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Time Warner Inc. (NYSE:TWX)

Q1 2007 Earnings Call

May 2, 2007 10:30 am ET

Executives

Jim Burtson - IR

Dick Parsons - Chairman and CEO

Wayne Pace - EVP and CFO

Jeff Bewkes - President and COO

Analysts

Doug Mitchelson - Deutsche Bank

Jessica Reif Cohen - Merrill Lynch

Benjamin Swinburne - Morgan Stanley

Spencer Wang - Bear Stearns

Tuna Amobi - Standard & Poor's Equity Group

Michael Nathanson - Sanford Bernstein

Jason Bazinet - Citigroup

Anthony Noto - Goldman Sachs

Michael Morris - UBS

Kathy Styponias - Prudential Equity Group

Presentation

Operator

Hello and welcome to the Time Warner First Quarter 2007 Earnings Call. (Operator Instructions).

Today's conference is being recorded. If you do have any objections, you may disconnect at this time. Now I will turn the call over to Jim Burtson, Senior Vice President of Investor Relations. Sir, you may begin.

Jim Burtson

Thanks, operator and good morning, everyone. Welcome to Time Warner's 2007 first quarter Earnings Call. This morning, we issued two press releases, one detailing our first quarter results, the other updating our 2007 business outlook.

Before we begin, there were a few 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 or the other most directly comparable GAAP financial measures as applicable, are included in our trending schedules. These reconciliations are available 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.

Second, as a result of the sales of the Parenting Group, most of the Time4 Media titles and the Progressive Farmer magazine as well as the planned sales of Leisure Arts, the Atlanta Braves franchise and certain non-core AOL Wireless businesses, the company has presented the financial results for these businesses as discontinued operations for all periods presented.

The 2006 discontinued operations also reflected the operating results of Time Warner Book Group and the Turner South network as well as Cable Systems transfer to Comcast, in the Adelphia and Comcast transactions.

Third, you will see a section of our earnings release that describes the basis of presentation for Time Warner Cables results. On January 1, 2007, Texas and Kansas City Cable partners distributed its assets to its partners. Time Warner Cable received the Kansas City Pool for which we began consolidating financial results on January 1, 2007.

In this morning's presentation, the systems that we acquired in the Comcast and Adelphia transactions are referred to as the Acquired Systems. The term Legacy Systems when used in the presentation of financial results refers to those systems that Time Warner Cable owned both before and after the Adelphia and Comcast transactions. This same term when used in the presentation of subscriber information also includes the Kansas City Pool.

Today, we will refer to certain pro forma financial results for Time Warner Cable. The pro forma financial information for the first quarter of 2006 presents the results as if the Adelphia and Comcast transaction and the consolidation of the Kansas City Pool had occurred on January 1, 2006. Reconciliations of the pro forma financial information to financial information presented in accordance with GAAP are included in the trending schedules posted on the company's website.

Finally, 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, strategic 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, and its quarterly report on Form 10-Q. 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

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Dick Parsons

Thanks Jim, and good morning ladies and gentlemen. We appreciate your joining us today on our first quarter earnings call. Here is the morning's agenda. First, I'll give you my perspective on the overall company and where we are headed. Next, our CFO, Wayne Pace, will briefly take you through the results of the quarter. And then we'll go to the Q&A session at which time our President and COO, Jeff Bewkes, will join us.

Before diving into the details, let me set out to you what I believe are the three main takeaways from this first quarter. First is that AOL, which had a great quarter continues to be on track with the strategy we laid out last August, and our confidence enables progress that keeps growing. Second takeaway is that Time Warner Cable is delivering outstanding results and we have every expectation that they will continue to do so. And third, taken together, our business results in the first quarter give us great confidence and should give you great comfort that we will attain all of our full year financial objectives.

Now, let's get into the details of the quarter. I am pleased to say, Time Warner generated strong operating results, adjusted Operating Income before Depreciation and Amortization or adjusted OIBDA grew 19% including the impact of the cable systems acquired from Adelphia and Comcast. We again delivered free solid cash flow converting over 30% or almost $1 billion of our adjusted OIBDA to free cash. Our adjusted diluted earnings per share in the quarter were $0.22, up 10% from the prior year.

As you saw in this morning's business outlook release, we've reaffirmed our expectation of mid to high teen full year adjusted OIBDA growth. Also, we continue to anticipate converting 30% to 40% of our adjusted OIBDA to free cash flow.

In addition, we raised our guidance for diluted earnings per share by $0.05 to approximately $1.05. We increased our EPS outlook, based primarily on better than expected first quarter operating results, coupled with the anticipated positive impact of financing activities we undertook this past April.

Turning to our businesses, I trust that most of you were able to listen to Time Warner Cable’s very first earnings call earlier this morning. So I won't spend as much time as I normally would, but let me review the highlights. Overall growth in every key subscriber category accelerated from the fourth quarter, driving over 900,000 net RGU additions.

The Legacy Time Warner Cable system performed extremely well, generating 12% revenue growth. The Acquired Systems began to show improvement and Time Warner Cable expects to stand the basic subscriber losses in these new systems during the second half of this year.

Cable also plans to roll out digital phones across the entire footprint by the end of 2007. Overall Triple Play penetration is now at 12% and we've plenty of upside ahead of us. Simply stated, Time Warner Cable is in a great position vis-à-vis its competition. With its robust plan, Time Warner Cable is the only company in this footprint that can provide today, compelling video, data and voice services at scale.

While competition works to catch-up with our existing offerings, Time Warner Cable keeps extending its leadership position by continually introducing a host of innovative new products that consumers want.

Moving to AOL, we are very pleased with the progress that it has made against its new advertising strategy, and as I started out saying, our confidence in our ability to achieve all of the goals that we outlined for you last August is higher than ever.

AOL’s advertising revenue grew at or above 40% for the fourth consecutive quarter. And we expect AOL to keep growing their online advertising throughout the year at or above the domestic industry rate. Albeit that gross rates is lower than the 40% we posted this quarter.

With strong adjusted OIBDA growth of 27% in the quarter, AOL was well positioned to grow overall profit for the year. Equally as important to the long-term success of the business, AOL is on track to begin to grow its page views, which is a key to the success of its advertising strategy. In fact, on a sequential basis, page views were essentially flat this quarter for the first time since we started reporting this metric.

Looking briefly at the performance of our remaining segments, the results at our Filmed Entertainment, Networks and Publishing segments were all strong enough to keep us on track to meet our outlook for the full year.

As we entered the year, we expected Filmed to be down substantially in the first half of the year and then up sharply in the second half of the year. This is due to the timing of releases as well as comparisons to the prior year's results.

Although the segment's adjusted OIBDA was down 27% in the quarter, we are pleased with the results given the difficulty of year-over-year comparisons to a quarter that included more than $220 million of contribution from Wedding Crashers and Harry Potter and the Goblet of Fire alone.

The results at our networks were largely in line with our expectations, turning ahead solid OIBDA growth while at the same time, we felt the impact of long planned incrementals through the output programming investments at HBO.

While we are not happy about being down at Time Inc., we are pleased with the progress the business is making with its digital initiatives. For example, gross in Time Inc.'s online add revenue more than offset declines in magazine publishing revenue. We see this not only continuing, but increasing over the course of the year.

I'll finish up by updating you on our share repurchase program. To date, we have spent approximately $18.4 billion buying back our stock. In total, we repurchased over 1 billion shares representing more than 21% of our outstanding shares since we began the program at an average price of $18.27 per share. And as I said before, we plan to complete our $20 billion program by the end of the second quarter. After we close it out, we will review with our Board how best to allocate the future incremental capital. As we consider this, I can assure you that we will remain committed to allocating capitals for the benefit of our shareholders.

In summary then, I would say we've gotten off to an excellent start and we're feeling pretty good about the rest of the year. With that, I thank you again, and I’ll turn the call over to Wayne Pace.

Wayne Pace

Thanks, Dick, and good morning also to everyone. As usual, the slides that I will refer to in my comments are available for you on our website, and we will start with a look at the first quarter results. Revenues increased 9% over the prior year to $11.2 billion. Adjusted OIBDA grew 19% in the quarter to $3.1 billion and our margin was 28%. That's the highest that it's been in five years. As Jim mentioned in his remarks, these results reflect certain businesses that we're accounting for as discontinued operations for all periods presented.

Moving to the next slide, diluted earnings per share before those discontinued operations and the cumulative effect of an accounting change was $0.30 in the quarter and that’s compared to $0.26 in 2006. Both years had items that affected the comparability. Included in this year’s current quarter were pre-tax gains of approximately $670 million related to the sale of AOL’s internet business, the access business in Germany, and approximately $146 million associated with the distribution of assets of the Texas and Kansas City joint ventures in our cable company. These gains were offset in part by $163 million related to the remaining securities litigation matters.

The net benefit of these items to our diluted EPS in the quarter was $0.08 and therefore adjusted EPS was $0.22, and that’s a 10% increase over the comparable prior year measure. This increase reflects the benefit from the share repurchase program and that’s offset in part by the dilutive affect of the acquired Adelphia and Comcast cable systems.

Looking on the next slide at free cash flow, we had a really good start to the year generating $973 million in free cash flow. We converted 31% of our adjusted OIBDA into free cash. The current quarter was negatively affected by a swing in working capital and that's related to the timing within the year of cash collections and payments. This slide provides the usual detail that we give you each quarter and certainly call us if you want more detail.

Moving to the next slide, we ended the first quarter with net debt of $34 billion that’s up about $550 million from the end of 2006. Walking down the slides, the increase reflects $2.1 billion in share repurchases and $2.11 million in dividend payments, offset in part by the free cash flow of $973 million. Net proceeds of $850 million from the sale of AOL's German Internet access business and the proceeds from the sales of the Parenting Group and most of the Time4 Media titles.

In addition, the increase in net debt reflects $551 million of payments related to the securities litigation and government investigations which is shown in the other line item on this slide. Also I would mention that an additional $360 million in payments is expected to be made in the second quarter and this will resolve substantially all of the remaining securities litigation claims.

This next slide shows you the numbers on the progress of our share repurchase program which Dick talked with you about in his remarks. Also, as Dick mentioned we've updated our full year business outlook for you this morning. We continue to expect the percentage growth and full year adjusted OIBDA to be in the mid to high teens, of a base of $11 billion in 2006 and we except to convert between 30% to 40% of our adjusted OIBDA into free cash flow.

We now expect earnings per diluted share for the full year of 2007 to be approximately $1.05. And as a reminder for you our 2007 EPS guidance reflects the impact from the share repurchase program and approximately $0.10 per diluted share related to the sale of assets in investments as well as expenses in the first quarter related to securities litigation and the government investigations.

So overall to repeat, we were pleased with the start of this year and remain confident that we are on track to meet all of our 2007 financial objectives. And so we want to go through the results for each of our segments and then we will get into Q&A.

We'll start with AOL. Last August, management laid out a strategy to prioritize AOL's advertising business while repositioning its subscriber business and to adjust its cost to reflect that strategy. As Dick mentioned, AOL has made great progress against these stated objectives and its financial results also reflect this progress.

AOL's advertising revenues in the quarter continue to grow at very healthy rates. They were up at least 40% for the fourth consecutive quarter. Growth was strong across all advertising revenue sources including display and paid-search advertising on the AOL Network of owned and operated properties as well as advertising on Partner Sites.

Display advertising on the AOL Network rose 32%. Paid-search on the AOL Network was up 26% and advertising on Partner Sites grew 81% and that includes the continuing impact of a relationship with a major customer that was expanded substantially in the second quarter of 2006. Even without this impact from that major customer relationship advertising revenues generated on the Partner Sites primarily through the advertsisng.com business, was a up a very strong 29%.

Included in display advertising revenues on the AOL Network for the quarter was a $19 million benefit relating to a change in accounting estimate. This resulted for more timely

system data and correspondingly improved estimates. Including this $19 million benefit, AOL advertising revenue still grew a very strong 35% compared to that 40% number -- excluding the $19 million benefit, it grew 35% compared to the 40%.

As expected, subscription revenues continue to decline as AOL strategically reduced acquisition marketing spending and subscribers churned or they converted to free accounts. In addition subscription revenues from AOLs Internet access businesses in the UK and France and Germany declined approximately $300 million from last year's first quarter to approximately $90 million in the current quarter due to the sales of those businesses.

The 43% decrease in subscription revenues in the current quarter led to the 25% decline in total revenues. Adjusted OIBDA rose 27%. Again these results reflect the impact of executing AOL strategy as a plan reduction in marketing cost and lower network cost offset the decline in revenues.

As you look out over the year, it’s important to be mindful that the first quarter is likely to be the largest in terms of adjusted OIBDA at AOL. This is because of significant portion of the cost reductions most notably reductions in marketing spending have already taken effect. While subscribers are expected to continue to decline throughout the year, thereby reducing quarterly adjusted OIBDA in the remainder of 2007.

Also please keep in mind that while AOL ad revenues are expected to continue to increase year-over-year resulting from growth across all ad revenue sources. Ad revenue is generated on partner sides are expected to increase at significantly lower rate than they did in this first quarter. This is due to the lapping if you will of the expanded relationship with the major customer that initially occurred in the second quarter of 2006 that we talked about just a moment ago.

This next slide depicts AOLs web metrics. For the first quarter, AOL’s domestic ad revenue less traffic acquisition cost or TAC was $345 million up 25% year-over-year. Average monthly domestic unique visitors of $111 million was flat compared to the fourth quarter.

Total domestic page views were approximately $44 billion that's down 1% from the fourth quarter. As a result AOL averaged 132 million page views per unique visitor. Domestic ad revenue less TAC for 1,000 page views of $7.85 for the quarter and that included the impact of advertising stock comps revenue generated on it's partner sites was 3% lower than the seasonally high fourth quarter.

Moving to Cable, we are not going to go into very much detail here since the Cable folks reported their first quarter results earlier this morning and we hope you had the opportunity to listen on to the call where they discussed the company's very strong operating and financial results for the quarter.

Time Warner Cable's revenues increased 61% and Web.de grew 54%. Once again these reported results reflect the impact of the acquisition of certain cable systems from Adelphia and Comcast on July 31, 2006 as well as the consolidation of the Kansas City approval on January 1, 2007.

Looking at these first quarter 2007 results compared to the pro forma results for the first quarter of 2006, revenues grew 10% while OBIDA increased 12% for the quarter. Margins improved about 50-basis points on a pro forma basis.

This next slide shows cable subscriber highlights for the quarter. We have provided you with additional discloser in the earnings release, detailing subscriber information for the Acquired Systems as well as the Legacy Systems. And you can also access Time Warner Cable's earnings release, its business outlook release and their earnings presentation and the call replay on their website.

Moving on to film, revenues declined 1% over the prior year due primarily to lower home video revenues and this decrease reflects the difficult comparisons to the prior year's releases of Harry Potter and the Goblet of Fire and New Lines Wedding Crashers. Offsetting these declines were higher worldwide theatrical revenues led by the release of 300 and increased television license fees. The 27% decrease in OIBDA was driven by higher print and advertising expenses related to the quantity and mix of releases by lower home video revenues and by a $42 million benefit in the prior year from the sale of certain international film rights.

These 2007 declines were offset partly by higher worldwide contributions from television product. As Dick mentioned, we expect film segment OIBDA to be down in the first half of the year and then up sharply in the second half. To that point, let me remind you that the second quarter of last year including contributions from the second-cycle just in the case of Friends, the off-network availability of the first three seasons of Without a Trace and the carryover home video sales of Harry Potter and the Goblet of Fire. We’d also like to remind you that our film slate is heavily weighted towards the second half of this year, which includes the midyear releases of Warner Brothers Ocean’s 13 and Harry Potter and the Order of Phoenix, which will be followed by New Line's Rush Hour 3 and His Dark Materials: The Golden Compass.

Moving to the Networks Group, revenues were flat for the quarter and this reflects the closing of operations at the WB Network in September of last year, offset by growth in subscription, content and cable advertising revenues. Subscription revenue growth of 6% was driven by higher rates and to a lesser extent an increase in subscribers at both Turner and at HBO.

As we expected the absence of the WB Network lead to a 12% decline in ad revenues. Turner's ad revenues grew 6% in the quarter as a result of gains across essentially all of their segments, most notably in the News Group. OIBDA growth of 6% was driven by higher subscription revenues and the absence of losses at the WB Network which represented 4 percentage points of that growth.

And lastly at Publishing. Revenues declined 1% compared to the prior year primarily reflecting a $28 million decrease in other revenues mostly due to declines at Synapse and Southern Living at Home, partly offset by 3% growth in ad revenues. Ad revenues benefited from higher online revenues including gains at People.com, CNNMoney.com and SI.com. This growth was offset in part by lower print magazine advertising. OIBDA was down 28% due to higher restructuring charges, lower contributions from the non-magazine businesses and decreases at certain domestic magazines.

That is the end of our prepared remarks and Jim will start the Q&A process for us.

Jim Burtson

Thanks Wayne, operator can we turn to questions?

Question-and-Answer Session

Operator

Yes we can. (Operator Instructions). Thank you, Doug Mitchelson you may ask your question and please state your company name.

Doug Mitchelson - Deutsche Bank

Hi, Deutsche Bank, good morning, thank you very much. Buried in Jim's scintillating opening comments was that the Braves were moved into discontinued operations. Can we get an update on the state of that transaction and the bigger question for Dick or Jeff is on your strategy at AOL. You spent much of the past few years successfully pulling a lot of capital out of AOL. Now it's at an interesting juncture in the new strategy with page view starting to flatten out and advertising growth terrific. Is now the time to start aggressively reinvesting in the AOL web business to begin to build traffic? And off-course that's the opposite of the view of those who would suggest you should spin the business out. So, I'm hoping for any comment on the strategy for AOL as well as if you could tell, if you do desire to begin reinvesting where that might be thanks?

Dick Parsons

Okay Doug. I'll start and then I am going to ask Jeff who has joined us follow up AOL piece a bit. In terms of the Braves transactions, as we put something out with there to go, saying that we have entered into a letter of intent with liberty and that it was before Major League Baseball. Beyond that I can't say, Major League Baseball is considering this transaction right now and we are hopeful that they will get through it in due course. But beyond that it would inappropriate for me to say, and so I won't.

Regarding AOL, I think the source to your question is right. I am going to pick up the last part first and then turn it over to Jeff, there are sorts of speculation that one reads in the business press. There are lots of people out there trying to help us figure what to do with our company including your spinning AOL and all that sort of things. We are focused on executing on this strategy, we think its going very well so far and making the kind of investments in the business that is going to strengthen it over time as part of our company and with that Jeff you want to give some sense or review of it.

Jeff Bewkes

Yeah Doug, I would continue in the direction Dick is going. We are interested and clearly we are able across Time Warner to invest resources in anything that’s got a superior return and that increases our strategic position. AOL is a very strong candidate for investment inside our company, because of the robust growth of the industry in which it completes and AOL own strong growth. You mentioned a very good point, which is page view is not only flattening but starting to increase this year, which is what our expectation is and that expectation is supported by our most recent month-to-month numbers across AOL's metric. So, we are very interested in both doing various parts of AOL's competitive advantage. You all did see that few months ago, we almost acquired a company in Sweden TradeDoubler, which at the end we did not finish due to basically what we've thought was an excess price.

But that's a fairly good indication of the kind of things we will look at and we can't and, obviously, we wouldn't say the things that we are doing right now. But we are always on the look for accretive investments and certainly at AOL.

Jim Burtson

Thanks Doug. Operator, next question please?

Operator

Thanks you. Jessica Reif Cohen, you may ask your question and please state your company name.

Jessica Reif Cohen - Merrill Lynch

Merrill Lynch. I'm having two parts. First on cable, you've indicated in the past a willingness to own a smaller piece of the bigger company. I was wondering if you would comment at all if Cablevision's announcement pushes this agenda on a faster timeframe. And the second question is on film; the DVD revenue when the trending schedule was down 22% and units were down roughly 7%. Where is the pricing pressure coming from?

Dick Parsons

I'll start Jessica and then ask Jeff to hit the second part of your question. Again, you’ve all had an opportunity to read the business press, once again helping us think through what to do with our assets. A lot of that is fanciful, I don't know where it comes from. My position is the same as it has been, and I have articulated in these calls over the last couple of years. We like cable first of all. We like the cable business. We think that the guys who are shooting the lights out, you heard them this morning, all our operating metrics were up and the business is performing strongly. We like the fact that we, with our own currency in cable, can continue to participate in what I think will be the inevitable, irretractable consolidation of businesses in the cable space. We think we are well-positioned to do that. As far as the Cablevision announcement, I thought what they said was they, the family was buying not selling. But our position going all the way back for years, on Cablevision is if the Dolans ever were to decide to part with that asset, we would certainly want to be on their list of people to talk to.

Jeff Bewkes

Your second question, if I heard it right was DVD, in general for Warner's. We are pretty happy with what's happening in DVD and our company. Warner Home Video was number one in the industry for the first quarter with about at 18.5% share. Two of our titles The Departed and Happy Feet were the two top sellers in the quarter. But even though that is good and that's great, when you look at any company and our Film company on DVD you got to look at slate availability on what's going on from one year versus last year and as Wayne, said we had some huge DVD titles, even larger than those last year's. So, that accounts for any fluctuation quarter-to-quarter for our company.

For the year we look forward to a very strong performance and we think industry leading performance in DVD, given what releases will happen later in the year. You didn’t ask Jessica, but in the overall industry consumer spending was down about 5% in the first quarter. But again, these things are in the industry as well, slate timing kinds of things and the US Film Industry is off to a good start and I think what every one is about to live through, fortunately consumers most of all is a very robust season of hits coming in to theatres in the next few weeks, and we will have some big films coming in there this spring, this summer as Wayne and Dick said.

Jim Burtson

Thanks Jessica. Operator, next question?

Operator

Thank you. Benjamin Swinburne you may ask your question and please state your company name.

Benjamin Swinburne - Morgan Stanley

Good morning, it’s Ben Swinburne. Thanks for taking the question. Jeff, can I ask you on the programming side of Turner, what do you think the impact of commercial ratings and DVR homes into the rating system is going to have on the business and how does that affect your sort of programming investment decisions?

Jeff Bewkes

Well, are you asking about the debates as to whether it should be three days or one day and looking at commercials minutes to the adverse of its programming, is that what?

Benjamin Swinburne - Morgan Stanley

That’s right. Yeah.

Jeff Bewkes

None of us, none of you know exactly how that works. We don’t worry about it too much. We think that there is a very strong first and second quarter scatter market, its going at the mid to high single-digit increases over upfront last year and this pretends a strong upfront usually, which is what we think will happen. As per our networks, we are having a pretty good year particularly in news. But our entertainment network ratings TNT and TBS are still in leading positions as they have been. TNT was a little down in the first quarter. Some of it's quarterly scheduling really, the only less than strong spot in the TNT programming lineup in the first quarter was the procedural dramas, which we have kind of rescheduled a little bit of that, we have put some movies in it. We are coming up to the strong part of our programming schedule, at TNT we've got our original Saving Grace coming in this next quarter, Heartland with Treat Williams, and The Closer, which is the biggest rated show on ad-supported cable is coming back, so are the NBA play-offs.

So that's basically why I'm pretty optimistic about TNT. TBS is holding its position in number two in prime, pretty well. Adult Swim remains the number one ratings deliverer for its 18 to 34 audience and more than any of the other networks that it competes, it's number one in that demo. So we're in a pretty good place in terms of the Turner ad-supported network. You didn’t ask about HBO but that continues to be rolling along in a fairly strong consumer performance way.

Jim Burtson

Thanks, Ben. Operator, next question please.

Operator

Thank you. Spencer Wang, you may ask your question and please state your company name.

Spencer Wang - Bear Stearns

Bear Stearns, thanks. Good morning. Just one question on AOL advertising. I think Wayne mentioned that excluding TAC or including TAC US advertisings at 25%. So, I guess if you take out that $19 million benefit that number would go to 19%. And I think in the fourth quarter ex-TAC US advertisings was up 39%. So I was just wondering if you could help us understand why there was a deceleration with this seasonality or am I missing something else. Thank you.

Wayne Pace

Some of it was seasonality and that’s the primary difference and so that you didn’t have the right answer there of seasonality. But, on an overall basis, if you take the one $19 million item out on an overall basis, we were up 35% on total.

Spencer Wang - Bear Stearns

Alright, thanks Wayne.

Wayne Pace

If you take out the expanded relationship for the one customer that started in the second quarter of last year, we were up 29% year-over-year.

Jeff Bewkes

We feel safe, Spencer in our other plans. We are going to grow our advertising performance at or above the industry average. So that means including in this quarter even after Wayne says all that that we believe we’re taking share.

Jim Burtson

Spencer it's Jim, the only think I would just add is that when I go through the numbers, net of TAC even you're up 27%. So, I would think it is pretty much in line or above where most of the industry was, certainly where most of the big competitors with the exception of Google were, higher than most of the big competitors actually. But thanks. Operator, can we move to next question.

Operator

Thank you, Tuna Amobi you may ask your question and please state your company name.

Tuna Amobi - Standard & Poor's Equity Group

Hi, Standard & Poor's Equity Group. I have two questions as well and the first one is for Dick. As you look at the deals, the Google deals with DoubleClick. I know you have a very somewhat intricate deal arrangement with Google. So, I guess the question is how does this affect the relationship in terms of specifically AD.com and what does that transaction in your mind mean for AOL's relationship with Google. And the second question, also a quick one, on capita allocation which you spoke about, what's the current bias right now that you are pretty close to finishing a $20 billion buyback. Would you be more biased to raising the dividends or are you looking perhaps to institute another buyback program or even perhaps kind of debt reduction.

Dick Parsons

Okay. First of all, with respect to DoubleClick and Google, as you know currently AOL and Google are partners on the ad side and DoubleClick is an ad serving vendor for AOL. So, with the acquisition of DoubleClick by Google, should better happen, we certainly expect that Google will continue to honor DoubleClick's obligations under their current arrangement with AOL. So, we don’t see much of a change there. And in terms of the state of our partnership with Google; we think its going very well. We think its one of that reasons that our ad numbers and gross has been as good as it is. And while we are taking share because we have been partnering very effectively together on that front and expect to continue to do so. With respect to a bias on the capital allocation side; I want to be careful here because, as those of you who have been listening to me going on here for years and years. Now I am sort of a one foot in front of the other kind of guy.

We have got to get through the current program, but we think we will beat through the current program, probably by the end of second quarter, at which point we'll take up with our Board, what to do next. I will just mention a couple of things that we have talked about before, but then you should keep in mind in terms of trying to anticipate our future.

One, we've said that we were comfortable in terms of running our balance sheet at a 3:1 leverage ratio. I still myself, I am pretty comfortable in that zone and I think as a consequence we'll be with a considerable incremental capital to sort of figure out how to put it to use best for our shareholders. And that could be any one of a number of things, you mentioned two of them, you mentioned dividends, you mentioned buyback. Jeff earlier talked about acquisitions in response to the question of Doug Mitchelson, I mean we are going to be alert on all fronts and we are going to evaluate where we think the highest return is for the placement of that incremental capital.

The only other thing I would say is that when we started our dividend program sometime ago, we did so with the hope and expectation that overtime if our confidence continued in the prospects of our business going forward which it certainly has and is, that we would seek to in a thoughtful and measured kind of way, increase our dividend as we go forward. I would just tell you that I remain highly confident in the future prospects of the business and so those are all themes that I would reinforce at this point in time, but I don’t think I'll go further than that.

Jim Burtson

Thanks Jim. Operator, if can you turn to our next question please?

Operator

Thank you. Michael Nathanson you may ask your question and please state your company name.

Michael Nathanson - Sanford Bernstein

Thanks Sanford Bernstein. I have one for Jeff on AOL. Jeff if you backed out the losses of the free trial subs of your AOL subs. It looks like that your subscriber losses are coming in below what people expected, so I'm wonder if you could speak to the composition of your current AOL sub base by tenured and non-tenured subs and how churn change over the past year or so, and what does that mean for your ad strategy?

Jeff Bewkes

Well, good question. You are right. We are I mean, if you want to look at that way you can quote a little better in that, changing method, although we are happy to migrate subs over we are basically right now. Remember what we are trying to do. We are trying to reshape the access business by making it free to anyone with broadband. And then based on that increasing the number of users that we have, we are going to drive engagement and monetization of those users and that acquires we've been reducing cost as we move of a subscription provision and business.

So back to your question on composition. At the end of the first quarter, we had little over 8 million free AOL accounts, which remember that's, we've only been doing that since August of last year. We had around 12 million access subs and so the access subs decline a 1.2 million in the first quarter, which is a lower level of decline than in the fourth quarter of '06.

So in a way the thing is kind of stabilized I think to some extent. That's basically what's happening and of course that means if the total users on AOL registered users gone up. Now the more important issue than that [Unix] is up in a modest way because of your issue we've lot more users, we've got registered users, we've got tick ups in e-mail and yet the question then becomes how much engagement can you get out of that.

And what we've said is we are learning a lot about the migration of ourselves to free and based on the experience that we have, most of the narrow band subs, that convert to free they have gone to broadband obviously and we see a natural lift, when they do that and their usage pattern goes up in the 50% range if not higher. And so that's kind of we think [baked] into this current positive situation. But we, in addition to that are confident that as we bring our new product development features that are going to be rolling out this year in all of the basic tools and things that AOL users, free or not are used to. We think the engagement will go up even more. So that's why we are essentially the timing here in Dick’s remarks and my remarks, it is positive [best it is].

Jim Burtson

Thanks Michael. Operator, please turn to the next question.

Operator

Thank you. Jason Bazinet. You may ask your question and please state your company name.

Jason Bazinet - Citigroup

I just have one other question on AOL. I guess if I go back to the third quarter of 2006 you lost about 2.5 million dial-ups subs, you lost about $2 million in the fourth quarter of '06 and you mentioned the $1.2 million this quarter. And you also mentioned just now Jeff about 8 million uniques. I was just wondering if you could give us a little bit of color in terms of how many people are coming to the free property that they didn't have a building relationship with AOL on the dial-up side historically. And then what portion of the dial-up subs are actually, you know, sticking around and still using the AOL content now that it's free?

Jeff Bewkes

Most of the subscribers moving [above all] subscription are sticking with the free registration over 80%.

Jason Bazinet - Citigroup

Okay.

Jeff Bewkes

Do you mentioned something like in unique visitor, did you see $80 million?

Jason Bazinet - Citigroup

I said $8 million. I was just trying to repeat the number you said.

Jeff Bewkes

Okay. That was accretive best of free. That's the free account. Unique visitors is well over a 100 million.

Jason Bazinet - Citigroup

Sure.

Jeff Bewkes

So you have got about half of those migrated from paying subscription and the rest are basically new.

Jason Bazinet - Citigroup

So $4 million in '08?

Dick Parsons

Yeah.

Jason Bazinet - Citigroup

Okay. That's very helpful. And then, just one follow-up, how were the efforts progressive regarding generating advertising revenue off of AOL e-mail?

Dick Parsons

That is what?

Jason Bazinet - Citigroup

Your efforts to generate advertising revenue off your e-mail?

Dick Parsons

It's going well, it's going up. By the way, our e-mail page views are growing at about, I don't know they are up about 7% that's quarter-to-quarter.

Jeff Bewkes

And I think in our ad revenue -- I'll get the number here, hold on. I'm looking for the percentage. It's 40 plus, it's up from basically 38% to over 40% of the ad revenue connected to e-mail and it's been going up.

Jason Bazinet - Citigroup

Okay. Thank you.

Jim Burtson

Thanks, Jason. Operator, next question please.

Operator

Thank you. Our next question comes from Anthony Noto. You may ask your question and please state your company name.

Anthony Noto - Goldman Sachs

Thank you very much. It’s Goldman Sachs. My question is on AOL advertising. On a reported basis, that growth rate is 35% as the accounting changes this quarter down from 49% in the fourth quarter and it's going up against the easiest competition of 2006 at 26% and my understanding over the last four quarters as that acceleration was really driven by increased sell-through and now we're seeing a deceleration. And I'm just concerned that is there enough sell-through left in the business of your existing pages that you haven't sold previously so that you can sustain a rate of growth in the 25% to 30% range beyond 2007, given in '08 there is less cost savings, subscription revenues will still be declining? Thanks.

Wayne Pace

Yes, there is. Well, I remember there is an uplift in terms of inventory. You start going into all the different pieces. One thing I guess I would start with is not the only thing it is that all ad growth in that dot com is driven by third party networks not just AOL page views. But as we've said here we think AOL page views are going to start turning up, we think engagements on AOL's network is going to start turning up. Search queries have been growing again. So, no I don't see the concern that your potential or the basis of your concern.

Anthony Noto - Goldman Sachs

Great thank you.

Jim Burtson

Thanks Anthony. Operator next question please.

Operator

Thank you. Michael Morris you may ask your question and please state your company name.

Michael Morris - UBS

Hi, thank you. I'm with UBS. Another question on AOL regarding this subscriber side of the business. How did the decline in sales compared to your plan and do you expect the migration to continue to slow from this pace or stabilize at this level?

And then secondly also I understand your interested in operating the advertising side of AOL, but would it be possible operationally and from a structural perspective to separate the domestic accesses business and would you consider a strategic alternative for the dial-up business such as the sell if you could maintain that relationship with users as they migrate to broadband? Thanks.

Jim Burtson

On you the first part of your question, which I think we've got it the way the that it' going in terms of how many subs are moving up and over to broadband, it's a little better idea a little lower, a little more retention to AOL than we thought. So at sense the one way of looking it you could say that's a positive.

Second thing that's positive and better than we plan is the retention of those who do go over to broadband the great majority or sticking and the number that’s staying with us and their engagement and use of the service is all higher than we had planned. So that is good.

Jeff Bewkes

Well, the third thing that's to the positive is that our ability at AOL to attract new users that aren't coming from migration out of its subscription service is going a little better than we had planned so all of that leads through both subscription economics and total user base on which to sell advertising that’s a bit better than what we had planned when we set out to do this.

Dick Parsons

Well, I hope I answered to the first part of your question? On the point as to what to deal we want?

Michael Morris - UBS

Yeah I might as well ask if you could expect paid subscriber level to stabilize at this level.

Jeff Bewkes

At this level no we are going to keep moving them to three. We are trying to get included in this its efforts with distribution partners we are trying to make supportive cooperative arrangement as we have with cable and telephone access providers to make it as attractive as possible for people to choose whichever method that they want to use AOL through paid or free that suits them. So, all of that we think is going well, our aim is customer relationships in whichever method the customers wants and we think the business in the future for us is mostly at or of that. Therefore to your last question on what to do with the access in the form of (inaudible) of course its possible to do something where it could be more separated financially. However, I think you are on condition that you based the question on which is that you asked whether you would want to have a strong relationship if you give that with AOL users for the advertising business would have to be accomplished in doing anything like that.

Michael Morris - UBS

Yes, at the risk of [overwriting] is putting. The other thing you should be thinking about is that one of the reasons I think we are feeling pretty good about where AOL is and is going against its new strategy because the focus has been on execution. Now, there is always tendency to think you can sort transact your way to some better place, but my experience is that, if you just stay focus on execution and get the execution right then good things come out of that. So, in the near-term here you can expect us to be focused more on executing against this strategy and driving more page views and then monetizing more effectively than trying to come up with busy transaction.

Jim Burtson

Thanks Mike. Operator, I think we have time for one more question, please.

Operator

Thank you. Our last question comes from Kathy Styponias. You may ask your question and please state your company name.

Kathy Styponias - Prudential Equity Group

Thank you. It's the Prudential Equity Group. Jeff my question is for you. We've heard from Q Cable company as far one including Time Warner own, regarding how day and date release of the VOD/DVD is going. And so far the result seems to be pretty positive on both end in that. It seems to driving cable VOD business without hurting the film DVD business. So, it appears as though its coming from rental as appose to shell through and I was just wondering if you can remind us whether or not they are current web share agreements with Netflex and Blockbuster and how big that business is? And whether or not you could conform it looks like it is not sort of eating out of sell through, it's coming out of the rental business. And, I'll stop there.

Jeff Bewkes

Good question. And I think and I know, I will give the same answer as Wayne gave earlier which is that, its too early we are not really ready to precisely lay out what the results are showing. But I will say, the way you are asking is right. It’s essentially a fairly positive outlook, which is what we went to the test for. And it seems that its going to be good in terms of how the consumers are responding for the sell-through business, it seems, it’ll be fine for the studios and it’ll be fine for the cable operators and to the extent that each sent to any card consumer used, its more rental than it is sell-through. So that is why the results seem positive. As for the arrangements we have with some of the current rental companies, we are not going to specify those.

Kathy Styponias - Prudential Equity Group

Alright, thanks.

Jeff Bewkes

Thanks Kathy and thanks to everyone listening in the call.

Jim Burtson

Thanks all. Bye-bye.

Operator

Thank you. That concludes today's conference call. You may disconnect at this time.

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