Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  
TRANSCRIPT SPONSOR
MF logo

Time Warner Inc. (TWX)

Q4 2006 Earnings Call

January 31, 2007 8:30 am ET

Executives

Jim Burtson - IR

Dick Parsons – Chairman, CEO

Wayne Pace – EVP, CFO

Jeff Bewkes – President, COO

Analysts

Spencer Wang - Bear Stearns

Michael Nathanson - Sanford Bernstein

Lowell Singer - Cowen and Company

Jessica Reif Cohen - Merrill Lynch

Anthony Noto - Goldman Sachs

Doug Mitchelson - Deutsche Bank

Jason Bazinet - Citigroup

William Drewry - Credit Suisse

Presentation

Operator

Welcome to the Time Warner fourth quarter and full year 2006 earnings call. (Operator Instructions) Now I would like to introduce Jim Burtson, Senior Vice President, Investor Relations. Sir, you may begin.

Jim Burtson

Thanks, operator and good morning, everyone. Welcome to Time Warner's 2006 full year and fourth quarter earnings conference call. This morning, we issued two press releases, the first detailing our full year and fourth quarter results, and the second providing our 2007 business outlook.

Before we begin, there are four items I need to cover. First, we refer to non-GAAP measures, including Operating Income Before Depreciation and Amortization, or OIBDA, and free cash flow. We use these measures when we analyze year-over-year comparisons. In order to enhance comparability, we eliminate certain items such as non-cash impairments, gains or losses from asset disposals, and amounts related to securities litigation and government investigations. We call this measure Adjusted Operating Income Before Depreciation and Amortization, or adjusted OIBDA. . Schedules setting out reconciliations of these historical non-GAAP financial measures to operating income and cash provided by operations are included in our trending schedules. These reconciliations are available in today's earnings release and on our company's website, at www.timewarner.com/investors. A reconciliation of our expected future financial performance is also included in the business outlook release that is available on our website as well.

Second, you will see a section in our earnings release that sets out a description of the basis of presentation for Time Warner Cable's financial results and operating results. On July 31 2006 a subsidiary of Time Warner Cable acquired a number of cable systems from Adelphia Communications Corporation. In addition, subsidiaries of Time Warner Cable and Comcast Corporation exchanged certain cable systems and Comcast's interest in Time Warner Cable and one of its subsidiaries were redeemed for cash and certain cable systems owned by Time Warner Cable.

Cable systems that were owned by Time Warner Cable prior to these transactions and then transferred to Comcast in the exchange and redemption transactions have been presented as discontinued operations. Those systems that Time Warner Cable owned and consolidated in its financial results, both before and after the transaction, served approximately 8.7 million basic video subscribers as of December 31 2006 and are referred to as legacy systems. The systems that Time Warner Cable acquired in these transactions, which served approximately 3.9 million basic video subscribers as of December 31 2006 are referred to as acquired systems.

On January 1 2007 Time Warner Cable and Comcast completed the distribution of assets related to Texas and Kansas City Cable Partners LP, a joint venture between the two companies. Time Warner Cable received cable systems that served approximately 788,000 basic video subscribers as of December 31 2006 in Kansas City, South and West Texas and New Mexico, which we refer to as the Kansas City Pool. Prior to January 1 2007 the joint venture was accounted for as an equity investment and accordingly, the financial results for the Kansas City Pool were not consolidated in the Time Warner Cable results. However, the subscriber information we will discuss today and shown in our earnings materials includes the subscribers in the Kansas City Pool within the legacy systems and total subscriber information.

Third, while our 2006 base year results do not include the financial impact of these cable systems, as I mentioned a moment ago, our 2007 business outlook that we provided earlier this morning includes the consolidation of the Kansas City Pool as of January 1 2007. For additional details, please refer to our business outlook release as well as the footnotes provided in today's earnings release.

Fourth, today's announcement includes certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are based on management's current expectations or beliefs and are subject to uncertainty and changes in circumstances. Actual results may vary materially from those expressed or implied by the statements herein due to changes in economic, business, competitive, technological and/or regulatory factors.

More detailed information about these factors may be found in Time Warner's SEC filings, including its most recent annual report on Form 10-K as amended; and quarterly reports on Form 10-Q as amended. Time Warner is under no obligation to, and in fact expressly disclaims any such obligation, to update or alter its forward-looking statements, whether as a result of new information, future events or otherwise.

With that covered, I'll thank you and turn the call over to Dick Parsons, our Chairman and CEO.

TRANSCRIPT SPONSOR

MF logo

Did the analysts get it right?

Wall Street hires some smart cookies. But it’s not always in their best interest to put the hard questions to management. Are YOU even their top priority?

Motley Fool co-founder David Gardner is still bullish on Time Warner. It’s up 54% since he recommended it to his Motley Fool Stock Advisor subscribers back in August 2005. Now, discover the companies David and his brother Tom recommend in their free research report “The Motley Fool's 2 Top Picks - Plus Wall Street's Dirtiest Secret.”

Read the complete report courtesy of Seeking Alpha FREE.

* Returns as of 6/12/2007

To sponsor a Seeking Alpha transcript click here.

Dick Parsons

Thanks, Jim and good morning, ladies and gentlemen. We appreciate your joining us today on our fourth quarter and full year earnings call. Let me start with the morning's agenda. First, I'll share my view on the overall company and where we're headed. Then our CFO, Wayne Pace, will briefly take you through the results for the quarter and full year. That should leave us plenty of time for your questions, and at which point in time, our President and Chief Operating Officer and Board Member Jeff Bewkes, will join us.

Let me start by saying that 2006 was a pretty good year for Time Warner. We met all of our financial expectations. Just as important, we accomplished all of our operating and strategic priorities that I laid out a year ago. That positions us for another strong year in 2007; but more on 2007 later.

Our revenues for 2006 reached over $44 billion and our Adjusted Operating Income Before Depreciation and Amortization -- or adjusted OIBDA -- including the impact of the cable systems acquired from Adelphia and Comcast, grew 11%, which was right in line with our outlook. We again generated impressive free cash flow of $4.8 billion or 42% of our adjusted OIBDA, again, right in line with our outlook.

Our adjusted diluted earnings per share for the year was $0.81, up 13% from the prior year. We achieved this growth despite the initial dilutive impact on EPS of the Adelphia and Comcast transactions.

Looking forward for just a moment, you may have seen in this morning's business outlook release, we have set a full year expectation for adjusted OIBDA growth in 2007 in the mid to high teens. We also expect to convert 30% to 40% of our adjusted OIBDA to free cash flow and we have, for the first time, provided earnings per share guidance. For 2007, we expect to generate approximately $1 per fully diluted share. I remind you that all of these expectations include the impact of the Adelphia and Comcast transactions which closed at the end of last July, as well as the dissolution of our Texas Kansas City Cable partnership with Comcast.

Now, let me turn to our strategic and operating priorities, both for last year and for the coming year. A year ago, I laid out four strategic and operating priorities for Time Warner. They included:

First, extending the leading competitive positions of all of our media businesses in an increasingly digital landscape.

Second, enhancing AOL's competitive profile and taking advantage of the strong and continuing secular online trends.

Third, improving Time Warner Cable's prospects for creating value by completing the Adelphia and Comcast transactions.

Finally, driving incremental returns to shareholders through more efficient allocation of our capital.

I'm very pleased to report that we achieved all of these goals in 2006. As we look to 2007 our priorities are a natural outgrowth of last year's successes.

First, all of our businesses remain leaders in their respective sectors, and each of them made significant progress in their respective digital strategies in 2006. For example, our Turner Networks were once again among the most-watched cable networks. TNT finished as the number one ad-supported cable network in the key total day demo of adults 18 to 49 for the fourth year in a row. CNN remains the preeminent news network, and Cartoon Network leads with both kids during the day and prime time with adults at night.

On the digital front, CNN.com is the number one online news destination, with more than 20 million unique visitors per month, and over 1.4 billion average monthly page views, which is ahead of all of its competition, including the portals. CNNMoney.com a joint venture between Turner and Time Inc. which was launched only a year ago, is already the leading standalone vertical finance site.

Moving to Time Inc., it remains the leading magazine publisher in the world in terms of readership and advertising share. One out of every two American adults reads at least one Time Inc. publication every month and its digital strategy, aimed at bringing those strong brands online, is working. Besides CNNMoney.com, SI.com now has 7 million unique visitors per month, with engagement levels on par with the online leaders. Even more impressive, People.com is the number one online celebrity destination in terms of engagement. It has over 5 million unique visitors and 350 million average monthly page use. By the way, we also own the number one celebrity site in terms of unique visitors per month and that's TMZ, a joint venture between AOL and Warner Brothers Television.

So moving to Warner Brothers, despite a record year in every category in 2005, Warner Brothers was still able to have another very solid year in 2006. For the sixth consecutive year, Warner Brothers generated over $1 billion in both domestic and international box office. Warner Home Video ranked number one in the world again, also for the sixth consecutive year. Warner Brothers Television remains the only producer to sell shows to every major broadcast network.

On the digital front, Warner Brothers has many initiatives underway, including driving the campaign for dual format high definition DVDs to several innovative digital downloading trials and agreements. We expect that all of our businesses will accomplish even more with their respective digital strategies in 2007.

Now to AOL, our second strategic priority for last year. During the year, we repositioned AOL as a primarily advertising-driven business and this strategic shift has already yielded strong financial results. AOL's ad revenue grew 49% in the fourth quarter, and 41% for the full year, to reach a total of almost $1.9 billion. For the last nine months of the year, we believe our ad growth was faster than the industry average, which of course means that AOL was taking share for the first time in many years.

We know that when our valuable tenured subscribers switch to free, we are maintaining the vast majority of their usage. We're also signing up a lot of new users. Although it's still early, we believe we're on track to reach the long-term goals we set forth last year when we made this shift in strategy. To remind you what they were: we said that we would begin to grow AOL's page use again in 2007 and that we would grow online advertising at or above the domestic industry rate going forward; and that we would grow our adjusted OIBDA at AOL.

We are successfully through the first six months of executing against that strategy, and our new management team is totally focused on laying the groundwork for continuing this success. While 2007's results rely largely on maintaining the base of usage that we already have, future growth will be more dependent on garnering incremental usage. Accordingly, AOL management is committed to insuring that the organization's composition and orientation is designed to create and deliver compelling new products to build AOL's audience and usage going forward.

Turning to our third goal last year, we completed the Adelphia and Comcast transactions. The integration of these acquired systems is well underway. Meanwhile, Time Warner Cable's legacy systems continue to perform exceptionally well. Wayne will take you through the details, but our excellent results demonstrate that our strategy of delivering innovative and compelling video, data and voice products is clearly working.

Completing the integration of the recently acquired Adelphia and Comcast properties is a key priority for Time Warner Cable in 2007. That will allow all of our new customers to enjoy Time Warner Cable's great array of products and services. At the same time, our Time Warner Cable colleagues will continue to expand and enhance these consumer offerings by once again delivering more innovation to their customers in 2007 than ever before.

Our industry-leading products are providing us with a clear advantage as competition intensifies across the telecommunications landscape. But we're not stopping there; we are continuing to invest in new initiatives that will provide the foundations for incremental future growth.

The first of these initiatives is commercial phone. In 2007, we will launch Time Warner Cable's Business Class Phone, an offering directed towards small to medium size businesses. Our management team believes the timing is right for this initiative, and we expect to launch this service in most of our legacy footprint during 2007.

The next big opportunity we see is Advanced Advertising, which we will work to develop this year. Like Commercial Phone, we believe that Advanced Advertising -- which provides greater targeting, interactivity and accountability for the advertiser -- will be a significant future growth engine for us.

The third Time Warner Cable initiative is wireless. We know that our customers are interested in mobile capabilities that would complement the services we already provide. Time Warner Cable is testing a number of wireless services to help them find out how best to meet their customers' needs in this regard.

Before I turn to our capital allocation efforts, let me tell you what I can about the process for Time Warner Cable becoming a public company. As you know, after closing on the purchase of the Adelphia Systems last July, there were two possible paths for Time Warner Cable to become a public company. First, Time Warner Cable filed a registration statement with the SEC in October, which begins the process for an initial public offering of Time Warner Cable shares. The second possible way was that Time Warner Cable could become public through the distribution of its shares currently held by Adelphia -- the debtor -- to the Adelphia creditors through a court approved bankruptcy plan of reorganization.

We have been simultaneously moving down both paths. Earlier this month, the bankruptcy court confirmed a plan of reorganization for Adelphia. The effectiveness of that plan, however, is temporarily stayed while certain creditors seek to appeal the bankruptcy court's decision. That stay is currently in place until at least February 6, and we cannot predict whether it will be extended at that time, or for how long, or the ultimate disposition of that appeal. Accordingly, we are continuing to pursue the registration statement process until the bankruptcy plan becomes effective. We are committed to proceeding on both paths to have Time Warner Cable become a public Company as expeditiously as possible.

Now let me update you on our capital allocation work. As I mentioned to you previously, we have had a very busy year on this front. We announced or closed on the divestiture of over $4 billion of non-core assets last year and we allocated more than $20 billion of capital to strategic acquisitions and investments. These included the Adelphia and Comcast transactions, and the purchase of the 50% of Court TV we didn't own.

Along these lines, we are also continuing to have discussions with Liberty regarding its ownership interest in Time Warner, including a possible exchange of a significant portion of that interest for a subsidiary of ours that contains a mix of non-strategic assets and cash. We are hopeful that we will shortly be able to reach a mutually acceptable agreement. But as usual in these types of negotiations, we do not know for sure when and if such an agreement will be reached.

One thing that is certain however is that we've already returned a significant amount of capital to our shareholders. In 2006 we paid almost $900 million in dividends and to date, we've repurchased approximately $16.4 billion of our stock. In total, we bought back almost 20% of our outstanding shares since we began the buyback program in the summer of 2005, at an average price of just under $18 per share. At current price levels, we expect to complete our $20 billion repurchase program in the first half of this year.

Going forward, we expect to maintain our targeted level of around three times leverage in order to maintain a healthy and efficient balance sheet. So as we complete the existing $20 billion share repurchase program, we will, with our board, determine how best to allocate future excess capital.

Summing up, we believe that all of our hard work against these stated priorities in 2006 have contributed to improvements in our stock price. But if there is one takeaway from this call, it is this: although we are pleased to have finally seen some meaningful gains in our share price, I know I speak for our board and all of our senior management team when I say that we are far from satisfied. For us, the fundamental task going forward is to build and continue to build incremental shareholder value from these levels.

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

Wayne Pace

Thank you, Dick and good morning, everyone. As usual, the slides that I'll refer to this morning are now available for you on our website. This first slide highlights our results for the fourth quarter and for all of 2006. Fourth quarter revenues climbed 8% over the prior year to $12.5 billion and this reflects growth at the Cable and Networks segments. Adjusted OIBDA grew 13% or approximately $350 million to $3 billion. This was driven by increases at Cable, Networks and at Publishing. Full year revenues increased 4% to $44.2 billion. Adjusted OIBDA grew 11% to $11.1 billion which was in line, as Dick said, with our full year guidance. Margins expanded nicely, increasing close to 150 basis points over the prior year.

2006 full year diluted EPS was $1.21. This is compared to $0.54 for 2005. Both 2006 and 2005 had a number of items that affected comparability and the more significant ones are listed here for you. 2006 income included approximately $1 billion in pre-tax investment gains related to the sales of the company's interests in Time Warner Telecom and Warner Brothers Australian theme parks, as well as $769 million in pre-tax gains on the sales of AOL's Internet access businesses in the United Kingdom and France.

The 2006 tax provision includes approximately $1.4 billion of tax benefits related primarily to the realization of net capital loss carryforwards connected to these asset sales, as well as the reversal of a tax reserve, as discussed more thoroughly for you in the earnings release. These gains were offset in part by $705 million in net expenses related to securities litigation, including the establishment of an additional reserve of $600 million in the fourth quarter related to the remaining securities litigation matters. In addition, 2006 included a $200 million non-cash goodwill pre-tax impairment charge to reduce the carrying value of the WB Networks goodwill.

In 2005 there were several pre-tax items affecting comparability, including $2.9 billion of net expenses related to the securities litigation and government investigations. This was offset partly by a $925 million gain on the sale of an investment in Google as well as $423 million in tax benefits. These items had the effects of raising our earnings by $0.40 per diluted share in 2006, and lowering our earnings by $0.19 per diluted share in 2005. As a reminder, items affecting both years are detailed in our earnings release and trending schedules.

Adjusting for these items, 2006 full year EPS increased $0.08 or 11% compared to the prior year. The improvement in EPS was driven primarily by our share repurchase program, which more than offset the dilutive impact of the Adelphia and Comcast transactions.

Onto free cash flow. In 2006 we generated $4.8 billion in free cash flow. That's a 13% increase from the prior year. Our 43% conversion of adjusted OIBDA into free cash was at the higher end of our guidance range. You will notice here that we benefited from a swing in working capital reflecting lower payments on securities litigation, and swings in timing of cash collections and payments in the fourth quarter. This slide shows the usual detail that we give you each quarter, and as always, call us if you have questions once you've had more time to study these details.

We ended 2006 with net debt of around $33 billion, an increase of approximately $17 billion from the end of 2005; certainly big changes, but fully according to our plans for the year. This increase reflects nearly $14 billion for share repurchases, and $11.1 billion related to the Adelphia and Comcast transactions. Also included is approximately $700 million paid for the acquisition of the remaining 50% interest in Court TV.

These items were offset partly by the $4.8 billion in free cash flow that we generated, as well as net investment proceeds of $2.8 billion. These net investment proceeds included $1 billion from the sale of a 5% interest in AOL to Google; $836 million from the sales of AOL's Internet access business in the UK and France, which I mentioned a moment ago; $800 million from the sale of our interest in Time Warner Telecom, which I mentioned a moment ago; and approximately $630 million in connection with the dissolution of the Texas Kansas City Cable partnership. In addition, as Dick said, we paid approximately $900 million in dividends during 2006.

This next slide highlights the progress of our share repurchase program, which Dick updated you on in his remarks.

This next slide is our business outlook for 2007. We expect adjusted OIBDA growth to be in the mid to high teens off a base of $11.1 billion. Included in this outlook is the impact of the Adelphia and Comcast transactions on what we refer to as an as reported basis, as well as a continued strong focus on cost management. We expect to convert between 30% to 40% of adjusted OIBDA into free cash flow. As a reminder, our 2007 guidance reflects the dilutive effect of the acquired Adelphia and Comcast cable systems. We're also establishing earnings per diluted share guidance of approximately $1.

Although we're only giving specific guidance on 2007 annual results today, we should point out that we face difficult comparisons in the first quarter. Of particular note is the Filmed Entertainment segment's results. Last year's first quarter included a little more than $200 million of OIBDA contribution, primarily from the releases of Warner Brothers' Harry Potter and the Goblet of Fire and New Line's Wedding Crashers. Exacerbating the difficult first quarter comparisons are strong results last year at Time Warner Cable, which grew OIBDA 16%, compounded by higher expected costs this year related to the integration of the acquired systems. Obviously, I should point out these tough first quarter comparisons are taken into account in the full year business outlook that's on the chart here.

So I'll take a few moments now to go through the results of each of our segments, and then we will go to Q&A.

We will start with Cable, where we posted very strong operating and financial results for the quarter and the full year. Details on our full year results are in the earnings release, so I'll provide primarily highlights of our fourth quarter results. Revenues increased 58% for the fourth quarter, resulting primarily from the systems acquired from Adelphia and Comcast, as well as the continued strong growth of Advanced Services. Revenue growth in the legacy systems was 15% with double-digit gains in both subscription and advertising revenues. Total ARPU, or once again, average monthly revenue per basic video subscriber, for the fourth quarter was more than $96. That's a 7% improvement from the prior year quarter. And in the legacy systems, ARPU increased 13% year-over-year to $101. OIBDA climbed 46% for the quarter and 27% for the full year, reflecting the impact of the Adelphia and Comcast transactions, and once again, the strong growth in Advanced Services.

These were offset partially by an increase in operating expenses, primarily video programming, labor, marketing and digital phone service costs. Our fourth quarter OIBDA margin was 36%, and that's compared to 39% in the fourth quarter of 2005. This decline was expected, as a result of the lower margin systems that we acquired from Adelphia and Comcast. Since the completion of the transactions in July, our legacy systems have continued to generate margins consistent with the levels prior to the transaction. While it is still early, we fully expect to achieve margin expansions in the acquired systems as we continue to integrate these systems and drive penetration of Advanced Services.

Moving to subscribers, detailed information by subscriber category is contained on this slide as well as our earnings release. Once again, please follow up with us if you have any questions on these details.

So we will move to Film. Revenues declined 15% for the quarter, and 11% for the year, due primarily to difficult comparison to the prior year's worldwide theatrical and home video performance. As a reminder, in 2005 Warner Brothers was number one in worldwide theatrical box office, led by the fourth quarter release of Harry Potter and the Goblet of Fire. In addition, Warner's home video results benefited in the fourth quarter from releases of the Polar Express, Batman Begins and Charlie and the Chocolate Factory. Adjusted OIBDA was down 39% for the quarter and 7% for the full year. Both the fourth quarter and full year declines resulted from lower revenues, as well as higher theatrical valuation adjustments. These items were offset in part by higher contributions from television product, as well as a $33 million reduction in restructuring charges compared to the prior year’s quarter.

On to Networks. Revenues increased 10% for the fourth quarter to $2.7 billion, which included $66 million from the consolidation of Court TV. Revenue growth benefited from a 9% increase in subscription revenue, due primarily to higher rates and subscriber growth at both Turner and HBO. In addition, content revenue increased 76%, driven by the domestic cable sale of HBO's The Sopranos to A&E. Advertising revenue declined 7% for the quarter as a result primarily of the closing of operations at the WB Network in September, 2006. Advertising revenue growth at Turner was 12%, and that included 5 percentage points of growth, or $38 million, from the consolidation of Court TV, as well as year-over-year gains at the news, domestic entertainment and animation divisions due primarily to strong scatter markets.

Adjusted OIBDA increased 12% for the quarter to $861 million, as higher revenues and contributions from Court TV more than offset the increase in programming expenses at HBO and Turner. The WB Network also contributed to this year-over-year growth due primarily to the reversal of certain programming accruals. Excluding the WB Network, adjusted OIBDA growth would have been closer to 7% for the fourth quarter.

For the full year, revenues increased by 7%, and adjusted OIBDA increased by 10%. Adjust OIBDA growth was driven by higher revenues, including Court TV, and this was offset in part by an increase in programming costs, as well as $114 million in shutdown costs for the WB Network.

Moving to AOL. As we expect you know, last August we announced a strategy to shift AOL's business to one that is driven primarily by advertising. Advertising revenue grew 49% in the fourth quarter. That's the third consecutive quarter of 40% plus advertising growth. The growth was strong across all revenue sources. AOL brand advertising grew 38%, search was up 34%, and AD.com increased over 100%, including the impact of an expanded relationship with a major customer. Even without this one account, AD.com was up a very strong 43%.

This strategy shift means that we have greatly reduced our subscriber acquisition marketing spending, and are actively assisting members when they want to stop purchasing access from us, and shift to using the AOL service for free. As a result, we expected and have experienced subscription revenue declines. In 2006, fourth quarter and full year revenues declined 8% and 5% respectively, primarily due to this change in strategy. Also affecting these results were the sales of AOL's Internet access business in France and the UK, which closed on October 31 and December 29 respectively.

Adjusted OIBDA was down 3% for the year and 10% for the quarter. The adjusted OIBDA decline in the fourth quarter resulted from the lower revenues, increased traffic acquisition cost, or TAC, and higher expected restructuring charges, offset partly by lower marketing and network expenses. Included in the fourth quarter results were $179 million in restructuring charges compared to only $15 million in the prior year quarter.

The next slide depicts AOL's audience metrics. Fourth quarter domestic ad revenues less TAC were $361 million. That's up 19% from the third quarter and 39% year over year. Compared to the third quarter, unduplicated domestic unique visitors remained essentially flat at a monthly average of 111 million, and total domestic page views declined 9% to 44 billion. As a result, average monthly page views per unique visitor were 133. In addition, domestic ad revenue less TAC per 1,000 page views grew 30% from the prior quarter to $8.13, which, as we will remind you, includes the impact of advertising.com's revenue that's generated on third-party websites.

Turning to this next slide on AOL's access membership base. Once again, as a result of the strategy that we announced last August, we have transitioned a significant number of subscribers to free accounts, and we have signed up a considerable number of new free accounts. We have had approximately 3 million members actively opt out for free accounts since the program began last August. In addition, we have had another 3 million new account signups. Although these registered users vary greatly in terms of usage, as Dick mentioned, we do know that we are retaining a meaningful amount of our tenured base's usage when they convert to free. Overall, we're pleased with the level of our free accounts.

We also still have a significant number of access subscribers. AOL's domestic subscribers ended the year at 13.2 million, down 2 million from the third quarter, and 6.3 million from the prior year. Monthly ARPU rose to $19.57, reflecting the significant reduction in AOL acquisition marketing efforts which naturally results in fewer trial and retention subscribers.

Lastly, Publishing. Publishing's revenues declined 1% for the quarter and the full year. In the fourth quarter, advertising revenue declined 1% due to lower revenues at domestic magazines, including the closure of Teen People, offset in part by higher online advertising revenue. Adjusted OIBDA improved 3% for the quarter and declined 3% for the full year. In the fourth quarter, lower revenues were more than offset by lower restructuring costs and growth at the non-magazine businesses, primarily Synapse. With that, we will go back to Jim who will start our Q&A.

Jim Burtson

Thanks, Wayne. Operator, we are ready when you are.

Question-and-Answer Session

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

Spencer Wang - Bear Stearns

Thanks, good morning. Just a question on cable. Can you talk a little bit about what's happening in L.A. and Dallas, and when you expect basic sub growth at the acquired systems? Just very quickly, if you could give us a sense how much CapEx will be tied to the rollout of Commercial Phone in '07, that would be great. Thank you.

Jeff Bewkes

Let's just start with L.A. and Dallas. Los Angeles first. As we said at our Investor Day last May, L.A. is a very complicated integrations scenario, because we are integrating the systems of three MSOs and a multi-year, probably year-and-a-half process. We believe we're making good progress, and we are finding about what we expected in L.A. We expect to stem the subscriber losses in L.A. in 2007 in the last half of the year. We think we will lose subs in the first half. Basically the reason for the timing is to have our new bundles of triple play, double play, et cetera, moving into the market.

You have seen in the press that we have had a couple issues in L.A. One of them, the first one really, was related to channel lineup changes. Any time you change the lineups, you have to expect customer calls. That's what we got. We do understand, and we have got pretty good track records in other systems that when we do this, the changes ultimately lead to better serving the customers, and better penetration in all of our Advanced Service packages.

Then the second issue in L.A. was related to the migration of high speed data customers, which caused a disruption of service, but we resolved that or we are in the middle of resolving it. So we believe we will be able to straighten out L.A. mostly during this year.

In Dallas, which is somewhat consistent with the expectation for L.A., we think 2007 is a year of stabilization. Here's what we're doing now: we're upgrading the plant in Dallas as quickly as possible. We have completed all the channel lineup changes. We have launched Digital Phone, which wasn't really much in evidence there, it's now available to more than a 250,000 homes in Dallas, and by March we will have it to 500,000.

In the newly acquired systems, I'm thinking back to L.A., we have launched it in about 600,000 homes. We think that will increase substantially during the year. So we have got a fair amount at Time Warner Cable of experience in pulling in systems that aren't either built to the standards that we are used to, or are not operated with the kind of aggressive Advanced Service packages that we have in the rest of the country. Because of the penetration, there is a lot of opportunity and upside.

Let's focus on Adelphia, not just in one market, but in all of the acquired systems, the OIBDA margins there are about 10 percentage points lower in those systems than in Time Warner Cable overall. There's a $17 a month gap in their average revenue per sub as compared to ours. So we think that as we bring those up to standard, which we know what to do and how to do it, that we will converge those and that's a terrific upside for us.

Wayne Pace

We're not going to give by product CapEx rollouts, because it depends on the CPE side for phone, obviously, on what the subs will be. The CapEx required for the upgrade of the acquired systems is in sort of a range of 450 to 550, which is a little bit lower than what we thought when we originally signed up the deal, which is good. That's in our filings, if you want to take a look at that. But that's what's contained as you look out into '07 in our numbers.

Spencer Wang - Bear Stearns

Thank you.

Operator

Your next question comes from Michael Nathanson – Sanford Bernstein.

Michael Nathanson - Sanford Bernstein

I have a question to Jeff or Dick. It's interesting, looking at the past five months since you changed your AOL strategy, what are you seeing really on an AOL usage level that gives you the confidence that page views, which have been down 17% year over year and 9% sequentially, are going to stabilize or even grow? So can you give me color on more detail on per sub page view usage?

Jeff Bewkes

The reason we think that page views will grow in '07 is -- let's start with the sequential decline in the fourth quarter that you just cited, of 9%. Really that decline is between 4% and 5%. If you're looking at the AOL brand and you're taking out some of the categorization where we moved the Road Runner subs out of the count, we moved the Time Inc. Publishing titles out, and if you leave MapQuest aside, which is a whole different situation in terms of page views and ad sales and so forth.

So at AOL, the decline was 4% to 5% in page views, quarter 4. The industry declined more than that. So we believe that if you take that as one point for us, and if we look at the dynamic as Wayne started to talk about, which is we're transferring some paying subs over to free. So we're replacing those, but we're getting quite a substantial number of new sign-ups. We have had basically 6 million or more new free sub registrations. Half of those basically came from new users, half of them were migrations from paid sub status. As that continues, which we expect that it will, and as the drop-off in the paid sub base tapers down, that also will lead to a base of page viewing increase.

Further, getting to your question of what are the individual subscribers doing, we're seeing early signs of e-mail page view growth. That's a very good leading indicator of overall usage. We're beginning to learn more about what happens when our paying member subs move over to free. Because most of the early migrations are broadband users, which of course, were using broadband levels of usage. As we dig in more to the narrowband users coming over to broadband under the free system, we believe the usage levels, if they go the way we have seen so far, those usage levels will go up 50% or more per sub.

So all of that, added to the fact that we're gaining confidence in our new product development this year, in terms of what we have got underway that we did not have as much a focus on a year ago or two years ago, a good example of which is the new search product which is already reinvigorated and starting to increase the search query volume, all of that together is why we think that the page views will come up.

Michael Nathanson - Sanford Bernstein

You've talked in the past about the tenured, non-tenured base. Of the 7.8 million still dial-up subs, do you have any idea what the non-tenured base would be? Meaning the ones that are subject to flight?

Jeff Bewkes

We do, we haven't broken it out. A majority is tenured and fairly long tenured.

Michael Nathanson - Sanford Bernstein

Thanks.

Wayne Pace

I would suggest, Michael, calling back, and we can give you that.

Michael Nathanson - Sanford Bernstein

Okay.

Operator

Your next question comes from Lowell Singer – Cowen & Co..

Lowell Singer - Cowen & Co.

Jeff, can you talk a little bit about Publishing? Do you think at this point you're done with all the personnel moves at Publishing? What sort of EBITDA growth do you think that business can generate over the next two years? Thanks.

Jeff Bewkes

Well, I think as Dick said, we expect all of our segments to increase earnings this coming year and that includes Publishing. In terms of the management changes, yes, I do think we are concluded with that. The prospects, as Dick mentioned in his remarks, are growing and we're seeing really, let's call it day-to-day execution benefits and evidence of growth in all of our digital moves, whether it's People, Sports Illustrated, CNNMoney, even Time Magazine, for example. So over two years, I hope -- and we're not giving any specific guidance -- but my belief is that the fortunes at Publishing will begin to accelerate in the out years.

Operator

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

Jessica Reif Cohen - Merrill Lynch

Jeff, can you give more color on what's going on in the cable networks? You or Wayne said that cable cash flow was up 7% in the fourth quarter excluding Warner Brothers, but including The Sopranos syndication and Court TV. So what's going on on the cost side? Are programming costs up a lot? Are you spending more on digital? If you could talk about '06, and then '07.

The second question is, could anyone give more color on the revenue opportunity for both the small and medium size business, as well as the Advanced Advertising, and what you think the timing will be.

Jeff Bewkes

Back to the first question. I'm not sure if I understood it.

Wayne Pace

It was OIBDA. OIBDA was 7% in the fourth quarter, if you take out Court TV's contribution from Networks.

Jeff Bewkes

Right. Has that got WB effect out of it?

Wayne Pace

It doesn't. That's got the WB in it. Only shutdown is in it.

Jeff Bewkes

So you have to take that out, Jessica. You're asking a year question, not a quarter question, right?

Jessica Reif Cohen - Merrill Lynch

Yes. I mean just generally speaking, what's going on on the cost side, both programming, maybe digital spending as well?

Jeff Bewkes

Let's do them together, and maybe separately. The earnings are going up steadily in '06 at both Turner and HBO. There isn't an appreciable or significant increase, let's say, in programming in relation to revenue at Turner HBO in 2006. HBO's sale, which Wayne flagged, of Sopranos, is a bit of a one-time expansion in terms of revenue and falling to profits. So that makes HBO's result a little lumpy from that source in '06.

Turner, on both ad sales, ad revenues, net margin, so forth, very steady. We didn't really get into the individual brands at Turner. Dick mentioned the ratings and the leadership at TNT. TBS is either first or second, depending which demo you look at. CNN had an increase in revenue and earnings, very strong one. Cartoon, as well. So I hope I'm answering your question. It's pretty steady at the Networks in '06.

Jessica Reif Cohen - Merrill Lynch

I actually thought Wayne said that excluding Warner Brothers, operating cash flow was up 7% in the fourth quarter, and that included The Sopranos and Court TV.

Wayne Pace

Fourth quarter, by itself for that segment, had just in the quarter, had some one-time programming costs, and had some marketing associated with that, that would be lumpy for the quarter, not for the full year.

For the full year, I think the Network segment was 10%. And the 10% was impacted by the shutdown costs at the WB, which was about $114 million, reducing it down to 10%. So I mean it was a good year if you think about it in those terms. Again, the fourth quarter had some one-time programming costs, primarily at Turner, and the related marketing that you'd want to spend for that programming. Not indicative of a change on a full-year basis for that reporting segment.

Jeff Bewkes

Jessica, I think your question is trying to get at what is '07. And although we're not going to give specific guidance on the segment, HBO has tough comps, partly because of The Sopranos and partly because some anticipated, which we had planned on, programming increases there more related to the underpinning of the program lineup there on the studio side. That does create lumpiness. Obviously, we have the easing comps because of the WB as well, and Turner as usual.

Wayne Pace

You should think of Turner's results as the kind of growth and margins that you're accustomed to seeing in that group.

Jessica Reif Cohen - Merrill Lynch

And then on the Cable question?

Dick Parsons

The question, I've got down here, sort of give a little guidance as to what the revenue potential is for Business Phone and for the Advanced Advertising. It’s a little early to do that.

Jeff Bewkes

It's early to do that. I don't think it's a meaningful impact in '07 in their plans. They do have some incremental costs associated with it. But they think really, it's the future opportunity of that. The small to medium size business, Jessica, as I'm sure you know, is we think at least on our end is potentially as big a pool of spending as all of our residential product spending is. So we do think it's a great opportunity. We are absolutely starting from a nascent position there.

Operator

Your next question comes from Anthony Noto – Goldman Sachs.

Anthony Noto - Goldman Sachs

Jeff, you had mentioned that Adelphia margins are 10 percentage points below your legacy systems, and the gap in ARPU is $17. I was wondering, how much of that 10% margin gap can you close without a corresponding increase in the ARPU? Can you get five percentage points without really moving the ARPU line?

Second question, the AOL advertising business has clearly benefited from a number of your initiatives and the growth is really impressive. Advertising.com is benefiting from the industry shifting to low CPMs. But I think the thing that's more interesting is that your branded advertising has really remained up 38% for two quarters in a row, gaining share from Yahoo, at 33% and 27% in the third and fourth quarter. I was wondering if you could comment, do you think that's because the branded advertising at AOL.com is providing a better value proposition, also leveraging the fact that advertisers are willing to go to lower CPMs, even though they may have better ROI? Thanks.

Jeff Bewkes

On the second one, yes, I do think that. But we will come back to it. Back on Cable, so I don't forget. You were asking how much of the 10 points gap between legacy and acquired can you close without ARPU increases. If the meaning of that is what can you do with costs, we're not going to exactly forecast what that is, although we have our plans for it.

I would answer it this way. Margins and the cost part, or cost efficiency part of margins, are certainly good opportunities any time we at Time Warner Cable take over most competing or other cable operator systems, because of how we operate, said enough there. The real way, or the most powerful way which I think starts to answer your question, to increase or close that margin gap, is really on the revenue side because of the Advanced Services we offer and the way that we handle those and through our personnel organization.

So I would say to you, probably we would be looking more to bringing up the penetrations, and therefore the revenues to close the margin gaps, because you run an increased revenue against the fixed and frankly declining cost base that we're also making more efficient as we take over those systems. I hope that answers it.

Dick Parsons

This is coming out of bankruptcy, right? There's not a lot of low-hanging fruit in terms of the large headquarters office, or something like that, that you could eliminate the duplication. By the time we picked it up, it was pretty lean and mean already. But we think that's why we run this sort of race to get the plant upgraded. The opportunity, real opportunity, is to flow these differentiated bundles that we have of these new products across in a way that they never did, and create substantially more revenue, as you say, that you then have over a relatively fixed cost base.

Anthony Noto - Goldman Sachs

Do you have a sense of when the triple bundle will allow the overall acquired systems to grow basic subs again? Because the two are kind of tied together. You've seen that obviously, at Time Warner Cable, and on top of that, Comcast and Cablevision, to give us a sense of when the triple bundle can allow basic subs to grow again?

Jeff Bewkes

Well, we think in the second half for some of the problem systems. Maybe sooner for others. I was thinking of going through all the different penetration levels of digital; it takes too long. We think basically that many of the systems this year, and in the L.A., Dallas, towards the last half of the year.

Wayne Pace

The only thing I'd add Anthony on that is that 80% of the of the basic sub loss in 4Q was just from what we're doing in L.A. and Dallas. Otherwise, there's not much of a drag there at all.

Jeff Bewkes

Just back on your AOL ad question, as Dick and Wayne said, the ad revenue is up 49% quarter four, 41% for the year, faster than the competition. One of the good aspects of that is the diversified nature of that ad performance and growth across brand, ads up 38%, search up 34%, and AD.com up 103%, or 43% without one of the key accounts. Frankly, that key account continues also. Modernization has grown fast, as well.

With this ad growth going faster than all the competitors except Google, the thing I would mention that you asked about, is there are really only three companies that have both a large owned and operated network and an extensive third-party platform. So we see AD.com continuing to benefit from some of the inventory that they can't efficiently use, that we can. That will continue to support our ad growth on the third party side. We have already talked about the gains we're starting to make in the AOL branded network, in our branded sites, in terms of visitors, usage, engagement, et cetera.

Anthony Noto - Goldman Sachs

Thank you.

Operator

Your next question comes from Doug Mitchelson – Deutsche Bank.

Doug Mitchelson - Deutsche Bank

Thanks very much. This is the second quarter in a row where you added fewer telephony subs than in the prior year. Not a dramatic moderation, but still lower year to year. Does this relate to just having churn now on a scaled sub base? Or due to competitors becoming more aggressive defending their turf? Have your phone penetration targets changed at all based on this recent experience?

Jeff Bewkes

Well, we have about 11% increase, and we now have second lines for phones in 11 of our divisions, and a lot more launching next year. In the acquired systems, there are a number of them that don't have phones. So in fact, most of them don't. You have that coming in to dilute the average percentage growth, which is, I think, the largest part explaining what you're saying. As we introduce phone and triple plays into the acquired systems, we see a very good opportunity to have the growth pick up.

Dick Parsons

Also, overall penetration you're always going to have the law of large numbers and early adopters, right? So the farther down the line you go, the harder it is to get the next guy. But, basically we're at 11% penetration of phone-ready homes. And our plans are to move substantially beyond that. I'm not going to peg it. But think order of magnitude, right?

Jeff Bewkes

We do have a lot of systems at 20% to 30%.

Dick Parsons

Exactly. We think there's no reason why over time that won't be reflective of our entire footprint. So we're very bullish to continue on phones. It's competitive, no question about it. But that's not a surprise to us. It's not as though we thought everybody was just going sort of to lay down their arms and say here, take my subs. But we are reasonably confident, in fact our cable guys are highly confident that what you're seeing in terms of level of penetrations in those systems where the phone has been available for two or three years, you're going to see reflected across our entire footprint, including the newly acquired subs, which are now being upgraded so they can take phones.

Doug Mitchelson - Deutsche Bank

In the systems that have been out there two to three years, where you have penetrations of 20% to 30%, are those penetrations still growing?

Jeff Bewkes

Yes.

Doug Mitchelson - Deutsche Bank

Great, thanks.

Operator

Your next question comes from Jason Bazinet - Citigroup.

Jason Bazinet - Citigroup

There's a bit of controversy in the investment community regarding some of the Verizon fiber numbers they have been putting out. And if you go through the math where they have rolled out fiber on the video side, they're running it about 20% penetration a year on the video product. And I was just wondering, if you look at some of those handful of markets where you do see overlap, are you seeing that sort of adoption rate for Time Warner Cable?

Jeff Bewkes

No. So far, in most of the nation's phone footprints, the competition has been fairly rational, essentially only offering meaningful discounts in bundled packages. For us, it's important for us to point out that today, builders only cover 3% of our footprint, which gives us, first of all just in timing alone, a heads-up in signing customers to packages and multiple bundled services, which naturally reduces the receptivity they have to competing offers.

So basically, the reason we call it rational, what's happening in most places, is that multi-channel video is fairly highly penetrated. It's a competitive landscape, with satellite having been in there a long time and so forth. On the other hand, the cable industry, our cable company, are taking meaningful share in both residential data and voice and we have, as Dick mentioned, a pretty interesting upside on the small and medium commercial side. So we really don't see video, while it will compete with phone, we don't see it as a particularly difficult challenge for us.

Jason Bazinet - Citigroup

Back in May, when you had the Time Warner Cable Investor Day, there was a slide that highlighted the L.A. market, where you showed the amount of network capacity within the various clusters within L.A. There was one market that was up to 1 gig, which I believe was Huntington Beach, which happens to be a FiOS market. Is that causal? I mean, do you anticipate moving to one gig where FiOS rolls out? Or is that just coincidence?

Jim Burtson

Jason, it's Jim. No, I think that that's just more coincidence. With digital switching, although there are markets where we're upgraded to that level of capacity in the plant, switching really is the strategy Time Warner Cable is employing in terms of providing enough capacity for the Advanced Services. I think we have been pretty aggressive about rolling that out through the footprint. It provides more than enough capacity to compete against the FiOS. At the end of the day, although FiOS is billed as all fiber, the reality is, it is like cable, a hybrid plant as well, when you get down to the last mile.

Jason Bazinet - Citigroup

Absolutely, thanks so much.

Operator

Your final question comes from William Drewry – Credit Suisse.

William Drewry - Credit Suisse

Just back on AOL, Jeff, it sounded like from your comments, that you're pretty optimistic about continuing to take share, and maybe that share gain accelerates. Just wondering how you would peg the overall health of the online advertising market for 2007? Do you think we will continue to see the overall growth rate continue at the same track? Or do you think it is going to start to slow down as it gets bigger?

Is there an optimal number for the base of narrowband subscribers now, given where you've gotten the cost structure to? Or would you like to just continually see that decline over the next several quarters? Thanks.

Jeff Bewkes

First on the industry, we expect/anticipate that the growth in ad revenue across the online community will continue at least as it was this year. Dick made the point, and clearly it's right, that over time, as something gets very large, you can't go at 20%, 30% for 100 years, obviously. So that will bite in, but we don't think that's happening this next year. We do think, as we have said, that we will continue to grow our ad revenue at AOL at or above the industry, therefore taking share in that sense.

On the question of optimal subs, first of all, our cost structure is not such that we can't follow and optimize whatever the right volume of continuing or sticking narrowband subs turns out to be. So we think we can continue to make efficient margin and economic structures around the narrowband business, however it moves.

Having said that, we want to go for long-term engagement and we think broadband is the best way to do that. We are very happy with what happens to AOL users when they're on broadband -- free broadband, that is now, of course. So we're going to continue trying to actively move and offer our subs that alternative in partnership, marketing partnership, with all broadband providers. Because we think in the long run, that's clearly the lion's share of our future.

We also do see and believe, and we talk to our subs, that a lot of them, for a fairly considerable outlook into the future, are going to stay on and be happy with a narrowband connection.

Jim Burtson

Thanks, Bill and thanks to everyone on the call. Appreciate your time today.

TRANSCRIPT SPONSOR

MF logo

Did the analysts get it right?

Wall Street hires some smart cookies. But it’s not always in their best interest to put the hard questions to management. Are YOU even their top priority?

Motley Fool co-founder David Gardner is still bullish on Time Warner. It’s up 54% since he recommended it to his Motley Fool Stock Advisor subscribers back in August 2005. Now, discover the companies David and his brother Tom recommend in their free research report “The Motley Fool's 2 Top Picks - Plus Wall Street's Dirtiest Secret.”

Read the complete report courtesy of Seeking Alpha FREE.

* Returns as of 6/12/2007

To sponsor a Seeking Alpha transcript click here.

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

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

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

Source: Time Warner Q4 2006 Earnings Call Transcript
This Transcript
All Transcripts