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Time Warner (NYSE:TWX)

Q4 2011 Earnings Call

February 08, 2012 10:30 am ET

Executives

Douglas Shapiro - Head of Investor Relations

Jeffrey L. Bewkes - Chairman and Chief Executive Officer

John K. Martin - Chierf Administrative Officer, Chief Financial Officer and Executive Vice President

Analysts

Spencer Wang - Crédit Suisse AG, Research Division

Richard Greenfield - BTIG, LLC, Research Division

Jessica Reif Cohen - BofA Merrill Lynch, Research Division

Michael Nathanson - Nomura Securities Co. Ltd., Research Division

Alexia S. Quadrani - JP Morgan Chase & Co, Research Division

Douglas D. Mitchelson - Deutsche Bank AG, Research Division

Anthony J. DiClemente - Barclays Capital, Research Division

Jason B. Bazinet - Citigroup Inc, Research Division

Operator

Welcome to Time Warner Inc.'s Fourth Quarter and Full Year 2011 Earnings Conference Call. My name is Christine, and I will be your operator for today's conference. [Operator Instructions] Please note today's conference is being recorded. I will now turn the call over to Doug Shapiro, Senior Vice President of Investor Relations. Sir, you may begin the call.

Douglas Shapiro

Thanks. This morning, we issued 2 press releases, one detailing our results in the fourth quarter and full year, and the other providing our 2012 business outlook.

Before we begin, there are 2 items I need to cover. First, we refer to certain non-GAAP financial measures. Schedules setting out reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measures are included in our earnings release and trending schedules. These reconciliations are available on our website at timewarner.com/investors. Reconciliations of our expected future financial performance are also included in the business outlook release that's available on our site.

And second, today's announcement includes certain forward-looking statements, which are based on management's current expectations. Actual results may vary materially from those expressed or implied by these statements due to various factors.

These factors are discussed in detail in Time Warner's SEC filings, including its most recent annual report on Form 10-K and subsequent quarterly reports on Form 10-Q. Time Warner is under no obligation and, in fact, expressly disclaims any obligation to update or alter its forward-looking statements, whether as a result of new information, future events or otherwise.

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

Jeffrey L. Bewkes

Good morning, and thanks for listening in. We had a great fourth quarter, capping another great year. In 2011, we grew revenue 8%. That's our highest rate since 2003. We grew adjusted operating income 9%, and we grew adjusted earnings per share 20%, exceeding our guidance. In fact, we've more than doubled our adjusted EPS over the last 3 years.

We had a strong year operationally, too. We not only maintained our leading position across almost all of our businesses, in most cases we took share. We're at the vanguard of the industry in advancing the next generation of digital business models, and we expanded our international presence.

At the same time, we significantly increased our returns to shareholders. We directed $5.6 billion to dividends and to stock repurchases, buying back 12% of our shares in just one year. And in 2012, we plan to keep the momentum going. We'll drive to deliver double-digit growth in adjusted EPS again, and we also just raised our dividend by 11% and announced a new $4-billion repurchase authorization.

We intend to achieve our financial goals while remaining as focused as ever on our key strategic priorities: first, invest aggressively to create and acquire the best content; second, accelerate new business models that harness technology to improve the consumer experience, but in a way that supports our economics; third, expand internationally in key territories; and fourth, continuously work to improve both our operating and our capital efficiency.

Let me tell you how we're pursuing these objectives at each of our divisions in 2012, starting with Networks. At Turner, we'll keep ratcheting up our investment in content as we seek the optimal mix of sports, originals and acquired programming. For instance, 2011 was the first year of our 14-year agreement to air the NCAA men's basketball tournament with CBS. It outperformed our expectations on every count in 2011: viewership, digital metrics, sponsorships and ad revenue. The 2012 tournament is just around the corner, and we are very pleased with advertiser demand as we head into the tournament.

We're also excited to have the NBA back on TNT. We've seen extremely strong ratings so far, and every indication is that the lockout did not diminish fans' enthusiasm at all. For 2012, we'll increase investment in original programming again. At TNT, we'll bring back some of the biggest shows on ad-supported cable, like the final season of the of The Closer; the next season of Rizzoli & Isles; and the #1 new drama on cable last year, Falling Skies.

Starting this summer, we'll debut several new shows, including our highly anticipated reboot of Dallas, as well as Major Crimes, Perception and The Great Escape. You'll also see more original programming on the TBS prime time lineup later this year. And in 2012, we'll build on the momentum of our original programming at truTV and on Adult Swim. Both of these networks are coming off record years for viewership.

And last but not least, we expect another strong year at CNN. In 2011, CNN was up more than 20% in its key demo, driven by the news cycle and by our programming moves over the past year. That momentum should serve CNN very well as we head into an election year.

We're refreshing our acquired programming on TBS and TNT in 2012 also, particularly in the key prime time period. Prime time in sports is where our entertainment networks generate the highest volumes and the highest pricing.

In October, we put The Big Bang Theory into its regular spot on the TBS prime time schedule, and it has been a runaway hit. It drove a big ratings improvement across the whole network in the fourth quarter, and that momentum is continuing. In January, TBS was up 30% in prime time, posting its highest ratings ever and making it the #1 entertainment network on cable.

At HBO in 2012, we'll bring back the biggest hits on premium TV. In their most recent season, True Blood attracted 13 million viewers per episode, Game of Thrones attracted 9 million and Boardwalk Empire attracted 8 million. Considering HBO is in 28 million homes, that kind of share is unmatched anywhere on television. In HBO homes, those are 30s and 40s. We're also excited about several new shows on HBO. Two weeks ago, we premiered Luck, a new show from David Milch and Michael Mann, starring Dustin Hoffman, which has received fantastic critical reviews. And later this year, we'll debut the Newsroom from Aaron Sorkin and a host of other new shows. We also will expand the slate of original shows on Cinemax this year.

In 2012, our networks will continue to be at the forefront of TV Everywhere. Two years ago, TV Everywhere, what many call authentication, was only an idea, with no technology underlying it and no industry support. It's come a long way. Today, authenticated TV has been embraced by every major distributor and program. Until now, we've been chiefly focused on availability of TV Everywhere. Now it's time for the whole industry to drive consumer awareness and consumer usage.

To really excite consumers, we think TV Everywhere needs to be easy: easy to access and easy to use. It needs to offer a robust amount of content for every network, and it needs to be on multiple devices, including connected televisions. HBO GO is a great example. It has millions of active users. Consumer satisfaction scores are through the roof, and we're seeing a big increase in the monthly viewing. And that's before we have a meaningful presence for these apps on everybody's television set, and that will happen soon.

During the fourth quarter, we signed agreements at HBO with both Time Warner Cable and Cablevision that will bring availability of HBO GO and MAX GO to essentially all of HBO's domestic sub base. And the HBO GO app will soon be available on the Xbox, and we'll continue to roll out apps for more connected devices throughout the year.

At Turner, we're now making almost 1,000 hours of on-demand TV Everywhere content and live feeds of CNN and Headline News available to almost 80 million homes. We've rolled out apps for all our major networks. And in 2012, we'll add more content and support more devices, including connected TVs.

Our networks are also growing at a rapid clip internationally. At Turner, our international operations grew to 20% of revenue in 2011. That's up from 18% in 2010. We saw a very strong performance in Latin America, in particular, where we're now the largest provider of multi-channel TV networks. We experienced very strong growth internationally at HBO, too. Including our joint ventures in Latin America and Asia, both subscribers and revenue increased well over 20% in 2011.

In 2012, HBO will launch new premium networks in several territories, including HBO Netherlands this week. We'll increase international local production and roll out new features at our international networks like high-def and on-demand.

We've now launched HBO GO as an authenticated service in 8 countries. And this year, we're shooting to complete our rollout across Central Europe and across Latin America. When including HBO Latin America and HBO Asia, our combined international network businesses at Turner and HBO generated over $3 billion of revenue and over $650 million of adjusted operating income in 2011. And as we told you last year, our goal is to reach $1 billion in operating profits at our international networks by 2014.

I'll turn next to Warner Bros., where we will also be investing to press our competitive advantages. Our film division had another great year in 2011, surpassing $4 billion at the global box office for the third consecutive time thanks to successful event films like The Hangover 2; Sherlock Holmes: A Game of Shadows, which is currently tracking for $0.5 billion in global box; and of course, the last Harry Potter.

As I mentioned to you last quarter, we expect the Harry Potter franchise to endure long after the last movie release. In December, we reached agreements with Universal Studios to expand The Wizarding World of Harry Potter in Orlando and to bring a new attraction to Los Angeles. These deals call for a significant increase in license fees starting in 2014.

We're excited about our event film slate in 2012, too. Just like you, we're eagerly awaiting the premiere of The Dark Knight Rises, which is already selling out midnight IMAX shows in July; and the first installment of The Hobbit coming this year; as well as Dark Shadows from Tim Burton and Johnny Depp; and a movie called Gravity, with George Clooney and Sandra Bullock.

At Warners' television production arm, after a terrific 2011, we are ramping up investment again in 2012. We're continuing to see very favorable demand trends. The broadcast and cable networks are increasing investment in original scripted TV. There's strong demand for the biggest hits coming off broadcast into syndication. We're still seeing international license fees climb, even in Europe. And of course, there's new demand from SVOD providers, both here and overseas.

On top of those secular trends, Warners has had a really strong first half in the 2011-2012 season. We're seeing fantastic performance from a number of our returning shows, including Two and a Half Men, The Big Bang Theory and Mike & Molly. And we have several freshmen hits, such as 2 Broke Girls, Suburgatory, Person of Interest and Alcatraz. These shows will pay dividends for years to come as they enter the syndication market.

Last year, Warner Home Entertainment had another standout year in a very challenging environment. We were #1 again across every home entertainment category and once again grew our share. This performance reflects the advantages of our scale, the demand for our event films even as consumers have become more selective, and it reflects the benefits of some of the steps we've taken to establish new windows.

In particular, in 2010, we instituted a 28-day window for kiosk and DVD-by-mail services. That enabled our titles last year to significantly outperform comparable titles released by other studios without a window. In 2012, we'll keep pushing to define the next generation of business models for home entertainment. As part of that, we're using windows to advantage our higher contribution distribution channels.

Last month, we announced an agreement with Netflix to extend the 28-day window for DVD-by-mail to 56 days. We'll keep working to extend the window for kiosk providers and for brick-and-mortar retailers, too. We're also trying to make digital ownership much more compelling for consumers. That's why we've been a big supporter of UltraViolet. Warners was the first studio to release UV titles, and Flixster was the first service to allow consumers to access them. All of our new releases on DVD and Blu-ray are now UV compatible. We're looking forward to more studios releasing more UV titles and more retailers supporting the standard over the course of the year. It's certainly early, but the consumer response we've seen so far reinforces how much pent-up demand exists for an easy way to manage and access digital movie collections.

Turning to Publishing. Time Inc. continues to be the clear leader in its industry despite a tough environment. In 2011, it took share for the third consecutive year, creating the widest gap over #2 competitor in 5 years. In 2012, we'll remain focused on continuing to grow our share and tightly manage our cost structure.

Like our other divisions, Time Inc. is pushing the digital evolution of its businesses more aggressively than any of its competitors. For instance, we've now launched tablet editions for all of our domestic titles. We're convinced that the tablet will offer more value to both our readers and our advertisers. And if the model develops properly, it should enhance traditional magazine economics.

That's one reason why I'm thrilled that we were able to bring on Laura Lang as the new Time Inc. CEO. Laura's leadership experience and her knowledge of the intersection of marketing and digital make her the perfect executive to lead that charge.

Next, John will discuss our financial results, including the fourth objective I mentioned earlier: improving our operating and capital efficiency.

Before I hand it off, I want to take a step back. We're only 2 years into our life as a smaller content-focused company. They've been 2 really good years, but I think our best years are ahead of us. The digital transition is driving higher usage across our businesses, and it's increasing the value of the high-quality content that we specialize in. New opportunities are opening up for us, technologically and geographically. We are focused on being able to capitalize on those opportunities, and we are in a better position than ever to do that.

And with that, I'll turn it over to John.

John K. Martin

Thanks, Jeff, and good morning. I'm going to begin by referring to the first slide, which is now available on our website.

As we headed into 2011, we discussed with you our plans to be more aggressive in pursuing our goals of investment, growth and returns. We achieved or exceeded our targets on all counts here. We grew revenues 8%, the highest growth rate since 2003, and we grew adjusted operating income 9% to a record $5.9 billion. That translated to 20% growth in adjusted EPS to $2.89, also the highest amount in the company's history. And as Jeff mentioned, over the past 3 years, adjusted EPS has now more than doubled. And we achieved these results while investing even more in our businesses to strengthen their competitive position and drive long-term growth.

In 2011, we increased investment in programming and production and marketing in the high single digits while reallocating resources away from less productive areas like G&A. Notwithstanding these significant investments, we were able to maintain very high levels of returns on invested capital. And as the way we look at it, which exclude certain purchase price adjustments, our return on invested capital was at about 20% in 2011.

And at the same time, we accelerated our direct returns to shareholders. And between dividends and share repurchases, we returned $5.6 billion. In 2012, our goal of once again delivering double-digit adjusted EPS growth reflects confidence in continued growth despite the uncertain economic environment, current volatility and some difficult growth comparisons. And we remain committed to direct returns to shareholders, as evidenced by our board's decision to both increase the dividend by 11% and to authorize a new $4-billion share repurchase program.

Turning to the next slide, I'll quickly take you through the quarter, where we had the highest levels of revenue, adjusted operating income and adjusted EPS in the company's history. As we expected, the fourth quarter was our strongest in terms of year-over-year growth in both adjusted operating income and adjusted EPS. It was the ninth straight quarter of year-over-year revenue growth, including growth across all sources of revenue.

Adjusted operating income was up 20%, with margins expanding nearly 300 basis points, and adjusted EPS grew 40% year-over-year in the quarter. In addition to the strong growth in adjusted operating income, the EPS growth was helped by having fewer shares outstanding due to our ongoing repurchases, as well as a lower tax rate.

So let me turn now to our divisional results, and let me begin with the Networks group, where the fourth quarter was very strong and it was a strong end to what was a really, really good year. For the year, we grew revenues 9%, with solid revenue growth at both HBO and Turner, and we grew adjusted operating income mid-single digits, and that's despite the effect of the first year of the NCAA basketball tournament.

In the fourth quarter, we posted the highest growth in adjusted operating income of any quarter in the year. Advertising revenues grew a modest 2% in the quarter, and that growth was negatively impacted by the NBA lockout, lower scatter demand and lower ratings at TNT, as well as foreign currency translation. At our international networks, advertising revenue growth was up in the high single digits, and that included about a 400-basis-point drag from currency translation. We continue to see strong growth in our European and Latin American entertainment businesses.

In 2012, advertising growth is tracking somewhere around the mid-single digits. That reflects positive rating trends at most of our networks, particularly TBS. Scatter pricing is up solidly over upfront levels, although volume remains relatively behind recent years. Advertising growth also reflects the ratings challenges that I just mentioned at TNT, as well as the lingering effect of the NBA work stoppage. While the fan and the viewer response to the return of the NBA has been very strong and very encouraging, some of the advertising dollars that are usually spent there were committed elsewhere during the lockout period. And we fully expect that to be a temporary effect that will be resolved by returning to a normal selling cycle.

Moving over to subscription revenues at the Networks, which grew 5% in the quarter and 6% for the year. Similar to what we discussed with you last quarter, certain affiliate fee adjustments in the fourth quarter and the prior year reduced growth by about 1 percentage point in the fourth quarter.

Looking over at the content revenue, sales of HBO original programming drove another year of strong growth in 2011. That included the second cycle syndication of Sex and the City and the international licensing of Boardwalk Empire and Game of Thrones.

Looking at HBO subscriber base for a moment, domestic subscribers increased nearly 200,000 for the year, and that was despite flat multi-channel households, as well as continued losses at a couple of major domestic affiliates. This year, in 2012, we're optimistic that we'll see improved trends at each of these distributors. As Jeff mentioned, we're also really pleased that HBO GO and MAX GO will now be available to nearly all domestic subscribers. And we believe that this will both extend the life cycle of existing subscribers, as well as help attract new subscribers. HBO also grew its international subscriber base by over 25% to end the year at about 53 million, so the global subscriber base now at HBO is around 93 million subs.

Adjusted operating income at the Networks group segment increased 27% in the fourth quarter, with margins expanding nearly 600 basis points year-over-year. Growth here was boosted by the timing of programming and marketing expenses, which were down from the fourth quarter of 2010. And for the year, programming expenses increased 12%, and we've discussed that with you in the past. Excluding the impact of the NCAA basketball tournament, underlying programming expenses would have been up in the mid-single digits, which is right on expectations.

For 2012, we're looking forward to another great year at the Networks group. We expect healthy subscription revenue growth despite the likelihood that currency is going to be a headwind, particularly in the first half of the year. And while we don't have a crystal ball on advertising, we are cautiously optimistic here. We had a very, very strong 2011, 2012 upfront, and advertisers continue to focus their spending on national television.

On the cost side, this will be the second year of the NCAA men's basketball tournament on our network, so we don't have the same challenging cost growth comparisons that we did a year ago. And while we'll keep increasing investment in programming in a controlled way, we'll fund that in part by limiting growth in non-revenue-generating expenses. So putting that all together, we anticipate the Networks group, the profit will grow faster this year in 2012 than it did in 2011.

Let me turn now to film, where Warner Bros. had its best year ever in 2011. Revenues were up 9%. Adjusted operating income grew 16% to a record of nearly $1.3 billion. Warner Bros. had the biggest box office hit and the most successful home video release of the year with Harry Potter and the Deathly Hallows. It also had the biggest syndicated hit on television with Big Bang Theory, which is now the #1 comedy in television syndication. And it also had one of the most successful video game releases of the year with Batman: Arkham City. So 2012 will obviously have difficult comparisons to the record 2011 performance, which may result in lower profits this year compared to last year.

Industry home video trends remain challenging. However, we still believe that it's going to be a very strong year at this division. At the end of 2011, for example, backlog reached around $5.5 billion, and that's the highest year-end level ever. And it's up close to 35% from just 3 years ago. Backlog is the amount of unrecognized cash licensing revenue for television and theatrical product. And although all of that won't be recognized in 2012, it's an important indicator of future revenue pipeline.

We're also optimistic about our film slate this year, as Jeff described, and we should also have another strong year at the TV studio as well. We're continuing to see strong demand across all end markets: broadcast, cable, domestic and international syndication, and SVOD. And we'll benefit from another solid lineup of the syndication pipeline, which this year includes The Mentalist. So tough comps aside, it should be a great year at Warner Bros.

Over at Publishing. In 2011, Time Inc. posted double-digit profit growth in the quarter and the year. Advertising revenues were flat in the quarter and slightly down for the year. Subscription revenues were also down 2% for both the quarter and the full year, and most of that was due to continued softness at the newsstand, particularly in the celebrity category.

Looking into the first quarter, we're seeing continued softness in both advertising revenues and newsstand sales. Adjusted operating income was up 23% in the quarter, with margins up 400 basis points, though much of that growth was due to lower restructuring and severance costs. For the year, margins grew 150 basis points, and that's the highest level since 2007.

2012, we continue to expect a challenging revenue environment, and we'll be making investments in tablet initiatives, as well as experiencing increased physical costs like postage and paper. All of that could make profit growth here at this division difficult.

Turning to the next slide. 2012, let me provide some context for the outlook this year. We fully expect to see longer-term secular strength in most of our businesses. Demand for high-quality content is increasing. TV advertising is taking share, and international opportunities are expanding. So we're investing aggressively against these significant opportunities, particularly in original programming and our company-wide Content Everywhere strategy.

We'll also invest in our enterprise efficiency initiatives, which are focused principally in the areas of real estate and information technology. As part of that drive, we anticipate corporate expenses will actually trend somewhat higher this year. We're doing that, though, with an aim to generate material recurring annual savings over time once these initiatives are fully implemented.

We're also doing all that against a backdrop of what is the uncertain macroeconomic environment, and we expect that there could be some volatility in exchange rate changes. And in fact, at current rates, FX translation could be a drag of about 200 basis points on growth in adjusted operating income in 2012.

We have a lot riding on the success of our film slate this year, although we've said we're very optimistic. And all of this that I just described perhaps makes forecasting a little harder this year than it has been over the past several years. But nevertheless, we're setting a goal for ourselves, and we expect to post double-digit adjusted EPS growth again this year.

One housekeeping note. As you think about the progression of the quarter, similar to what happened in 2011, keep in mind that we have difficult content comps at Networks in the first quarter. And our film profitability will likely be heavily weighted towards the back half of the year as it was, as I mentioned, in 2011 due to the timing of theatrical and home video releases.

Turning now to the next slide, which details free cash flow. 2011, we delivered approximately $2.7 billion, and that was higher than we anticipated when we came into the year. And that was the result of very strong free cash flow generation in the fourth quarter. In 2012, we expect the conversion ratio of free cash to be in the same range as it was in 2011. Our use of working capital should be somewhat lower than it was in 2011, but we expect that to be somewhat offset by higher cash taxes and higher cash interest. And that's due to the debt that we issued last year.

So let me end with the final slide, which shows a reconciliation of our net debt balance. We ended 2011 with $16 billion in net debt, and that was up about $3.2 billion compared to the end of 2010, and it was up about $750 million compared to the third quarter. Our leverage ratio is now close to our target of 2.5x. That's up from around 2x at the end of 2010, and it was the result of an effort to improve our capital structure. We achieved that by spending $5.6 billion on share repurchases and dividends, and that's up 80% from 2010 levels and was more than double our free cash flow generation in 2011. We also spent a little under $400 million on M&A actions. In addition, we took advantage of market conditions last year to strengthen our balance sheet by raising long-term debt and amending our $5-billion revolving bank credit facility, which reduced annual cost and extended terms.

So if you look back over the past 3 years, the approach that we've taken has really been one of balance and consistency. And since 2008, we have generated around $8 billion in free cash flow. We've paid out close to $3 billion in dividends. We've repurchased almost $8 billion of our shares or 20% of the base, and we've made $2-billion worth of acquisitions. At the same time, we remained very, very focused on maintaining our balance sheet strength and retaining flexibility.

This year, our philosophy of capital deployment will not change. We're going to continue to look for the right balance between maintaining a strong and flexible balance sheet, while actively deploying our capital to invest in our businesses, make acquisitions and deliver returns to shareholders. We continue to believe that a target leverage of 2.5x is the level that best balances all of these aims and goals.

So you could see from our continued commitment to direct returns in the board's decision to increase the dividend and authorize the new share repurchase program. But now that we have reached the target leverage, the excess capital that we're going to deploy will be primarily determined by the growth in our businesses and our free cash flow generation. So as of now, we expect buyback levels in 2012 to be lower than they were in 2011.

Now let me turn the call back over to Doug to begin the Q&A portion of this phone call. Thank you very much.

Douglas Shapiro

All right. Thanks, John. Christine, can we get the Q&A started? [Operator Instructions] Thank you.

Question-and-Answer Session

Operator

[Operator Instructions] The first question comes from Spencer Wang from Crédit Suisse.

Spencer Wang - Crédit Suisse AG, Research Division

I have one for Jeff and one for John. Jeff, on some of the new technology initiatives, I was wondering if -- with HBO GO, if you've seen that help the churn numbers. And if so, if you could maybe quantify that. And on UltraViolet, would you consider an earlier UltraViolet window to stimulate UV sales? And then secondly, for John, I know at cable networks, you said the margin sounds like they'll be up year-over-year. Should we expect programming cost growth then to be around mid-single digits?

Jeffrey L. Bewkes

I think your first question was HBO churn?

Spencer Wang - Crédit Suisse AG, Research Division

Right, from HBO GO.

Jeffrey L. Bewkes

We're really happy with the user data and the satisfaction letters -- levels that we're getting. The subs really like it. Viewership is up a fair amount in the homes that are using GO. It's pretty early to tell exactly what that will do mathematically to the churn across the base. So we expect it will be sometime before we start to get a real sense of that. But GO basically, it obviously makes it easier to watch HBO. It brings new subs in and extends the life of existing subs. So it's going to be an increasing net positive. Think of it really as what we've already seen at HBO over the years on Video on Demand, which raised the viewing and helped stabilize the sub base. Same thing with GO. And then what should make that even more powerful is when more and more affiliates put HBO GO across all devices. There's been a little friction and not as much speed as we would like in having all of our subscribers to HBO get GO on every kind of device. On the early window for electronic sell-through, we're evolving the windows all the time. And as you know, we've had some efforts on rental which are more like tests. The powerful thing would be to have that electronic sell-through start earlier. And one of the issues for that is really the security of the television. And as the ability to secure the early release gets more -- when we get more confident in that, I think that the whole industry will move towards earlier sell-through. But not -- we don't see any reason that, that has or will cannibalize theatrical. And we think it can fit in correctly with the current retail distribution system that you have for physical.

John K. Martin

Spencer, it's John. Your question regarding programming cost and network margins. For 2012, I think it's going to be pretty consistent with what we've done over the past 3 to 5 years. Think about programming cost increases going up in a controlled way, mid to high single digits. Remember, it's an election year. We'll spend a little bit more at CNN for news gathering costs. There'll be an increased investment in original programming to try to take advantage of our lead positions. And like we've done in the past, we're going to continue to shoot for all other costs at the Networks division, including marketing, SG&A, overhead, other back-office-related costs -- those are going to grow at a much slower rate. So those will grow sort of low to mid. So that on a combined basis, overall expense growth should be mid-single digits, and we would anticipate margin improvement.

Operator

The next question comes from Richard Greenfield from BTIG Research.

Richard Greenfield - BTIG, LLC, Research Division

I wanted to follow up on the last question because I think it's important. When you look at the goal of getting TV Everywhere to the television, some of your biggest distributors like Comcast, Time Warner Cable and DirecTV have all decided that HBO GO isn't going to be accessible for right now on devices like the Roku. And it's unclear what they will or won't allow in the future. They seem to cite customer data retention or viewership information as an issue here. Just wondering if you could give us your sense of kind of how this gets worked out and how the industry is going to get comfortable with this, because it seems like getting into the television is what has made Netflix so successful, and it seems like what it will really drive HBO GO's success, as well as other of your TV Everywhere platforms. And then just a quick follow-up. In the press release, you cite licensing profits from Turner for both Q4 and 2011 drivers. Can you just give us a little sense on what was in there?

Jeffrey L. Bewkes

I'm glad you asked us both of those. So let's go to the first one. Frankly, I don't understand the reticence of distributors to authenticate on third-party sites like Roku and get HBO and TNT and all of those channels to television. As a general principle, we, as an industry, should be making viewers have availability with on-demand TV of all of their favorite networks on any platform, any device that they want to use. And what's kind of powerful about it, and I think it's in your question, is that by authenticating TV Everywhere, basically that whatever network you like on all devices and platforms, cable operators would be making the video subscription they sell to consumers enormously more valuable. They would, therefore, make it much less likely that a consumer would cut the cord. They would basically bring on stream all those younger people that are wondering whether they're ever going to subscribe to cable. And so by providing ubiquitous access to TV channels on demand, they would diminish the relative value of over-the-top services or SVOD services that are really nothing more than the same programming offered on demand in a later window. So as an industry, and I'm speaking now for all our networks, we've got great, fresh, really popular programs. We ought to make it available to our viewers on all their devices on demand, as easily as we can at no extra charge. All the -- that's how you fulfill the promise of your brands and of television to viewers. And I'm hopeful that the industry will move pretty quickly past some of its -- I think their more minor concerns that they have, and they ought to speed up.

John K. Martin

Rich, it's John. On your licensing revenue question, I think that the press release highlights the content revenues from HBO and licensing from Turner. It's really "normal course of business" type of stuff. There's nothing notable in there. It's the type of licensing revenues that we generated on an annual recurring basis from Cartoon Network, merchandising and licensing of our properties there, as well as some NCAA stuff.

Operator

The next question comes from Jessica Reif-Cohen from Bank of America.

Jessica Reif Cohen - BofA Merrill Lynch, Research Division

I have 2 questions. One, John, I just wanted to review what's in the guidance really quickly. I think you said you were cautiously optimistic regarding advertising, and I was wondering if you could just maybe size it. Does that mean mid-single digits or high single digits affiliate fees? It kind of sounded like mid to high. And then what is in -- would you encompass, like SVOD deals for -- well, SVOD deals for Warner Bros. in that guidance? And the second question -- Jeff, I'm sorry -- Jeff said that there would be a meaningful increase in Harry Potter license fee beginning in 2014. So I'm just wondering if you could size that. How meaningful of an increase and what is your share or what is your split with J.K. Rowling?

John K. Martin

I'll start, Jessica. Look, on the guidance, we're not going to give specific forward-looking guidance on a line-by-line basis. And my cautious optimism, I think, is a reflection of the fact that we are planning to see an acceleration from Q4 to Q1 as it relates to ad revenue. We are seeing scatter pricing up nicely over upfront pricing levels. In the upfront, as I mentioned, we were up low double digits in pricing. The volume has been a little bit light. And certain categories, such as packaged goods, have been a little bit light. So I mean, there's some mixed signals there. But we've got ratings momentum at most of our networks, which we're actually quite pleased about, and it's not just TBS. It's Cartoon Network, which has been up nicely. It's CNN. It's truTV. And we're optimistic that TNT's ratings are going to improve as we progress through this year. On the subscription revenue side, which has been an amazingly consistent revenue line for us, the networks where we've got about $8.2 billion of annual revenues, I think what we've said in the past continues to hold true, which is that we're experiencing about mid-single-digit pricing increases across the board. In part, the subscriber revenue levels will depend on whether we get unit growth, particularly in the U.S., because we anticipate getting unit growth outside of the U.S. And then FX, which -- FX, over the last several months, has moved around quite a bit. Right now, it looks like it's a drag, but who knows what happens going forward? But the fundamentals of the subscription revenue growth is still very strong, and we did experience the high single-digit growth at Turner a year ago that we predicted. And we think for the sustainable future, it's going to be a strong revenue generation source for us. And remember, all of this is before we'd see a meaningful acceleration from the NCAA. As it relates to SVOD deals, I'm not going to be specific. We had -- in 2011, I think I might have mentioned on the last quarter's call, we had revenues recognized in the fourth quarter that were -- that was a little north of $100 million. And from the deals we've announced, we expect at least that same level in 2012, but we've got numerous discussions occurring with multiple SVOD providers. And what's very clear is there's a fair bit of demand out there. And frankly, Warner Bros. has the deepest, richest and broadest library of both films and TV shows. So we're quite confident in our ability to monetize that in a value-accretive way going forward.

Jeffrey L. Bewkes

Let me just add -- John just said it. Warners has 6,000 films and over 75,000 TV episodes, so we're feeling pretty good about that situation. I think you asked about Harry Potter parks, if I understood the question. And we're really excited about the new agreement that we have with Universal. It's a great example of how Harry Potter is going to live on and be vibrant in coming years. It's going to include taking the Wizarding World of Harry Potter to Universal Los Angeles, and we're going to expand the widely successful gate in Orlando. We think it really is promising. It highlights the power of Harry Potter and really of any great franchise. And we will start, and I think this goes to your question, to recognize the revenue from that once the parks open. So that's a few years off. I shouldn't forget, we're also opening up The Making of Harry Potter this March at our studio outside of London. And there are many other international theme park locations you're all well aware of, all of which represent big opportunities for Harry Potter, but we don't -- we're not ready to announce those yet.

Operator

The next question comes from Michael Nathanson from Nomura Securities.

Michael Nathanson - Nomura Securities Co. Ltd., Research Division

I have a couple of housekeeping questions for John. So, John, on affiliate fees in Networks, can you give us the detail between, in this quarter, domestic affiliate fee growth and international fees? You gave it for advertising. I want to get it for affiliate fee growth.

John K. Martin

Sure, Michael. Let's start with the bigger picture, and then we'll drill down. So affiliate fees in the fourth quarter grew about 5% at the Networks. And that was, I think as I had mentioned in my proactive remarks, held back about 100 basis points or so from some, what I'd call ordinary types of adjustments that would have occurred in HBO. And FX as well. Thanks, Doug. In addition, so if you look at the breakout between domestic and international, we saw domestic affiliate fee growth of around 4%, and international was about 3x that. If you look, though, more broadly over the year, which I think is a more relevant barometer than any one particular quarter, basically, our international growth is growing at about twice the level as our domestic growth. And I think it pretty much holds true that if you look at -- we grew affiliate revenue about 6.5% at the Networks and that was about 5% -- a little more -- around 5% domestic, and then international was high teens. And then averaged out overall, as I said, on the ad side, international growing much faster than domestic and around twice the level.

Michael Nathanson - Nomura Securities Co. Ltd., Research Division

Okay. And then, John, on cash flow, you gave us a lot of detail. If you look at your Slide 11, something that jumped out at us was the difference between cash interest and P&L interest and the cash taxes and P&L taxes. And the question would be is, at what point do those 2 things narrow, do you start booking cash at the P&L rates for taxes and interest? So what's going on there?

John K. Martin

It's really timing, Michael. I wouldn't look too much -- that much into it. One of the reasons why we think cash taxes are going to up in 2012 as compared to 2011 is because of the timing of when the payments occur. So it benefited us a little bit in '11. We'll have to deal with higher levels in '12, but we're also going to grow the underlying free cash flow from operations in '12. So -- but it's one of the reasons why, as we talk about 2012 free cash flow, we're anticipating our conversion rate of operating income and EBITDA to be roughly constant as compared to '11. And some of you may remember that we had been projecting that free cash flow conversion levels would accelerate in '12 versus '11. I would just remind you that our free cash flow actually came in higher in '11 than we were anticipating. So as a result of that, flat conversion is still at very strong levels, but it's basically growth in operating income being somewhat offset by growth in interest because of higher net debt levels and growth in taxes.

Operator

The next question comes from Alexia Quadrani from JPMorgan.

Alexia S. Quadrani - JP Morgan Chase & Co, Research Division

I know you're in the early stages of monetizing your NCAA affiliate deals. Can you give us an update on how the conversations are going? And do you think these conversations imply that you could see an acceleration in affiliate fee growth beginning in 2013?

Jeffrey L. Bewkes

Well, we're really confident in what is going to happen on affiliate side because of that deal. We've already signed some deals, and we're getting more than the -- well, we're getting the value we sought. I'm also -- we're also having pretty constructive conversations with other affiliates beyond the ones we've already done. Basically, we are above the levels that we want and aim to be at in order to go and make this programming investment. So we're even more confident now than when we signed that this is going to be very profitable for us. I'm not -- we're not going to get into the exact timing of when the effects of this hit affiliate rates. It won't be as much in '12 and '13 as it will be in later years, and it's going to be very significant.

Alexia S. Quadrani - JP Morgan Chase & Co, Research Division

And you mentioned some softness in the volume and the overall advertising market in the first quarter, even though scatters are obviously up nicely over the upfront levels. Have -- those verticals that have sort of pulled back are staying out a little bit. Are you seeing any abnormal activity in terms of cancellation of commitments for the June quarter maybe from those verticals or just in general?

John K. Martin

Alexia, it's John. The answer is no, in terms of abnormality. We're seeing cancellation levels in Q2 at or about the same level as we've seen in each of the last 3 years. And in terms of verticals, I think, as I mentioned in, I think, an answer to an earlier question, we have seen some pullback from global packaged goods companies. We've also seen a little bit of softness in some other categories that you wouldn't ordinarily think of, and we think it may be more due to timing than anything else. But there has been some softness in media spending and some softness in movie studio spending, but that could be more product specific as opposed to anything secular or cyclical there rather. So we're not setting off the alarm bells here in any way. I don't want to misguide you in terms of -- but it's just early days, and we're in the middle of February. And so we just feel like being cautiously optimistic at this point is a prudent way to approach the year.

Operator

The next question comes from Doug Mitchelson from Deutsche Bank.

Douglas D. Mitchelson - Deutsche Bank AG, Research Division

So for Jeff, you mentioned expansion in key international territories as a core goal this year. So I was just hoping if you'd provide more specifics around which territories would be considered key territories and what expansion could entail. I mean -- well, I guess, where we're trying to go here is trying to understand the potential size of acquisitions looking forward and whether the $1-billion guidance for international 2014 EBIT includes -- is organic from here or includes likely acquisitions.

Jeffrey L. Bewkes

We think we can hit those goals with organic growth of what we've already got. Just to give you a little more flavor, we grew revenues double digits around 14% in 2011. And that's despite the exposure to more mature businesses, such as home entertainment and Publishing. And we're seeing even better growth than that at the Networks. As you know, and John said this, we grew the revenue there more than 25%. The secular trends overseas for Networks are stronger than the U.S. We're seeing particularly strong growth in Latin America. We did well over $1 billion across the company there this year. And as we go to the cable network side, we think it's going to be a very key, steady and reasonably fast-growing part of the business. I think we just -- we said it already on the call, the $650 million of adjusted OI [ph] that you just referred to. And we think that, that's going to hit $1 billion in the next few years just on organic growth. The areas where we've been focused, to answer, I think you asked it geographically, are Latin America, Eastern Europe. We put some effort into India. It hasn't worked very well so far. But we continue to look at that pretty hard. And that's where we're going, and we're going to build on our positions. Our margins, just to go to that part, are reasonably strong in Latin America. They're not as high as the U.S. domestic levels. But it shows you, as you go through the world in our Network business, that you can have strong margins heading towards U.S. levels as the markets in which we're operating develop, so Latin America first, Eastern Europe next and then South Asia after that.

Operator

The next question comes from Anthony DiClemente from Barclays.

Anthony J. DiClemente - Barclays Capital, Research Division

I was enjoying the narrative from Jeff on more strategically on content and distribution. I'm just wondering where Apple fits in. I think, I mean, it's hard to deny Apple has just become a tremendous force in terms of media consumption. Is Apple good for Time Warner and the content companies? Where do you see them fitting in terms of distribution of your content?

Jeffrey L. Bewkes

Yes, Apple's great for Time Warner. It's great for films. It's great for networks. It's great for magazines. Remember, all are -- basically what happens when you have great interface devices like Apple, and you could say the same thing for Facebook, is that you have better opportunities for consumers to read or watch our TV, our movies and our magazines. And what you've seen -- and there's, I think, been confusion out there over the last couple of years, is when you look at strong brands, hit titles, movies, TV shows, magazines like People, all the viewing when you give people choice goes to the hit titles, the newest things. And what we're doing, which we've said it over and over -- I'm sorry, I'll have to say it again. We're making our hit shows, movies and magazines available to our engaged readers and viewers exactly how they want it, for no extra cost, in a way that's really even more engaging than how they used to get what they read or what they watched. So what you have, not just Apple, but all these technological advances just makes the programming and the magazines more valuable. And we think we have a model that appeals greatly to consumers. It's really a proven model. There's no reason it can't succeed wildly, and I think you're really seeing that happen now.

Anthony J. DiClemente - Barclays Capital, Research Division

And does that stay true as Apple -- there's been talk that Apple television and Apple television will be introduced. So if the consumer increasingly actually uses Apple as the primary interface for content consumption, does that change, that create risk to the affiliate model? Or do you hold by your comments here? I'm just trying to figure that out in my mind.

Jeffrey L. Bewkes

An Apple screen is a television. So if you like your Sony TV at home or your Samsung TV on the wall or your Apple iPad sitting in your lap, they're all televisions, and our shows are all on them. And you can get them all whenever you want for no extra charge.

Operator

The next question comes from Jason Bazinet from Citi.

Jason B. Bazinet - Citigroup Inc, Research Division

I just had 2 quick ones. I think there was a difference between net income and adjusted net income of about $173 million in the quarter reflecting the write-down of CETV, which I assume is just a mark-to-market gain. Has anything changed in terms of your view of the strategic value of the assets, sort of holding aside the vagaries of the market? And then my second question is, and I may be reading something into this that's meaningless, but your definition of adjusted EPS seem to include some incremental items related to pension plan curtailments. Is that meaningful at all?

Jeffrey L. Bewkes

So the good news is I can give the pension plan accounting. That's just an accounting. It hasn't changed in our view. We're very optimistic about CME in that market. And it's essentially just the stock market there for all companies there. And we have the mark-to-market on that.

Jason B. Bazinet - Citigroup Inc, Research Division

But you still like the asset?

Jeffrey L. Bewkes

Yes.

John K. Martin

And, Jason, it's John. Regarding the change in the definition, there's really nothing there other than periodically, we go and review the definition and try to figure out whether there are other potential things that could happen that really aren't indicative of our ordinary course of business or our normal business actions. So -- but it's not significant at all. In fact, if you look back, there's nothing really in history that would have captured or fallen into this definition. So if you -- so it doesn't change the base of EPS with which we're going to compare our future performance against for 2011. So that's the first point I'd make. And the second point I'd make, and I just want to be clear on this, we're not considering doing anything at this point either. So I don't want to foreshadow something that we're going to do and we're trying to get ahead of it by changing the definition. That's not the case at all. It's just that periodically, we evaluate the benefit plans that we have, and we could make adjustments if we determine that they're in the best interest of the company. So that's all. It's immaterial. There's virtually nothing going backwards.

Douglas Shapiro

Thanks a lot. And Christine, I think with that, we're just about on the hour. It's probably time to cut it off, but thank you, everybody, for listening in.

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