Time Warner (NYSE:TWX)
Q4 2010 Earnings Call
February 02, 2011 10:30 am ET
John Martin - Chierf Administrative Officer, Chief Financial Officer and Executive Vice President
Jeffrey Bewkes - Chairman and Chief Executive Officer
Douglas Shapiro - Head of Investor Relations
Jessica Cohen - BofA Merrill Lynch
Spencer Wang - Crédit Suisse AG
Michael Nathanson - Sanford Bernstein
Benjamin Swinburne - Morgan Stanley
John Janedis - UBS Investment Bank
Douglas Mitchelson - Deutsche Bank AG
Tuna Amobi - S&P Equity Research
Good day, ladies and gentlemen, and welcome to the Q4 and Full Year 2010 Time Warner Earnings Conference Call. [Operator Instructions] I would now like to turn the presentation over to your host for today's conference, Mr. Doug Shapiro, Senior Vice President, Investor Relations. Please proceed.
Thanks. This morning, we issued two press releases, one detailing our results for the fourth quarter and full year, and the other providing our 2011 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 non-GAAP measures to the most directly comparable GAAP measures are included in our earnings release and trending schedules. These reconciliations are available on our website at timewarner.com/investors. Reconciliations of our expected future financial performance are also included in the business outlook release that's available on our site.
And second, today's announcement includes certain forward-looking statements, which are based on management's current expectations. Actual results may vary materially from those expressed or implied by these statements due to various factors. These factors are discussed in detail in Time Warner's SEC filings, including its most recent annual report on Form 10-K and subsequent quarterly 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.
Thanks, and let me turn the call over to Jeff.
Thanks, Doug, and good morning. The impressive results we posted today reflect the continuation of a multiyear plan we put in place a few years ago. In 2008, we shifted our focus to become a pure content company and moved to permanently reduce our cost base.
In 2009, we successfully navigated the economic downturn. And in that year, we further improved the company's operating efficiency, strengthened our balance sheet and grew adjusted earnings per share almost 30%. This last year, 2010, we significantly accelerated our pace in three important areas: Growth, investment and returns. We posted our highest revenue growth in years, and we grew adjusted operating income well ahead of plan.
We increased adjusted EPS by over 30%, putting us up 70% over the past two years. We invested substantially to strengthen the long-term competitive position and growth profile of our businesses, and we returned $3 billion to our shareholders in the form of dividends and stock repurchases. That's more than 100% of our free cash flow.
In 2011, we'll continue this course, grow, invest and return. We're even more confident, so we're going to take even more aggressive steps. This year, we intend to again deliver strong financial results. As you saw in our outlook release this morning, we expect to grow adjusted EPS in the low-teens in 2011.
Assuming we achieve that, it means we'll have almost doubled our earnings in three years. At the same time, we'll ramp up our investment in programming, production and marketing even more than we did last year. And this morning, as you saw, we announced that we are raising our dividend 11%, and we're increasing our repurchase authorization to $5 billion. That paves the way for us to return even more capital to our shareholders this year.
We'll achieve these goals by focusing on the four strategic objectives that we've discussed with you before: First, invest aggressively to use our competitive advantages in making great content; second, develop and accelerate new business models that harness technology to improve both the consumer experience and our economics; third, expand internationally in key territories; and fourth, improve both our operating and capital efficiency. For example, while we plan to invest more in our businesses this year, we'll fund that by keeping a lid on our other costs.
So what does that mean in practice at each of our four businesses? At Turner, we'll keep acquiring and developing the high-quality programming that drives audiences, bolsters our brands and attracts advertisers. This year, that means sports programming like the NCAA men's basketball tournament. It means the top original programming on cable including returning hits like Rizzoli & Isles and new shows like Falling Skies from Steven Spielberg. It means acquiring blockbusters like The Big Bang Theory and our new late-night powerhouse, Conan, which is the number one late-night talk show during the fourth quarter.
This emphasis on high-quality programming increases the value we deliver to both advertisers and to our affiliates. As advertisers shift dollars away from broadcast to seek more efficient products, they're increasingly looking to Turner. That was evident this quarter when Turner's domestic entertainment networks grew ad revenue in the high-teens organically. And it was evident in the upfront last year when Turner's CPM growth exceeded all the broadcast networks, and that's tangible evidence that the CPM gap is narrowing.
With healthy advertising climate, our strong programming lineups, the strength of our brands and the appeal of the environments we offer, we're confident that we'll post strong advertising growth again this year. Our affiliates are also increasingly recognizing the value of the must-have programming that we air. As you know, affiliate fees are one of the most important growth drivers for our company.
Lately, we've become even more confident that we will continue to post high single-digit affiliate fee growth over the next several years, and that is before all of the benefits of some of our recent investments like the NCAA kick-in. Just last month, we completed a multiyear deal with one of our largest distributors, covering some of our biggest networks, and I can't be specific about the terms, but importantly, in that deal, we're increasing our rates of affiliate fee growth even faster than the prior agreement.
At HBO, we'll continue to invest aggressively in our content too. In 2011, we'll air 12 original shows, up from 10 last year. We'll bring back True Blood, Boardwalk Empire and Entourage, which ranked among the highest rated original shows on cable. Among other new shows this year, in the spring we'll debut Game of Thrones, based on the popular fantasy novels, which we expect will be another big hit. At the same time, this year, we'll continue making progress in rolling out TV Everywhere at both Turner and HBO.
Turner ended 2010 with TV Everywhere versions of our networks available to over 45 million households. And by the middle of 2011, we expect to have agreements covering 70 million homes. HBO GO is now available to over 40% of its subscriber base and is on track to be available to the overwhelming majority of its subscribers in the next few months.
We'll also keep expanding internationally at our Networks businesses. At Turner, our international operations grew to 18% of revenue in 2010. That's up from 15% in 2009, powered by strong growth in Latin America and in Asia. You may recall that on our Investor Day in May, we set a goal that international would reach 20% of revenue at Turner over the next few years. We now expect to exceed that target.
At HBO, we continue to experience strong growth internationally as well. International subscribers grew over 10% in 2010 to 43 million, and in 2011, HBO will increase local production internationally and continue to roll out new features like high-definition, On Demand and GO.
When including our majority on joint ventures at HBO, our combined international network businesses generated nearly $2.5 billion of revenue and around $500 million of adjusted operating income in 2010. Based on current trends, over the next four years, we expect to double operating profits from our international networks to $1 billion.
Okay, let me turn to Warner Bros., where we're also stepping up our levels of investment. We are excited about our theatrical slate in 2011, which includes event films like the finale of the Harry Potter franchise, Green Lantern, Happy Feet 2, The Hangover 2 and the next Sherlock Holmes. As you know, we're focusing even more of our resources on event films. Warner produces more of these films each year than any studio, and it distributes them better than any studio. Importantly, event films also tend to be more consistently profitable for us than smaller movies.
We are also increasing our investment in TV production in 2011, both domestically and internationally. We see very strong secular dynamics for TV production in the U.S. Broadcast networks are funneling retrans payments back into programming investments. There's growing demand for original cable series, and we've seen record prices for the top shows coming off broadcast in the syndication. This year, we'll ramp up the development of new shows for broadcast, particularly comedies, and we'll increase production to meet the demand for original cable series. We're expanding our local production capabilities internationally. There is rising demand for local production globally, and building this infrastructure will also enable us to export successful shows and successful formats around the world, including back into the U.S.
Last year, we acquired Shed Media, one of the largest independent production companies in the U.K., and we'll keep looking for ways to expand our capabilities. At the same time, Warner Bros. will be at the forefront of accelerating the digital transition in film. It's arguably the area of our business that's going through the most change right now. There are risks associated with that, but also a lot of opportunity. As you know, we've been pushing to create windows that advantage our most profitable channels and to increase the appeal for consumers to buy and to rent movies digitally.
This year, we plan to launch a premium VOD offering that will enable consumers to watch movies in their homes 60 days after theatrical release. We'll begin offering it in the second quarter and expect it to be available through all major distributors by year end. Another important initiative for us this year is UltraViolet or UV for short. As a reminder, UV will allow consumers to buy movies or TV shows via download or in physical media and then watch them through a broad array of apps and devices wherever and whenever they want.
At CBS last month, we announced that in the second half of this year, all theatrical new releases from Warner will be UV-enabled along with those from Fox, Sony and Universal. If the industry executes it right, UV should dramatically boost the appeal of owning movies.
As we push to accelerate the digital transition, we'll also look at the economics of the entire home video category. We're rethinking how much we extract from some of these new distribution channels. For instance, this year, we'll determine whether to lengthen the window for Netflix and Redbox, and how much the increase what we charge them for our DVDs.
Turning to Time Inc. Although the environment is still challenging for print magazines, we intend to grow profits again in 2011. Our first priority is to drive top line growth. That will require strong execution in traditional areas like circulation and ad sales, but will also come from new areas of focus like marketing services and e-commerce. At the same time, we'll remain focused on our operating efficiency. We'll also keep investing to develop new tablet versions of our magazine brands. We're quite proud of what we have out there so far. As we have discussed with you before, we're very optimistic about the tablet opportunity. It's a great experience for our readers and a rich environment for our advertisers.
For digital magazines to take off, we need to offer consumers the flexibility of purchasing single-copy digital issues, having digital-only subscriptions and having a content everywhere approach that allows us to offer dual print and digital subscriptions. And it's critical to the long-term health of our business that we can do that while also retaining the customer relationship and the data of what they are using and what they like. We've had constructive discussions with a number of tablet manufacturers, and we're confident we'll be able to offer consumers the flexibility they want across a wide variety of tablets this year.
I'll wrap up before I hand it off to John. When I became CEO three years ago, my goals were to refocus Time Warner into the premier global content company and to improve shareholder returns. We've made a lot of progress towards those goals over the last few years, and I'm excited about our momentum heading into 2011. But in many respects, I think we're still in the early part of this process, and there's a tremendous amount of opportunity in front of us. This is a time of significant change in the media industry, but I'm confident more than ever that we are well positioned to benefit as shifts in technology increase the demand for our content, both in the United States and around the world.
With that, I'll turn it over to John.
Thanks, Jeff, and good morning, everyone. I'm going to begin by referring to the first slide, which is now available on our website. And as Jeff just said, last year, we accelerated the pace of growth, investment and returns. And this year, our plan is to make even more progress and be even more aggressive in pursuing those goals.
Financially, that means in 2010, we delivered 17% growth in adjusted operating income and more than 30% growth in adjusted EPS. This growth rate beat our most recent outlook and was well ahead of our initial outlook at the beginning of 2010 of mid-teens growth. To put this in perspective, we've grown adjusted EPS, as Jeff said, 70% in just the last two years. And at the same time, we've been fully investing in our businesses.
Last year, we increased our investments in programming, production and marketing in the high single digits, and we reallocated resources away from less productive areas like G&A. That investment will drive long-term growth for the company, and we did that while continuing to maintain very high levels of returns on invested capital.
As we discussed with you on our Investor Day in May, we consider returns on invested capital or ROIC to be an important yardstick of our performance and an important tool in making capital allocation decisions. The way we look at it, which excludes certain purchase price adjustments, our ROIC increased to 20% in 2010, and that's very good. And reflecting our commitments to improve shareholder returns, we've also stepped up our returns of capital, increasing both our dividend and our share repurchases. When taken together, we returned more than 100% of our free cash flow last year.
This year, our outlook calls for low-teens growth in adjusted EPS. And as Jeff mentioned, that means that if we achieve this year's outlook, we will almost doubled our adjusted EPS over a three-year period. This outlook reflects our plan to increase investments in programming, production and marketing, but to restrain overall expense growth, we're going to continue to keep a lid on other costs. Also reflecting our commitment to returns, our board recently authorized both an increase in our annual dividend to $0.94 per share and an increase in our share repurchase authorization to $5 billion.
Turning to the next slide, which shows consolidated fourth quarter and full year financial results. For the full year, revenues grew $1.5 billion or 6% year-over-year. That's our highest growth rate since 2004. Revenues were up nicely at most of our divisions, with increases across subscription, advertising and content. The largest portion of that increase was in subscription revenues, driven by an 8% increase at our Networks segment, and that was due to a higher affiliate fees at both HBO and Turner.
Advertising revenues grew even faster, up 10% for the year, and the vast majority of that growth came from our networks as Turner saw a big rebound in advertising growth for both its domestic and its international networks. Publishing advertising also increased for the full year as the print advertising environment stabilized. And content revenues were up nicely as well as in 2010, and that was primarily due to stronger television product at both Warner Bros. and HBO, as we benefited from our increased investments in high-quality programming there.
Continuing down the income statement. Overall operating expenses grew only in the low single digits, and that reflected significantly higher spending on programming, including originals and sports, TV and film production and marketing as I mentioned. But we funded that by lowering the rest of our expenses. So as a result, we were able to grow adjusted operating income nearly 3x as fast as our revenue growth, with margins expanding close to 200 basis points.
Looking very quickly at the quarter, we had a strong fourth quarter. Revenue growth accelerated to 8%. That was our highest growth rate in the last three years. Advertising revenues were particularly strong, up 13% in the fourth quarter, and that was our highest growth rate of the year. Adjusted operating income grew 14% as expenses, again, rose more slowly than revenue. And adjusted EPS grew 22% year-over-year in the quarter, and that growth rate was helped by having fewer shares outstanding due to our ongoing share repurchases.
Turning next to our divisional results, and let me start with our Networks group, where 2010 was another terrific year. We grew revenue double digits, and along with ongoing expense control, that led to growth in adjusted operating income of 18%. And both HBO and Turner recorded their highest annual revenues and profits ever. The fourth quarter was particularly strong, with revenue growth accelerating sequentially across HBO and Turner.
I'll remind you that this year, we had some transactions that benefited growth, and those included international transactions, as well as Turner assuming management of Time's digital sports properties. If you were to look through those, organic advertising growth accelerated to 12% in the fourth quarter.
Domestic entertainment networks, together with kids and young adults, grew advertising strong double digits in the quarter, and that was offset by mid-single-digit declines at domestic news. At our international networks, organic ad revenue growth was in the high single digits in the quarter. And for the year, organic international advertising revenue was up high-teens, and adjusted OI margins expanded by 400 basis points.
Looking to the first quarter, domestic scatter pricing remains very strong, up solid double digits over the upfront; and cancellations have remained extremely low, which is yet another positive sign as we enter the new year. Also recall that this is the first year of our coverage of the NCAA men's basketball tournament. So in the first quarter, we expect to see a significant boost in ad revenue. Advertising trends were also very positive at our international networks.
Looking over at subscription revenues, they continue to show nice growth in the fourth quarter, increasing 9%, and there was about 200 basis points of that growth coming from the consolidation of HBO Central Europe. Over at HBO, as we expected, we ended the year with our domestic subscriber count lower by about 1.6 million. And as I outlined in detail on our last earnings call, these declines were primarily tied to two distributors and were mostly non-revenue-generating subscribers, so they had little to no financial impact, and HBO still grew domestic subscriber revenue in the mid-single digits year-over-year in the quarter.
Moving on, our programming lineup at HBO drove content revenues higher for both the quarter and the year. And in the quarter, that related primarily to the home video release of The Pacific and the international licensing revenue for Boardwalk Empire. Adjusted operating income at the Networks group increased 20% in the quarter, as margins expanded 140 basis points year-over-year. As planned, our programming expenses were up 9%, and that was mostly due to increased originals and sports programming. But for the full year, programming expenses were up only 5%.
For 2011, our investments in the NCAA men's basketball tournament is a clear example of how we're investing to drive growth, and we're actually more enthusiastic about the deal now than when we signed it. Both the partnership with CBS and our initial ad sales have exceeded our expectations. As you know, the basketball contract will be a modest drag on network profitability in 2011 that will mostly hit in the first quarter of the year. And given its impact, networks' adjusted operating income is likely to be up only modestly in the March quarter, but we expect it to be very profitable for us in the coming years, and we fully expect it to be a key growth driver over the long term. Even when you consider the NCAA impact, however, we expect 2011 will be a great year for our Networks group, and we see continued growth in our subscription fees. We're optimistic about our advertising environment, and we expect strong growth from our international businesses, so we anticipate very, very attractive profit growth for the full year.
Moving over to film. Warner Bros. had a terrific year in 2010, with its profits falling just short of the record levels achieved in 2009. And this year, as Jeff said, we have a terrific film slate ahead of us, and Warner Bros. should benefit from releasing the last two films in the Harry Potter franchise on home video later this year. 2011 will also be a big year for Warner Bros. TV production, which has maintained its position as the leading supplier of network television content, and we'll benefit from a syndication pipeline that includes the off-network availability of The Big Bang Theory.
The performance of our Games business should also improve in 2011 versus 2010. The release slate this year includes Batman: Arkham City, LEGO Star Wars 3 and Mortal Kombat 9. Taking all this into consideration, we expect Warner Bros. will have its highest profit year ever in 2011.
As you think about this year's quarters, however, keep in mind that film profitability will likely be weighted towards the second half of the year, and why is that the case? That's due to tough comparisons in the first quarter wherein last year's first quarter, we had a huge growth rates year-over-year, and it's also due to just the timing of our theatrical and home video releases this year.
Moving on to Time Inc., which is on the next slide. Despite a still challenging operating environment, publishing posted great profit growth in the quarter and for the year in 2010. Advertising revenues were up 3% for the year. As anticipated, they declined slightly in the quarter, and that was due to the impact of transferring management of SI.com and Golf.com to Turner in the fourth quarter. If it were not for this transfer, during the quarter, ad revenues would have been up slightly year-over-year. And as we look at the first quarter, for the moment, of this year, overall advertising trends are relatively consistent with what we saw in the fourth quarter of last year.
Subscription revenues were down 7% in the fourth quarter, and that was due largely to softer trends at newsstands. However, we expect subscription revenue fundamentals to stabilize this year and improve as the year progresses. Adjusted operating income was up 63% in the fourth quarter, and margins expanded 700 basis points. This is the fifth consecutive quarter of year-over-year margin improvement at Time Inc., and note that this included the impact of about $40 million in restructuring costs, and that compares throughout $90 million in the fourth quarter of the prior year.
For the year, operating expenses declined by about $300 million, and they are now down nearly $900 million over the last two years. We anticipate overall cost this year at Time Inc. to be relatively flat as compared with what they were last year.
Moving on now to the next slide, which has our 2011 outlook. We expect revenue growth this year to remain very strong, and that's due to current trends in the advertising environment, an expanding programming lineup, healthy and consistent subscription revenue trends, and a higher content revenues led by TV licensing and games. We also anticipate significant growth from our international operations.
As I previously mentioned, we're going to continue to invest fully in key growth areas across our businesses, while keeping a lid on overhead expenses. From a P&L standpoint, what does that mean? It means that in 2011, we expect expense growth in areas such as programming, production and marketing to be up in the high single digits, and that includes the impact of the NCAA. But we expect all other operating expenses to grow at a much, much lower rate.
This is all reflected in today's outlook. As you saw in the release, we expect full year adjusted EPS to increase in the low-teens, and that's off a base of $2.41 from a year ago. Last quarter, we mentioned that due to proactive tax planning and a larger share of our earnings coming from international operations, we expect that our effective tax rate to be around 37%. I'd add to that now by saying that due to the recent tax legislation that occurred in December, we now expect it to be a little bit lower than that, possibly around 36% in 2011.
Turning to the next slide, which looks at free cash flow. Our businesses continue to convert at high percentage of profits into free cash. For the year, we generated approximately $2.7 billion of free cash flow, and that was burdened by a significant increase in working capital, which included $250 million in payments related to the resolution of litigation, as well as a $70 million prepayment to the NCAA. As we move forward, we don't see any change in the capital needs of our businesses; and therefore, we anticipate that we'll continue to convert a significant amount of adjusted income. Our conversion could be down somewhat in 2011, however, and that would be due to timing of our investment spending in programming and production, as Jeff described, as well as higher year-over-year cash taxes. We anticipate that conversions will trend higher over the next several years, as our near-term investments in content pay off.
And moving on to the last slide, which is our final slide, and it looks at our net debt. We ended the year with about $12.9 billion in net debt, and that was up about $1.4 billion compared to the end of 2009 and up slightly compared to the third quarter.
During the past two years, we've invested in our businesses while improving our balance sheet strength and preserving overall flexibility. To put this in some perspective, in 2009, we used the dividend from Time Warner Cable to pay down $6.6 billion of debt. And in 2010, we took additional advantage of the low interest rate environment to extend the maturities of approximately $5 billion of our debt and reduce future interest expense. At the same time, we deployed excess capital to reduce our cash balances and improve our balance sheet efficiency.
The significant majority of the excess capital we have deployed has been used to provide direct returns to shareholders. In 2010, we returned about $3 billion of capital directly through increased dividends and share repurchases, and we also spent a little more than $900 million in M&A activity in 2010, most of that was invested in international cable networks and video game companies, both of which are areas of strategic importance for the company.
Our continued commitment to provide returns to shareholders is evident in our board's decision to raise the annual dividend and to increase the amount available under our share repurchase program. This year, our philosophy towards managing the balance sheet will not change, but our approach rather continues to evolve. In an effort to improve shareholder returns, this year, we will likely move leverage up somewhat closer to our target of 2.5x, and that's up from around 2x today. Right now, we would expect to do that through increased returns to shareholders, and if they arise, targeted M&A opportunities. At the same time, we're going to continue to maintain a strong balance sheet that provides significant flexibility and a solid credit rating.
So with that all being said, now let me turn the call back over to Doug, and we'll be ready to start the Q&A portion of the call.
Thanks a lot, Michael. Can we get the Q&A started? [Operator Instructions]
[Operator Instructions] And your first question comes from the line of Spencer Wang of Credit Suisse.
Spencer Wang - Crédit Suisse AG
First question is for Jeff on the TV Everywhere deal you signed with Comcast. I was wondering if you could just expand and talk about if Turner was compensated explicitly for the TV Everywhere rights, or was it perhaps just reflected in the accelerated affiliate rate growth you mentioned? And the secondly, Jeff, I was hoping you could expand about on the topic of increasing the prices for DVDs you charge Redbox and Netflix, and how you see that evolving.
On the Comcast Turner deal, which we announced yesterday, it was a pretty wide ranging deal that included some of our biggest networks, including CNN. And the short answer to your question is we don't separately price or bill for TV Everywhere. We think this is part of the overall definition of any TV network, and basically along with multiplex, high-definition, VOD and now TV Everywhere. It's part of the pricing that goes across the networks, across the sub basis, across devices, across platforms. So we're very pleased with the deal we struck. We think Comcast is also. And it really does support our expectation that both John and I said very clearly that we're going to continue to have very attractive affiliate fee growth in the future, and this deal supports that. Now in terms of the second question, which is what are we thinking about and why are we re-evaluating the Netflix, Redbox. Think of it as a subscription service or the economy subscription service business and how it relates to all of our different windows. We're very happy that the window that we've got on DVD, it's currently 28 days, if not current. We think it's better to have the window than not have the window in terms of supporting higher-priced DVD sales, electronic sell-through and rental and VOD. But it's getting kind of clear that the acceleration in consumer usage of these kinds of services, including Netflix, makes it a good time for us to re-evaluate the terms. And in our view, the current pricing and window are not really commensurate with the value that those kinds of availability of our films are extracting. So we can't really be more specific at this time. We just think that the value that film companies or our company should get for that period of exhibition is considerably higher than what's there now.
Your next question comes from the line of Doug Mitchelson of Deutsche Bank.
Douglas Mitchelson - Deutsche Bank AG
Time Warner's occasionally mentioned to the press as a bidder on international media assets, you viewed one of your four goals is to expand internationally. Would you say you're seeing more interesting M&A prospects internationally today? And can you put more meat on the bone related to international expansion desires, given it's one of your four core goals.
I'll start. John may want to fill in. As we said on Investor Day, we think there's some great secular growth opportunities out there. Among them certainly in the lead would be cable networks. Local TV and film production is included, and not all the places, of course, offer the same opportunity. We have to consider the growth in certain sectors like cable networks even in Western Europe are actually still going pretty strongly, so are games. And in the developing market, there's basically growth across the media sector almost in every part of the sector. We tended to focus, and we've said this on our Investor Day, on Latin America right up through Mexico, Central and Eastern Europe and India as places that we think have attractive growth dynamic, hospitality to international investors and networks and media companies, and a commitment to the rule of law that allows media to function well. That's essentially how we've been looking at the world. The numbers we gave today where we’re going to increase dramatically, and we think double our earnings over a period of just a few years. That's for our existing networks and investments. And I wouldn't want to re-emphasize whether it's the Turner, HBO, Warner channel group across Latin America, which is the number one group for that entire region. Whether it's HBO's networks in Central Europe, Latin America or Asia, all of which are number one in their markets. Whether it's our investment in CME, which we think will increase its competitive position across Eastern Europe, the places where we already are are pretty strong. And we see opportunities, and we'll be fairly disciplined about those for us to get in market-leading positions further in those markets, networks, local production, including TV formats that can be used across the world. And basically, that's how we see it. We think it's an attractive opportunity.
I don't have much to add other than I think the numbers are bearing it out. I mean, if you look at the revenue growth rates internationally versus the overall company in 2010, they essentially grew at twice the rate, and that was true in the fourth quarter. It was true for the full year. And if you look at the organic growth rates at the networks, which is some of the fastest-growing areas and where we've been investing new money, we had organic growth that was in the high-teens, and we expect 2011 to be another terrific year.
Your next question comes from the line of Ben Swinburne of Morgan Stanley.
Benjamin Swinburne - Morgan Stanley
John, thanks for all the data points around return of capital. A couple of just clarifications. I think to get towards 2.5x, the buyback would have to be pretty significant this year. And in general, buyback and dividends would again be over 100% of free cash flow. I don't want to put words in your mouth, I just want to throw that out there. And the one missing piece, you touched on it briefly, but working capital was a big use and impact that calculation. It was a big use in '10. Do you expect '11 to be another sort of $1 billion year plus use on that line item? And then maybe more of a strategic question for Jeff. A lot of the distributors have started to roll out these low-end TV essential digital economy packages, and whether it's Netflix cord cutting or the economy, million of multi-channel subs aren't really growing anymore. So there's probably an argument to be made at least in the short term that a low-end package makes sense. How do you as a programmer and as a company that generate significant earnings from fully distributed networks think about those low-end packages, and how you sort of make your content available to those?
I'll start, and I think you had two questions in there. I'll probably take it. The first is as a quick answer to your question, without putting words in my mouth, it's yes. If you look at the math that it would require in order to lift the leverage ratio from around 2x to 2.5x, we have excess capacity that would be in the billions of dollars and would indicate that utilization of that capacity would be higher this year versus last. And as I said in my proactive remarks, that would be some combination of direct returns, and if opportunities arise and we're applying the same discipline and filters that we have over the last few years as it relates to M&A, but if opportunities arise, we'll reduce the target and M&A as well. But absent those opportunities arising, you would expect the pace of our repurchases to go up. Second question is on free cash flow. Again, what I would basically say is that we would expect in 2011 though our conversion percentage is going to dip a little bit versus 2010, there's nothing systemic or structural in that. It's the timing of payments related to investments that we're going to be making, and then we would expect the conversion to go right back up beyond '11. The materiality of the conversion decline also is not expected to be all that much, but we just wanted to at least give you a sense of the direction.
So I guess it’s question three is lower price packages will come from the cable industry. Basically, we don't expect any material impact from these. These packages are usually not very attractive even relative to other low-cost packages in the market. And similar packages like this, which are a good thing for the industry to offer in case consumers, probably small groups of consumers want to avail themselves, it just haven't received traction in the past. And so without getting into too many specifics about it, our distribution contracts have terms and conditions that would limit the potential penetration of this kind of a package. So it's not a concern for us, and as the distributors do this for certain consumer groups, we basically have to be carried on the most wide distributors here. So we don't anticipate any particular effects, certainly not a negative effect from them.
Your next question comes from the line of Michael Nathanson of Nomura.
Michael Nathanson - Sanford Bernstein
I have one for John and one for Jeff. John, I wonder if you could just help us with 2010 affiliate fee growth. It was up 8%. I wonder if you could separate out your organic growth rates for HBO and for Turner.
You want me to answer that before you ask the second?
Michael Nathanson - Sanford Bernstein
We don't disclose separately Turner from HBO, but directionally, I can give you a sense. I mean, if you think about for the full year, we reported subscriber revenue growth of about 8%. It was almost 8.5%. It was slightly slower growth domestically versus internationally, and there was about 200 basis points in there related to the international acquisitions. The most significant one in there is HBO CE. And I think organically, we had strong growth at each of Turner and HBO for the year, and there wasn't a big difference in the growth rates in 2010 between the two groups.
Michael Nathanson - Sanford Bernstein
And then for Jeff. Phil Kent I thought made some pretty good comments last time he spoke, it was early in January, about his interest in buying TV shows that have been widely run on, on the web like Modern Family. I wonder after he said those comments, have you heard at all from some of the guys who supply those TV shows, and whether they acknowledge that they have to change their strategies in order to sell more TV content going forward?
I think I'll speak for our company rather than others. Whether it's us on the selling side at Warner or us on the buying side at Turner, it's becoming pretty clear that the big value in TV licensing, both the value to consumer, so that for network you want to bid for and offer it on your channel, that would be Turner or the value that comes from that with pretty high or actually increasing syndication prices that go to licensors like Warner, it makes no sense to take those rights that are sitting, let's say, a big show like The Mentalist coming on to TNT and have it in another place where the sprockets running off of it. So what happened of course is that our networks aren't licensing anything, because remember, when a show now, even a show off network, a syndicated show, if it goes on TNT or CBS or truTV, it's going to be available to our viewers four or five episodes on a free On Demand basis. If you've got the networks, you've got that show, and you can keep up with the show on any device. You can watch it on your iPad, you can watch it wherever you want and you don't have to pay extra for it. As every network in the country moves to that model, people are not going to want to pay extra for some subscription service when they've already got all these shows. And by the same token, really powerful networks like TNT buying themselves to ours. They're not going to pay big money for those shows if the shows are somewhere else being sold at a bargain basement rate. So I think it's pretty clear that value of syndication rights are going up because TV Everywhere is making things more valuable and more useful to consumers. And the windows are going to have to be clearer as to when these things go into, let's call it, end-of-life unlimited sprockets running off kinds of exhibition.
Your next question comes from the line of Jessica Reif Cohen of Bank of America Merrill Lynch.
Jessica Cohen - BofA Merrill Lynch
Also one for Jeff and one for John. Jeff, as you think about the evolution of distribution, can you walk us through how you're thinking about potential HBO models. For example, would you or could you move it to a basic tier, or would you offer HBO GO or some form of it to non-pay TV subscribers?
No. So HBO, if you think about it, which is about a third of the people in the country currently gets. It's available with 10 or 15 multiplex channels, it's high-def, it's going to be 3D, it's now going to be On Demand, on broadband on every device. So all of that is there for HBO subscribers. It's really one service. It's a programming environment. And as a viewer, you know that you may want to watch this show on HBO and not that show. So we're not going to breakup the network, either as a service from show to show. We're not going to turn it into a -- it's not advertising supported, so it doesn't look for kind of mass audience. So what we really have now is first is that HBO GO is through its subscriber base and it's just becoming, as it has in VOD, ever more valuable, ever more useful, ever more easy for you as an HBO sub to get and watch your favorite show whenever you want them, whatever device that you have. If you go to the specific question that you asked about whether we'll make a direct to consumer product separate from the package it's currently in, we do have the ability to do that. It's not something we're about to do today. We have a very good relationship with our distributors. There's significant benefits in that for our distributors marketing it, doing customer service, providing the infrastructure both the VOD streaming along to your set-top and your big TV and the internet infrastructure that supports broadband delivered to your house. These are not small items, and I think everyone has to think carefully about what is needed to maintain the capability of the broadband infrastructure to deliver video because what we're talking about here with TV Everywhere and HBO GO is a massive increase in the amount of video that American consumers are going to be able to have at no extra charge. That needs a strong plan in the cable, telco, satellite companies to support that capability.
Jessica Cohen - BofA Merrill Lynch
And then, John, I guess similar to Doug's question but really closer to home. The highest return in invested capital division to you guys is cable network. So as you think about opportunities and given your flexible balance sheet, would you want to add more to cable networks, or is there something you can acquire or invest in on the film and entertainment side that would actually drive those returns higher?
I think the answer could be either or both, depending on the particular situation. I think the organic returns in the Networks business, you're absolutely right, it's the best business we have. It's we believe arguably one of the best business models in the entire media industry. And notwithstanding the fact that we've been ramping up programming investments, the returns are staying at very, very high rates because the revenues are growing at very fast rates too. So in the past couple of years, few years, we've been investing to grow our scale positions internationally, and we're going to continue to look, as Jeff said earlier, at more and more opportunities to do that within targeted parameters. I think more broadly, we do think there are opportunities or there may be opportunities over time to gain scale domestically horizontally by adding to our footprint with domestic cable networks. But that really comes down to what is the available asset and then what is the price paid. You can drive your returns into a ditch pretty fast if you overpay. So I think there, it would have to be opportunistic and a prudent allocation of capital. And then on the film side, I think our film group probably has at or near the highest returns in the industry is our guess, and given their lead position every year, year in and year out, their profitability would seem to support that. And, yes, we've been investing in the film business, and we would certainly entertain incremental investments wherever they make sense.
Your next question comes from the line of Tuna Amobi of Standard & Poor's Equity Group.
Tuna Amobi - S&P Equity Research
I have one for John and one for Jeff as well. So, John, when I look at your outlook, which is low-teens EPS growth, which is I guess pretty impressive. In the context of what you've done in the past, one of the charts you put up on Investor Day showed a double digit. I think it was 11% growth in adjusted operating income. But I think one of the trends that seems to be occurring is that free cash flow, while it's still very significant, seems to be actually going the other way. It's kind of down slightly last year, down significantly versus 2008. So the question is, at what point do you expect some kind of convergence in the operating income and free cash, which I think some of your peers actually are looking at double-digit free cash flow growth, and I realize that some of that had to do with working capital trends that you mentioned. So some color around that would be helpful.
I can start there, and I appreciate the question. I mean, a few things around that. First of all, '08 is hard to even look at our free cash flow numbers because we had Cable and AOL. I think '09, we had very, very strong, frankly, even higher than we anticipated free cash flow conversion. And I think it was very, very high based on historical standards. And in '10 versus '09, bear in mind that we had a $250 million payment that we made to settle litigation, and we had a $70 million prepayment related to the NCAA. So those are notable working capital adjustments, coupled along with higher cash taxes, that if you just look at the working capital of those two items, year-over-year we would have been up versus down free cash flow. And I mean, frankly, this is not to say that we don't pay attention to free cash because obviously we do. It's just harder to look at any one year-over-year growth comparison because I think the nature of the working capital adjustments are going to bounce it around. But when you look at the characteristics that underlie our businesses, if we can continue to grow revenue and earnings, the free cash is going to be there, and we feel very strongly about that. Our capital intensity in the businesses are not changing. We have very low CapEx. That's not going to change, and so I'm not that worried about it. I think this is going to be very, very attractive free cash flow story.
Tuna Amobi - S&P Equity Research
And for Jeff, regarding the first-look deal with Amazon Studios, which was kind of surprising to me, given the fact that you guys are clearly the event film kings, and just some color around that, your thinking there, because I would have expected that something like that would have probably kind of fit in well with some of your specialty independent studios, which ironically you closed down a couple of years ago. So what is it that Warner Bros. is looking to kind of motivated for hearing and getting into this kind of deal, and how would you reconcile that as well with your digital distribution philosophy?
Tuna, help us out. The Amazon first-look deal, is that what you said?
Tuna Amobi - S&P Equity Research
Yes, with Warner Bros. Is that my understanding that there is a deal that you made recently with Amazon to kind of incubate some titles. And is that an experimentation or hobby? I'm trying to understand the thinking there. That was in November, if I recall.
If that's true, it's got to be pretty small because we're not even aware of it.
Tuna Amobi - S&P Equity Research
Your next question comes from the line of Richard Greenfield of BTIG.
It's Brandon Ross in for Rich. A couple of questions related to TV Everywhere and the release of the XFINITY iPad app. In terms of content depth, I was just wondering why it is that on Entourage, you could get every episode, but there's no Conan, there's only three episodes of Lopez. Wondering if we should expect a similar situation going forward, or what goal is there?
Yes. So you're asking when you have TV Everywhere rolling out on any network, which programming or how much of that programming is going to be available?
Exactly, and what's behind that decision making?
Yes. Well, our bias and aim is to have as much of it, hopefully, all of it available. So we think if its' on a network, it ought be there for you to watch on-demand, a limited number of episodes but certainly recent ones. All the originals, both HBO basically has this for all of its programming. It was the first in doing this on VOD, and it will move it to GO. In terms of basic cable networks like Turner, all our originals will go that way. In acquired series, we want to be the same, but you have to just get the rights. We believe that we will do that, and we think both Warner and Turner agree that TV Everywhere kinds of rights think of it as a four, five or six current episodes rolling will be available for everything. So I would just make a point as this thing is rolling out, HBO is probably in the lead and Turner is probably second. It really is the fastest deployment in pay TV history, far faster than VOD or DVR. And so it's getting out there in basic cable the fact that we've got roughly half the country, 70% by the spring or summer doing this, you now have to have usage and interfaces follow. But it seems to be inevitable, and it seems to be something that there's going to be tremendous excitement and as viewers get used to seeing programming this way, there's be going to be huge demand throughout the distribution plan to really expedite.
Just further along on TV Everywhere, just wondering why you think your competitors have been so slow to follow your lead, really no other basic cable networks are on the XFINITY app at all?
I thought most of them have that. We don't, obviously, manage those. I thought all of them were following that. I fully expect to say they're there.
Your next question comes from the line of John Janedis of UBS.
John Janedis - UBS Investment Bank
You guys talked about the HBO promotional subs on the last quarter's call, and I think your expected losses for the year is somewhere being down about $1.5 million. I know the difference here is a rounding error, but did it come from that promotion or paying subs, and do you expect to get that back in 2011?
It's John. Look, I'll take it. It's a rounding error. I mean, I will tell you the sub numbers for HBO came in at year end right on top of where we thought when we last disclosed, and so there's no need to sort of go through what the extra loss was because it's virtually de minimis. As we look ahead to 2011, we fully expect to see a stabilization in the HBO sub count, and we're hopeful that you see some improvement as the year progresses.
I have some interest in HBO. HBO is gaining share. Everybody pay attention. Please listen to that. HBO is gaining share in revenue. What they're not doing is giving away a lot of subs. You'll see some of their competitors do that. It won't work well for them in the long run. HBO's gaining share on the subscription side, and it's gaining share on the content revenue side. It's going to lead to continued strong earnings growth.
And look, I mean, on the $1.6 million, just to repeat again, they were overwhelmingly non-revenue-generating subs, and you saw the continued strength in the sub revenue, and that's really what we pay attention to. And the sub counts you’ll see from some of the competitors that are fixed rate deals are sort of irrelevant.
John Janedis - UBS Investment Bank
And then just from the TV Everywhere platform, when will the viewers there be measured similarly to linear viewers from an advertiser perspective? Is the Nielsen have it ready to go yet?
It's there now. In fact it’s already in place. So any viewer on three days of C-3 across any platform, whether it's VOD, whether it's on your iPad, it's all the same viewing.
So we’re at the bottom of the hour. I think we're going to cut it off there, and thank you very much for listening in.
Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a good day.
Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.
THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.
If you have any additional questions about our online transcripts, please contact us at: email@example.com. Thank you!