that includes the #1 position at the domestic box office 7 out of the last 10 years and the #1 spot in home video for 13 straight years.

But that's not all. Warner Bros. Television group is also leading the industry. Heading into the 2014 to '15 TV season, Warner's is, again, the #1 producer of shows for broadcast. That's a position we've held for 11 of the past 12 seasons.

Starting this fall, Warner will have 31 shows on broadcast networks, including at least 2 primetime series on each network and 60 shows overall across broadcast and cable.

Now what's also really notable and unprecedented is that 5 of those shows are based on IP from DC Entertainment, including the highly anticipated Gotham on Fox, The Flash on the CW and Constantine on NBC.

That's early evidence of Warner's ambitious plans to further mine the DC catalog across our television, film, video game and consumer products businesses.

Warner's is also leveraging its lead skill position in broadcast television by significantly expanding production for cable networks and SVOD services, growing its non-scripted output and widening its international local production footprint.

During the quarter, for example, we completed the acquisition of Eyeworks' international television production operations, and we've now built out a global network of wholly-owned international production companies.

A key part of our strategy for Warner's to expand in cable TV production is working more closely with both Turner and HBO. That collaboration is one of the many benefits of having a smaller, more focused company with commonalities across all the businesses and a management team that's worked together for years. And we continue to augment our strong operating performance with disciplined capital allocation. So far, this year, we've repurchased $3.5 billion of our stock and including dividends, we've returned over $4 billion to shareholders.

Even at recent highs, we believe share repurchases were a very attractive use of capital. And today, we announced that the board has authorized an additional $5 billion in share repurchases. That decision is a strong indication of the confidence we have in our growth prospects. Over the next several years, we have great opportunities across our businesses.

At Turner, we'll benefit from our domestic affiliate renewal cycle and strong international growth while investing to reinvigorate our key brands and take advantage of under-monetized opportunities like the global kids business.

At HBO, we'll capitalize on the growing demand for our industry-leading content both here and around the world while investing in technology to provide the very best next-generation experience to our consumers.

At Warner Bros., we'll roll out an even stronger slate of franchise films with global appeal and leverage our leading position in broadcast TV to drive growth in cable, SVOD, unscripted and international sales.

And across the company, we'll remain laser-focused on operating and allocating capital as efficiently as possible to maximize shareholder returns. We know that many of you are interested in hearing more about our long-term growth plans, and we look forward to sharing additional details about those plans at an investor event this fall.

With that, let me turn it over to Howard.

Howard M. Averill

Thanks, Jeff, and good morning. As a reminder, we completed the Time Inc. spin at the beginning of June, and it's now continued in discontinued operations.

I'll begin by referring to the first slide of our presentation, which is now available on our website. We're thrilled with our financial performance in the first half of the year. We delivered strong growth in the first quarter and even better results this one.

So through the first half, our adjusted operating income is up 14%, and adjusted EPS is up 27%, and we think that growth is both indicative of the strength of our industry-leading businesses and the validation of the strategy we've been executing the last several years.

In the second quarter, we posted double-digit increases and adjusted operating income at all 3 divisions and total AOI increased 17%, boosted by an acceleration in subscription revenue at both HBO and Turner.

Margins expanded nearly 300 basis points in the quarter, and that's the 11th time in the last 12 quarters that margins have increased year-over-year.

Total operating expenses were down 1% in the quarter, and that's despite higher content investments that Turner and HBO and increased expenses associated with the consolidation of HBO Asia and HBO Nordic.

SG&A was down 3% in the quarter. This is a great example of how our disciplined approach to expense management allows us to balance aggressive content investments with continued margin expansion and profit growth.

We continue to leverage growth and adjusted operating income into even faster growth in adjusted EPS, which increased 29%. And that was mostly due to our ongoing share repurchase program and improved results at our equity investments, including CME.

During the quarter, we repurchased almost $2 billion in shares, a significant acceleration from the first quarter and paid over $280 million in dividends.

So year-to-date, we've returned over $4 billion to shareholders, including over $3.5 billion in share repurchases and well over $500 million in dividends.

And as evidenced by the authorization of an additional $5 billion in share repurchases, we remain committed to delivering significant direct returns to shareholders.

This morning, we also reaffirmed our 2014 guidance for low teens growth and adjusted EPS. So with a very strong first half, we remain on track for our sixth consecutive year of double-digit growth and adjusted EPS.

Now turning to the segment highlights. I'll begin at Turner, which had record second quarter revenues and adjusted operating income.

Subscription revenues were up 8% in the quarter despite a 70-basis point drag from FX. Domestic Subscription revenues once again grew high single-digits as Turner continue to benefit from the rate increases associated with its domestic affiliate renewals.

International Subscription revenues increased double-digits with the largest gains coming from Latin America.

Looking forward, we'll continue to benefit from Turner's domestic affiliate renewals for the remainder of the year, and we expect domestic sub revenue growth to remain in the high single-digit range. Longer term, we remain confident in our ability to grow domestic sub revenue double-digits annually on average through 2018.

Moving on. Advertising revenues increased 1% in the quarter, in line with the range we expected coming into the quarter, and that included the benefit of approximately 300 basis points from the airing of 2 final 4 games.

While our new original programs at TNT are off to a good start, ratings at our domestic networks remain a headwind. In addition, scatter demand remained moderate, particularly for sports. And as we've discussed with you previously, we think that was at least partially due to the impact of the World Cup.

Domestic advertising growth was up slightly in the quarter with very modest growth at both our domestic entertainment networks, including kids and young adults, and news networks. Excluding the drag of approximately 400 basis points from FX, international advertising would have been up in the high single-digits, led by solid underlying growth in Latin America.

Looking ahead to the third quarter, scatter pricing is healthy, pacing up high single-digits over the upfront, however, volume remains relatively modest, and we expect ratings to remain a near-term drag on our performance.

Taking those factors into account, we anticipate total advertising to be flat to down low single-digits in the third quarter.

Adjusted operating income grew a really strong 15% in the quarter and margins increased over 300 basis points. That reflects both revenue growth and our continued focus on limiting non-programming expenses, which were down in the quarter.

Programming expenses increased 5% due to higher sports cost, primarily associated with the NCAA Tournament. And that was balanced by lower original programming cost at our domestic entertainment networks due to the timing of series premieres.

Looking ahead, we expect cost related to the new Major League Baseball deal and continued aggressive investments in original programming to result in somewhat higher programming cost growth in the second half of the year. So we expect full year programming cost growth to be in the high single-digits.

To free up resources to invest even more in programming, as well as technology and international expansion, earlier this year, Turner kicked off a global initiative called Turner 2020.

Turner 2020 is designed to improve efficiency and maximize performance across the organization and will likely result in restructuring charges in the second half of this year. This is all consistent with our company-wide strategy to limit non-programming expense growth in order to fund investments and drive continued margin expansion.

Turner will also be evaluating whether to dispose of certain licensed programming in connection with these restructuring activities.

To the extent it decides to, we could also incur programming impairments. We'll provide more details on both those fronts in the coming months.

Excluding those potential impacts, we're on track for another year of margin expansion and solid growth at Turner. And looking beyond 2014, we expect revenue and adjusted operating income growth to accelerate over the next several years as we continue to benefit from attractive domestic affiliate rate increases, strong international growth, efficiency initiatives and upside from under monetized opportunities like our global kids business, Adult Swim and truTV.

Turning now to HBO, where we had another very strong quarter with revenues up 17% and adjusted operating income up 23%. Subscription revenues increased 10% in the quarter with the consolidation of HBO Asia and HBO Nordic contributing around 500 basis points to that growth.

Domestically, our subscriber trends remain healthy, and we're starting to see some improvement in the subscriber mix, which contributed to a modest acceleration in our domestic Subscription revenue growth.

Content revenues grew over 50% in the quarter. That increase was due to revenue from our licensing deal with Amazon, balanced by lower domestic syndication.

Adjusted operating income was up 23% in the second quarter with margins expanding nearly 200 basis points, and that obviously benefited from the Amazon deal. Also, keep in mind that prior year's quarter benefited from an adjustment to a receivable allowance. Absent that, adjusted operating income would've been up over 30%.

Programming expenses increased 11% with 600 basis points of that growth coming from the international consolidations. Excluding the consolidations, programming expenses increased 5% with double-digit growth and original programming, tempered by lower acquired theatrical expenses due to the timing of film availabilities. In addition, marketing spend increased to support our original programming and due to the consolidations.

Across HBO's international properties, we've posted another quarter of solid growth. Total international revenue, including unconsolidated JVs, was up double-digits. And that was driven by continued subscriber growth with international subs up around 15% year-over-year.

Looking ahead, we expect total expense growth, excluding the consolidations, to accelerate somewhat in the back half of the year. This is due in part to the timing of programming, the reinvestment of the Amazon proceeds and higher distribution expenses.

As we've previously discussed, we intend to invest the majority of the Amazon proceeds back into the business in programming, marketing and technology. As a result, we expect adjusted operating income to be relatively flat year-over-year in the second half of the year. Despite that, with our strong first half results and healthy underlying trends, HBO remains on track for solid growth in 2014.

And given the strength of its brand and content and the significant global opportunities we see in front of it, we think that HBO is poised to accelerate its growth over the next several years.

Moving onto Warner Bros., which reached its highest second quarter profits in a decade. Despite tough theatrical comparisons, Warner's had another very strong quarter, underscoring its diverse earn extremes [ph].

Adjusted operating income grew 28% and margins expanded around 200 basis points. That included strong growth in TV and home entertainment, combined with lower film and distribution costs.

Adjusted operating income growth this quarter also benefited from the reversal of bad debt reserves and lower restructuring charges.

On the TV side, revenues grew mid single-digits. That was related to higher license fees from television production and international syndication. And as Jeff described earlier, Warner's completed another very successful upfront season, so the outlook for our TV business continues to be very strong.

Across theatrical and TV, home entertainment was up 14%, largely due to the timing of the release of the second Hobbit film and the strong performance of The LEGO Movie.

Digital trends also remained positive with electronic sell-through up close to 70% in the quarter.

Consumer spending across the broader home video market was down modestly in the second quarter due to the declines in rentals and sales of catalog product. However, total sell-through was up in the quarter, led by 32% growth in electronic sell-through. So we remain encouraged with the continued digital transition in home entertainment.

Looking ahead to the second half of the year, theatrical comparisons remain challenging, but we expect continued momentum in TV. We're really well positioned for the new TV season and expect continued growth in TV license fees. We also expect demand for our content outside the U.S. to remain healthy.

So given the strong start to the year and positive outlook in the TV business, Warner's remains on pace for another great year in 2014.

And looking beyond 2014, we remain confident in our ability to grow both our TV and theatrical businesses at very attractive levels as global demand for high-quality video content continues to grow.

Moving to free cash flow, where we're also having a great year. We generated nearly $2 billion in free cash flow in the first half, a 16% increase compared to last year. The year-over-year improvement is primarily due to the strong growth and adjusted operating income and a favorable swing in working capital. And that was despite increases in cash taxes, capital expenditures and cash interest.

The improvement in working capital primarily reflects lower participations at Warner Bros. And cash taxes increased largely due to higher pretax income and the expiration of certain favorable tax legislation.

Meanwhile, the increase in cash interest was due to higher debt balances and given the $2 billion of debt we raised during the second quarter, we expect cash interest to be higher in the second half of the year.

So with our solid performance in the first half of the year, we're on track for another very strong year of free cash flow generation in 2014.

Next, I want to talk about our balance sheet and capital allocation philosophy. We're strong believers that effective capital allocation can be as important to shareholder returns as strong operating performance, and we've been steadfast in our commitment to maintaining an efficient balance sheet and to prudent capital allocation in order to provide superior shareholder returns.

That strategy has been working, and we have no intention of changing it. Our capital allocation priorities remain first and foremost to maintain a strong balance sheet so that we can fully invest to drive growth in our businesses. Even so, we generate substantial free cash flow. We have committed a significant portion of that cash flow to our dividend with the highest payout ratio in the industry. We've grown our dividend double digits each of the past 5 years and intend to continue to grow it along with our businesses.

Next, we always look at M&A opportunities as they present themselves. Potential transactions need to provide strategic benefits with reasonable execution risk and risk-adjusted returns that are more attractive than our alternative uses of capital. But we have leading scale in our businesses, so we don't need to do anything.

Finally, we believe share repurchases remain a very attractive use of capital and intend to continue using them to complement our dividend. You can see that philosophy at work so far this year.

We ended the second quarter with $18.1 billion of net debt, down about $230 million from the end of 2013. That's largely due to our strong free cash flow generation, the $1.4 billion in proceeds we received from Time Inc. in connection with the spinoff, and the $1.3 billion in proceeds from the sale of our space in Time Warner Center. Our net leverage ratio was 2.5x as of June 30.

On the M&A front, we've invested over $850 million year-to-date. The majority of this came in the second quarter as we closed our acquisition of Eyeworks' international television operations and completed financing arrangements with CME. We're optimistic about the long-term opportunities for both and they fit in perfectly with our strategy of investing selectively in attractive international territories.

We also returned close to $3.5 billion to shareholders during the first half of the year, including almost $3 billion of share repurchases. And we believe our stock remains very attractive at current levels.

Now onto the final slide, which shows our 2014 outlook. We had a terrific first half of the year with all of our divisions delivering strong results. And looking to the back half of the year, we expect our underlying revenue trends to remain solid, led by strong affiliate revenue growth at Turner and HBO. At the same time, we'll be making significant programming investments at both Turner and HBO, face difficult theatrical comparisons at Warner's and anticipate a negative swing in intersegment eliminations.

So as implied by our outlook, that will cause a deceleration and adjusted EPS growth in the back half of the year.

A few minutes ago, I mentioned that we anticipate incurring restructuring charges and programming impairments in the second half. In addition, we anticipate a favorable tax settlement over this period. While these items aren't currently reflected in our outlook, on balance, we expect they will have a net positive impact on adjusted EPS. We'll share more details on those items as the year progresses. Putting all that together, we're on track for another year of solid double-digit growth and adjusted EPS. As Jeff discussed, we're confident that we can grow adjusted EPS even faster in the years to come.

Demand for the type of high-quality video content that we produced is only increasing, and we expect to convert that into continued healthy revenue growth. At the same time, our efficiency initiatives and strict discipline managing non-programming expenses should result in further margin expansion driving strong growth and adjusted operating income. And when you factor in our capital allocation strategy, we believe we can deliver very attractive adjusted EPS growth for the foreseeable future.

As Jeff noted, we look forward to sharing more of our plans with you at an investor event this fall.

With that, I'll turn it back to Mike to start the Q&A.

Michael Kopelman

Thanks, Howard. [Operator Instructions]

I'll also remind you that will be not commenting on 21st Century Fox's proposal or its withdrawal.

Joe, can you please open up the call for Q&A?

Question-and-Answer Session


[Operator Instructions] And our first question here comes from Mr. Michael Nathanson from MoffettNathanson.

Michael Nathanson - MoffettNathanson LLC

I have 2 for Jeff. Jeff, I think over the past few weeks, it was clear that you guys and the board have a strong conviction in the internal plan of Time Warner. So you've helped us in the past talk about Turner's affiliate fee growth outlook, but I wonder from where you sit as an insider, what are the drivers of Time Warner's financials do you think are underappreciated from the outside world?

Jeffrey L. Bewkes

Thanks, Mike. Well, I'm glad you asked. Look, it's a pretty long list. So let me just tick it off. First of all, I think that global growth in multichannel TV and in connected devices is fairly strongly increasing the value of high-quality video content, and that's true all around the world. And we think that if you look at Time Warner -- HBO, Warner, Turner, all of our brands are very strong global brands. We have global scale that gives us an advantage in creating the content and also distributing the content. If you go to each company, at Turner, we've got very good visibility the next few years from the domestic affiliate renewal cycle, and so that's a pretty significant contributor to growth. We also expect to complement that with strong growth internationally, particularly in Latin America. That's true across Turner and HBO. And I think people underestimate the opportunity we have in terms of reinvigorating our key Turner networks and in capitalizing on the under-monetized opportunities that exist there. I'll just cite one, you're going to hear more about it, global kids, Turner and Warner's. HBO, we're seeing really strong increased demand for the services and the content. So both HBO subscription demand, wherever we take it; and HBO content, wherever we take that. That's true all over the world. I think people underestimate that. Warner's is also very well positioned for continued growth with both the film side -- huge pipeline of franchise films, and there are very strong secular trends in the TV series business, which Warner is the leader in producing. So I don't think that there's full appreciation of what we can do there. And this is both film and TV. And if you take just an example like DC, which is pumping out so many new shows at Warner this year, and then add to that, as you look at more and more realized power from DC, consumer products is an area, where, frankly, we've underperformed what we can do, and we think that, that's going to be a real driver going forward. So if you take all those together, we're pretty confident that we can deliver very attractive revenue growth, and we can turn that into even faster growth and adjusted OI. And of course -- and I think our record speaks to this, our approach to capital allocation, if you take increased operating income growth levels, we complement that with a fairly clear plan for capital allocation. And so we feel comfortable that we can take increased OI growth and turn it into increased EPS growth. And remember last quarter, we said publicly that we expected to deliver EPS growth in the low- to mid-teens, if not better. You probably noticed, I'm emphasizing the phrase if not better. I'd also like to note that over the years, we've consistently over-delivered, and we look forward to sharing more about that in our -- of our long-term plans in the fall.

Michael Nathanson - MoffettNathanson LLC

Okay. Jeff, can I ask you just a quick follow-up on SVOD? There's a rumor or a report over a couple of weeks ago that Seinfeld could actually be sold into SVOD, and given the library of content you own in all the comedies, does this suggest that you and Warner's are rethinking maybe your previous positions on SVOD? Or will you be a bit more aggressive about some of your library content in comedies, especially?

Jeffrey L. Bewkes

Well, we've had a lot of SVOD rev, and I'm going to come back to that, but I think the crux of your question is that the emergence of new players is increasing the value of great content, and we have more of that than everybody. That's true on the film side; it's true on the TV series side. It was quite obvious this quarter that even without the Amazon agreement, our SVOD revenue would've been up double-digits. As we look to the full year, we expect SVOD to grow solid double-digits even without the HBO-Amazon deal. And that growth is obviously even stronger if you include the HBO-Amazon agreement. I'd like to point out, since we mentioned the HBO deal, that Amazon deal doesn't include some of HBO's most valuable content like Game of Thrones and True Detective. Now there's nothing preventing us from monetizing kids shows like those in the future if we think it makes sense, but the same thing is true for Warner Bros. We have the biggest library of TV series and films in the world. If you look at our SVOD revenue, which was quite healthy. Last year, we had a base of -- in 2013, of about $400 million. We're going to be up solid double-digits. And by that I don't mean 10 to 20, I mean more. And I think the opportunity is very, very large in international territories. So it's very clear there's big consuming [ph] amount for this content. We think there is a increasingly competitive and strong set of buyers out there, including Netflix, but including Amazon and some others. And so we're very confident we'll be able to effectively monetize our content, and we're actually pretty happy with the way we've timed or sequenced the release of our library, and you're going to be seeing more about that as the years go on.


Our next question here comes from John Janedis from Jefferies.

John Janedis - Jefferies LLC, Research Division

Howard, can you talk a little bit more about third quarter guidance for advertising? Now, obviously, Jeff talked about the success of some of your originals. How much of the weakness is ratings versus the ad market? And to what extent are you seeing signs of improvement in underlying demand?

Jeffrey L. Bewkes

Your question is third quarter advertisers?

John Janedis - Jefferies LLC, Research Division

Yes, Jeff.

Howard M. Averill

Okay. So scatter pricing for entertainment nets is pacing up high single-digits over the upfront, but we're just not seeing the volume overall. And that's been true generally speaking. Additionally, the ratings at our networks do remain a drag. Internationally we're [indiscernible] to see continued drag from FX and a modest slowdown in organic growth due to a tough comp. So as I said in my prepared remarks, we think, overall, advertising is going to be flat to down low single-digits.

John Janedis - Jefferies LLC, Research Division

Okay. And maybe on a related topic, Jeff, can you talk more ratings at Turner? Is the weakness from new or returning shows, and how much of the programming expense maybe skews to originals versus licensed relative to a few years ago?

Jeffrey L. Bewkes

Yes, okay. So you got to deconstruct Turner through a different networks. Let me kind of break it down. You're asking about all of them, right? I mean, in general?

John Janedis - Jefferies LLC, Research Division


Jeffrey L. Bewkes

Okay. So let's start with TNT, which we mentioned on the call was #1 and a number of age groups in prime. TBS was basically #3 in prime. Adult swim was still #1 18 to 34. CNN is still the destination [ph] for breaking news and leader in mobile. If you really go from that in the ratings performance, it's been a little weaker in the acquired programming, not just at Turner but, really, in all basic cable networks. The originals are doing well. We mentioned on the call that the new originals we've launched this year are up 20% or more over the season -- all the originals are up 20%. So it's coming around. In 2014, we're ramping up the original programming. I think we've said this publicly. We've been around 20% of the air [ph] time original. We're heading to 40% in the next year. So we're going to still have very strong acquired programming, but it will be a smaller piece of the schedule. I think I've said on numerous calls in the past that our access to acquired programming is an advantage, even though acquired programming as a general category is going a little weaker in basically all GE cable networks.


Our next question here will come from Ben Swinburne from Morgan Stanley.

Benjamin Swinburne - Morgan Stanley, Research Division

Jeff, since you've taken over as CEO, you've gone through shrinking the company down and clearly, based on your prepared remarks, you see a strategic advantage in being a more nimble, focused company. Does that reflect a view that there is a disadvantage or dis-synergy in size and complexity? And I'm wondering, when you look at M&A and consolidation in the space either as a seller or a buyer, are you -- is there a general reluctance at Time Warner on the board level to sort of take on large-scale M&A because of just the view that it actually hurts the business outlook?

Jeffrey L. Bewkes

No, I think you got to -- you can't make a general statement. I think we've said and I think it's pretty clear, we have leading scale in all of our businesses. So we're not subscale. We're not lacking something that we need. And the next question, it's not that it's ever a bad thing, necessarily, to add something that would bring either complementary fill-ins and maybe more scale in a given case, maybe more efficiency and elimination of redundancy. Those things are all fine. But when you're looking at any particular case, you have to look at what kind of scale are you adding? Let's take Time Warner. On the studio side, we're the biggest movie producer and distributor in the world. We're the biggest producer and distributor of series in the world. We have the biggest supply relations with the American 4 broadcast networks of anybody in the world. So if you take that and you consider combining any number of other companies that do the same thing, you'd have to ask, just on that thought, we'll get to networks, is it a good idea? Does it add operating benefits, or doesn't it? So that's on that. If you go to the network side, we've got the biggest network group. We're second to nobody in the world. And if you think -- and we've got very strong networks. If you look at the Turner networks, 4 of them are 85% of our business. Basically, the Turner networks don't have any weak sisters in the group. If you look at HBO, together with Turner, it's an extremely strong network group. If you then say, "All right. Well, let's look at other networks around the world," which ones would improve the operating capabilities or the leverage or the programming capability or the distribution and marketing capability of that already strong group of networks? You can make cases depending on the hypothetical of which networks would help. You can also look at networks that aren't so strong that would not help. So you basically look at it that way. When anybody is -- and if you take a big combination, and I'm not speaking of any particular one, there are always a number of issues. There are benefits and there are risks to making any kind of combination like that. There's also the factor of business interruption, regulatory scrutiny and timings that comes into play. So I would just encourage everybody, because you're all looking at these kinds of things in more than one case, to look at all sides of the issue when you're contemplating the benefits and the risks of putting very large companies together.

Benjamin Swinburne - Morgan Stanley, Research Division

If I could just ask a follow-up. You talked about at least low to mid or better. One tool you have is the balance sheet. And maybe Howard, you'd want to comment. Like, I know it's an imperative to keep a strong balance sheet. Do you -- are you committed to investment grade? I think the answer is yes. And how high could you go and keep that kind of rating? Any comments on whether you guys would be more aggressive. And I realize you've raised it in the past?

Howard M. Averill

Yes. In setting our target, we've had a very consistent and very balanced approach. We've been very straightforward. First of all, we want to maintain a strong balance sheet that provides us stability to fully invest in our business. We want to make sure we do have flexibility to engage in strategic M&A that presents itself. And it's really important that we continue to have access to capital markets across whatever is happening in the economy. At the same time, we really are trying to optimize our cost of capital to drive equity returns. So as you know, we incorporate a number of factors into that analysis, including in our discussions -- on-going discussions with the rating agencies. You know we raised our leverage to 2.75x earlier this year. And that was to reflect an increased stability of our cash flow based on the timing [ph] spend. We're always evaluating these factors. But right now, we feel like 2.75x does strike the right balance among all of those.


Our next question will come from Vasily Karasyov from Sterne Agee.

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

I have a couple on HBO. Jeff, I wonder if you could share the feedback from HBO's distributors and their reaction to the Amazon deal. The reason I'm asking is several years ago, Starz damaged its relationship severely with distributors when it -- they were relicensing to Netflix. I was wondering what made the difference for you?

Jeffrey L. Bewkes

Okay, look. Thank you. That's a great point. I think the difference, a few years ago, what Starz did was they sold their service as a subscription service at a lower price direct undercutting their own affiliates who were their partners. It was literally the same service. The HBO deal is selling programming that's very -- classic HBO hits that are about 3 years old to Amazon where Amazon is distributing that to a lot of viewers and households that don't have HBO. So from the point of view of Amazon, it's a fantastic product offering. From the point of view of our cable and satellite and telco distributors, it's a fantastic thing because you have the resources and marketing of Amazon to a subbase that, frankly, our distributors didn't have as much penetration as they would like. So that's a great kind of partnership for our cable and sat distributors from the Amazon -- which, Amazon's a very powerful retailer. It's great to bring them into harmony with our cable and electronic distributors. Therefore, the distributors have really approved of the deal. It's actually given everybody a new enthusiasm, and particularly our underperforming affiliates, on marketing more HBO and realizing that they can do much better -- huge profit for them if they add variable subs, there's no real costs on their side. And so, what we're seeing is essentially, a regeneration of really the upside of what distributors realize they can do with HBO. Remember that one of the things that is intended [ph] to the Amazon offer, which our distributors do have, and it tends to get overlooked by everyone because it's "not new." HBO's got the strongest lineup of Hollywood movies of any subscription VOD service in the world. They're current, they're new, they're powerful. That's where you get them. HBO also has a very well-recognized original programming slate that's at the top of its game. Both of those are important. And that's going to mean a big marketing push in our cable, sat, telco distributors this fall to regenerate subscriber growth all over the HBO footprint. So what you really have is Amazon and the retail industry working together with the cable, electronics, satco industry, to bring subscription premium TV in its best form to all people in the United States. You can see us doing similar things overseas. Scandinavia is the current vibrant case. And of course, HBO, with its VOD offerings in U.K., Germany, Italy, Australia, in partnership with Sky in a number of those territories, another powerful offering for consumers. I think it's really a period of tremendous upside for HBO.

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

A quick follow-up. So clearly, HBO is at the very height of the creative cycle. Can you help us understand or map out what would be the sequence of events that would allow to translate that into possibly acceleration in subscription revenue in the U.S.? Is it renegotiating contracts? Or how does it work?

Jeffrey L. Bewkes

Yes, thank you. It's a good question. I think what you're really saying is, what can we do to improve the mix? Because you see some vibrant HBO sub growth domestically, 2 million subs that we just reported, even stronger overseas. But on the domestic side, we're constantly working with affiliates to figure out how can be better market and position the networks among our better performing affiliates. Because some of them are up in the penetration areas that are quite inspiring for everybody. But we've given them incentives to do that. And we need to work together with them to share the economics of that. If you then go to the less penetrated affiliates who are, frankly, missing a very important net operating contribution that they should have, and it should provide sufficient incentive -- we're working hard to market with them in order to get them to be more effective in their distribution of our product. That's all part of the renewal cycle. Over the next couple of years, we're going to turn over all the deals or most of the deals at HBO. We think that we've got the right mix of incentives and consequences to drive better net performance, and I don't say that in a way that would leave out profit gains for all our affiliates, including the less performing ones, but it certainly includes increased contribution to us.


Our next question here comes from Richard Greenfield from BTIG.

Richard Greenfield - BTIG, LLC, Research Division

A couple of questions. First off, just in light of the A&E and Disney OTT linear deals, we saw A&E yesterday, curious how you think about single- and multi-stream offerings. Disney and A&E seemed to have taken pretty different approaches in terms of single versus multi and wanted your perspective on either.

Jeffrey L. Bewkes

Thanks, Rich. Well, we're certainly open to opportunities to grow our business, and we're not philosophically opposed to an over-the-top virtual MVPD model. We've said that before. We just have to believe that it will be additive to the total situation that we've got, rather than subtract it. And so in the 2 that you mentioned, there's still a lot of questions in terms of the ad model, the quality of service, how it would impact investment in the plant. But take the DISH streaming service. It's a concept we're interested in, because of the way that it is designed very much targets incremental subs and at a price point that would be attractive to younger people, particularly. A similar one would be Comcast selling HBO on a lightweight TV package, which allows you to target a group of consumers that might otherwise not subscribe to the multichannel TV package. And that could be a great entrée into the ecosystem for the younger consumers, who would then trade up over time. To your point on the Disney and A&E approaches, the parameters of the offering are important to make sure that it's incremental. So the number of streams, as you're, I think, asking is an important consideration. So we can't -- we're not going to set a rule on a 5-amps call about how we're doing it, but I think that the Disney approach is kind of directionally the right philosophical approach.

Richard Greenfield - BTIG, LLC, Research Division

Just following up on that, we believe that part of why Rupert was so interested in acquiring Time Warner was he saw this as a way to launch an everything Fox. I mean, basically, an everything Fox including Warner Bros. and Time Warner's consumer offering. Could you do the same on your own? Do you look at Turner and HBO as something that you could offer directly to consumers as a package? I guess, why or why not?

Jeffrey L. Bewkes

Well, yes we could. And let me just say what we are doing. At HBO, we're investing in top talent, including a large team of software developers in Seattle that are working on HBO. And as I think you've been among several reviewers groups have said, I think, you're right. That's a very good product. It's a very good consumer experience. So what we're doing there is we're trying to be best in class to have a platform that could not only deliver HBO networks but also Turner networks and frankly, other networks. It doesn't have to be just be ones that we own. I think it's important for everybody, in thinking about that, to ask themselves, should offerings be determined for consumers based on what a company owns? That's not how consumers would program their dial. And I think one should always look at what consumers want to do and harness those platforms that keep in mind exactly the range of products that consumers want. We think that we can have that for our HBO Turner or Warner product, but we're anticipating that people will want more than that.


Our next question here will come from Doug Creutz from Cowen and Company.

Douglas Creutz - Cowen and Company, LLC, Research Division

You guys have talked about some of the ratings challenges you faced recently, but more broadly, it seems like ratings in the second quarter were pretty weak across the board. Do you think there's anything bigger going on there? Or is this just kind of normal variability in TV viewing?

Jeffrey L. Bewkes

Thanks, Doug. Well, let me note, I think you're generally right. Ratings were kind of weak across the dial -- the TV dial. Broadcast finished out 3%. Ad-supported cable was down 4%. There's some -- some did a little better, some did a lot worse. But essentially, viewing was stable but a little on the weak side across the TV dial. That, however, is before online viewing is fully captured. And it isn't really being measured. And it's not that big. But it's significant to some extent at the margin. And even though it's not being measured, a decent amount of it is being monetized. So the issue's a little overblown. If you're asking, "Do we think there's a secular trend in lower audience viewing across the TV dial?" we would say no.

Michael Kopelman

Thank, Doug, and thanks, everybody, for joining us today. If you have any questions, please follow-up. We'll be around. Thank you.


And thank you, ladies and gentlemen. This concludes today's conference. Thank you for your participation, and you may now disconnect.

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