Time Warner Q2 2008 Earnings Call Transcript

| About: Time Warner (TWX)

Time Warner Inc. (NYSE:TWX)

Q2 2008 Earnings Call

August 6, 2008 10:30 am ET


Doug Shapiro - Vice President, Investor Relations

Jeffrey L. Bewkes - President, Chief Executive Officer, Director

John K. Martin Jr. - Chief Financial Officer, Executive Vice President


Jason Bazinet - Citigroup

Jessica Reif Cohen - Merrill Lynch

Benjamin Swinburne - Morgan Stanley

Tuna Amobi - Standard & Poor’s

Rich Greenfield - Pali Capital

Michael Morris - UBS

Doug Mitchelson - Deutsche Bank

Imran Khan - J.P. Morgan

Anthony DiClemente - Lehman Brothers

David Joyce - Miller Tabak & Co.


Hello and welcome to the Time Warner second quarter 2008 earnings call. (Operator Instructions) Now I will turn the call over to Doug Shapiro, Vice President of Investor Relations. Thank you, sir, you may begin.

Doug Shapiro

Thank you and thanks and good morning, everyone. Welcome to Time Warner's 2008 second quarter earnings conference call. This morning we issued two press releases, one detailing our results for the second quarter of 2008 and the other reaffirming our 2008 business outlook.

Before we begin, there are a few items I need to cover. First, we refer to certain non-GAAP financial measures. Schedules setting out reconciliations of these historical non-GAAP financial measures to the most comparable GAAP financial measures are included in our earnings release or trending schedules. These reconciliations are available on our website at 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, 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 quarterly reports on Form 10-Q. Time Warner is under no obligation to 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.

Finally, I would like to draw your attention to Time Warner's new quarterly investor newsletter, In Focus, which features news and operational highlights from our businesses and we think you will find it helpful. It’s now available in the investor relations section of the company’s website.

With that covered, I will thank you and turn the call over to Jeff. Jeff.

Jeffrey L. Bewkes

Thanks, Doug. Good morning, everybody. With half the year behind us, today is a good time to take you through what we’ve achieved so far and what we are working toward in the months ahead.

If you boil it down, or goal at Time Warner is to create, package, and distribute high quality branded content across multiple platforms and all around the world, and doing all that at the highest returns possible.

When you hear that word platforms, you tend to think of it as kind of organized speech. For us, it’s basically TV screens, computer screens, movie screens, magazine pages, anywhere that media content goes in the world and whichever one is most important in the country where you live.

Well, at the beginning of this year, we laid out three key objectives to help us reach this goal. First, to make sure we have the right businesses and the right structure; second, to improve the competitive position and the operating performance of all of our businesses; and third, to actively manage the balance sheet.

So as we’ve been doing, I would like to start with the first of these priorities, our structure. I think we’ve made substantial progress since we last met on the call. In May, we announced the terms of our separation from Time Warner Cable. This is the right step for both Time Warner and Time Warner Cable stockholders because it will increase the long-term strategic, operational, and financial flexibility of each company. It also marks an important step in the continuing transformation of Time Warner. Since May, we’ve made a lot of progress toward the cable separation and we still expect the deal to close around year-end.

Still in the structure area, turning next to AOL, we’ve now made the key financial and strategic decisions that will enable us to operate the access and audience businesses separately. First, we classified all of AOL’s assets and liabilities into one of three groups -- access, audience, and a share service group that will support both of the operating groups. Second, we are finalizing operating agreements among these groups so that they can operate fairly flexibly. And we are pretty clear that implementing these decisions in the coming months should enable us to begin running these businesses separately in 2009.

So with the progress we’ve made on that to date, we have the necessary flexibility to do something strategic with either of these businesses today.

In the film area, still in the question of structure, we also essentially completed the reorganization of New Line Cinema. We still think that the cost savings and revenue improvements will produce benefits in excess of $140 million annually starting next year. And then last, our effort to streamline our corporate costs is running ahead of our target of $50 million in annualized reductions this year.

So that was all the structural moves that you know that we’ve had underway. Let’s move to our second key objective, improving our operating performance.

Overall, we’re delivering results in line with our plan and in line with our guidance, as you saw this morning, despite the tough economic climate. Some of our businesses are tracking ahead of expectation, some are essentially on target, and some are behind. Let me start with the businesses that are performing ahead of expectations this year, networks and film.

At Turner, we posted another quarter of very strong financial results with 11% advertising growth and double-digit subscription revenue increases. Ratings remain strong at our largest networks, beginning with CNN. Delivering was up better than 20% in the key primetime demos compared to last year. The election season is helping, of course, but we are also taking share. Consider that CNN is also up almost 20% from the second quarter of 2004, and that was the comparable period in the last presidential election. Each of the broadcast networks’ news divisions and our key cable news competitor are down double-digits over the same period, so that’s essentially the news sector inside Turner.

In Turner’s entertainment networks, also posting very strong growth, TBS up 33% and TNT up 8% in the key primetime demos. And TNT’s original programming strategy, which we have been talking about on these calls, continues to gain momentum. Last month, the premiere broadcast of the The Closer and Saving Grace captured the number one and number two highest rating cable debuts for this year.

And we’ve longed maintained that our entertainment networks are broadcast substitutes, and this position has increasingly resonated with advertisers as we’ve continued to enhance our brands, our programming, and our reach but never more so than during this year’s up-front.

On average, our entertainment networks posted CPM increases in the high-single-digits and dollar volume increases well into the double-digits. These increases mark the top-end of the entire TV universe. That includes both broadcast and cable.

Subscriber supported television -- after a pause last year, HBO is on track to again growth its OIBDA by double-digits this year, and that’s driven by solid affiliate fee growth and a very predictable, well-managed expense base.

Underscoring its continued success in attracting top talent, HBO received the most Emmy nominations of any network for the eighth year in a row -- 85 nominations, 23 for John Adams alone, and if you saw John Adams, he was alone a fair amount of the time.

In recent months, HBO has accelerated its production of pilots for original series and it now has more in development than at any time in its history, with the goal of having new seasons of original shows on every quarter.

Now, let’s go to Warner Brothers. Warners has had an extremely successful run this year. Unless you are living in the batcave itself, by now you know that the -- you are aware of the record-breaking summer of The Dark Knight, which is now on track to become the second-highest grossing film of all time and who knows -- we might make it to the top.

Some view the film business as unpredictable. That’s not really been our experience at our company because viewed through the prism of a multi-year timeframe, The Dark Knight is no fluke. Our studios have now produced eight of the top 15 grossing films of all time and no other studio counts for more than two. This success reflects our scale and our strategy, the machine we’ve built up around tent-poles, from development to production, marketing and distribution particularly, manufactures hits, turns them into hits, and over a multi-year period has done so consistently.

It’s the film business, so occasionally we misfire, as we did with the Speed Racer, but our hits far outweigh our misses and you can see it in the consistency of our financial results in film.

It also reflects our ability to mine our intellectual property. You are familiar with three of our most successful franchises -- Batman, Harry Potter, Lord of the Rings. These three are already among the top six highest grossing franchises ever at the box office worldwide and there are more films yet to come from each of these franchises. And please keep in mind that we have yet to exploit much of our DC Comics portfolio or our vast TV library.

For example, our most successful theatrical release in this second quarter -- remember, Dark Knight is third quarter -- in the second quarter was Sex and the City and Get Smart, both originating as TV shows and the success of Sex and the City, just to pick one, was particularly gratifying because it’s a property that touched so many parts of our company. It has its inception on HBO, it was syndicated with great success on TBS, then became a film produced by New Line and finally was marketed and distributed worldwide by Time Warner Brothers, so that would be one.

Another example that we are very excited about coming up, Star Wars: Clone Wars. This will be the first CGI Star Wars theatrical release. It will be released by Warners next month in theaters and after that, we’ll debut The Clone Wars TV series on Cartoon Network and then it will have rebroadcast on TNT.

Now, Warner Brothers also continues to lead the industry in the most promising growth areas in the film business. Two of these are Blu-Ray and VOD. As you know, since our decision to embrace the Blu-Ray format exclusively, industry sales have accelerated significantly. We’ve been the most aggressive studio also on the VOD front. For example, next year every release, with the exception of Harry Potter coming out of Warners, will be released to VOD day-and-date, and in both Blu-Ray and VOD, we have the highest sales of any studio, substantially over-indexing relative to our theatrical share.

Now, still in the films segment is the games business, and our games business is also ramping up. Lego Indiana Jones was the top-selling videogame in June and we have high hopes for Lego Batman, as you can imagine, which we are releasing in September. Over time, we expect games to become an increasingly important part of Warner Brothers' business.

So moving from -- now I think I’d like to move over to the business that’s performing essentially in line with our financial expectations but it’s actually ahead on subscriber growth, and that’s Time Warner Cable.

As you heard on its earnings call earlier this morning, Time Warner Cable posted another quarter of very strong RGU net additions. It was the best second quarter in its history, and that’s in pretty stark contrast to concerns about the impact of competition, whether from phone or satellite, and the economy. So the company remains on pace to achieve the key elements of its full-year financial outlook.

Turning last to AOL and publishing, these are both tracking behind our expectations this year but for different reasons. At AOL, there continues to be encouraging signs about the underlying health of the business; in particular, it continues to post strong usage growth, which is accelerating from last quarter. Total page views, for example, during the quarter on the AOL network were up 6% over last year, powered by almost 60% growth in our content verticals, which shows the success of all our recent relaunches there.

In addition, as John will outline, our third-party advertising business continued to deliver solid growth even in a difficult ad environment, which highlights the competitive position and the value of platform A. But as anticipated, display advertising declined in the quarter. It was down 14%. We saw pull-backs on some ad categories, notably autos, financial services, telecom and travel. But we believe this performance was also due to the continuing effects of the acquisition integration issues that we discussed on our last earnings call, because as you’ll remember we put a lot of pieces together over the last year. And as we cautioned then, we did not expect to reverse those trends in the second quarter.

The good news, or the better news, is that we have made substantial progress since then, particularly this month, during the recent period. Platform A is now fully integrated -- that’s across sales, marketing, operations, and engineering, and we fully integrated Tacoda and Quigo targeting technologies, which we can now offer access to across the AOL network inventory and across, of course, the third-party network.

We remain optimistic, as we said last time, that we are going to see the benefits of these organizational changes starting in the second half.

And then moving last to publishing, which as I said is behind our targets, of all our advertising driven businesses, Time Inc. felt the greatest impact from the difficult advertising environment. There was softness in the quarter across many of the same categories, including pharmaceuticals, autos, cosmetics, and financial services, and that drove down advertising revenues by 9% year over year in the quarter. Online ad revenue continued to grow rapidly but this quarter, it was not sufficient to offset the decline in print.

There are a number of bright spots in our publishing business. Time Inc. continues to drive traffic to its websites. Unique visitors are up more than 30% year over year in the quarter across all of its sites, according to Nielsen, and magazine readership growth also remains strong. We have about double the growth pacing of the rest of the industry in the second quarter, and our publishing company continues to manage its cost structure aggressively.

So we don’t know when the ad market will turn but we are confident that Time Inc. will be well-positioned when it does.

I’ll close by touching on our third primary objective, which is actively managing our balance sheet. We define that as maintaining a level of leverage that supports a solid investment grade rating for our businesses, while balancing opportunities to invest against returning capital to stockholders.

Our first priority in using our financial capacity will always be to continue investing in the growth of our businesses, but this is unlikely to use much, and certainly not all of our excess capacity.

We will also pursue acquisitions, those that improve our competitive position and our growth prospects in our existing operations but only in a disciplined way. And that means the expected return on investment must be better than alternative uses of our capital, including repurchasing our own stock. And of course, with the current price of our stock and earnings multiples attached to that, that is a high hurdle to meet in acquisition assessment.

And we do believe strongly in the merits of returning capital directly to stockholders. You may notice in our press release that we didn’t buy back any stock in the quarter. We do consider the stock extremely attractive at current levels but in light of all that we have had going on, we decided it was prudent to stay out of the market.

As you know, a key element of the cable separation is that when it closes around the end of the year, Time Warner Cable will pay a special dividend to all of its shareholders, including $9 billion in a quarter to Time Warner. That step will better optimize the balance sheets of both Time Warner and Time Warner Cable. And post-close, it will provide Time Warner with a lot of flexibility. We regard that as an important advantage but we recognize that it also has raised questions about how we intend to use this capacity.

We just want you to know that as we assess our capital allocation options, we will continue to adhere to the disciplined framework that I just outlined.

In sum, I am proud of how well we performed so far this year. We’ve made significant progress on our key objectives and on the whole, our businesses have proven resilient in a tough economic environment, as evidenced by our ability to reaffirm our full-year business outlook.

The resilience stems from the strength of our brands, from the expertise of our people, and the scale of our operations, which we believe give us a sustained advantage in creating, packaging, and distributing the most compelling content worldwide. It’s something Time Warner has always done extremely well and it’s why I’m excited about both our continued transformation toward an even more content focused company and about our long-term growth prospects. Certainly a lot more to do but we believe that we are taking the steps to deliver the most value to shareholders.

Thanks for listening and now I’ll turn over the call to John Martin.

John K. Martin Jr.

Thanks, Jeff and good morning. I am going to briefly provide some additional context around the second quarter results and as usual, there are slides now available on our website to help you follow along with my remarks.

Jumping right in, the first slide shows our consolidated second quarter financial highlights. There were a few takeaways to what we believed was a pretty good quarter overall. First, revenues were up 5% year over year, or $575 million, and adjusted OIBDA grew 4% or $115 million.

As you know, we’ve been increasingly thinking about our businesses in three buckets, and they are cable, content, and AOL. In the second quarter, it’s interesting to note that Time Warner's results will exclude the impact of both Cable and AOL, so effectively just the content businesses, which we are defining as networks, filmed entertainment, and publishing plus corporate expenses and eliminations. Those revenues grew high-single-digits in the quarter and adjusted OIBDA was up 11%.

The second takeaway is that our adjusted earnings per diluted share increased a solid 9% compared to the year-ago quarter, and third, we have now generated $2.9 billion of free cash flow year-to-date, which is a terrific start to the year and it represents a very high OIBDA conversion rate of 46%.

The next slide shows a little bit more detail related to our EPS figures. Diluted EPS was $0.22, which compares to $0.25 for the second quarter of 2007. Both quarters, however, had notable items affecting comparability. These are highlighted in broad groupings on this slide and in greater detail in our earnings release. Adjusting for these, the quarter’s EPS was $0.24 and the 9% growth rate was due to both higher adjusted OIBDA and a smaller outstanding share count due to our buyback program.

Turning to free cash flow on the next slide, as I mentioned, year-to-date free cash of $2.9 billion is up considerably over the first half of last year, almost $900 million in fact. Much of this difference is due to a positive swing in working capital so far this year but we do expect at least a portion of this to reverse in the back half of the year.

Our cash interest expense is relatively flat and CapEx is also flat, or approximately flat over last year, with 83% of our capital at the cable segment year-to-date. It’s interesting to see that when you exclude Time Warner Cable, the company’s CapEx represents only about 2% to 3% of our revenues, which is very, very low.

I will also add that Time Warner has been delivering significant free cash flow on a very consistent basis. In fact, for nine of the last 10 quarters, our free cash flow has been close to or above $1 billion, and I believe in eight of the last 10 quarters, our conversion of OIBDA has been in excess of 30%.

Turning to the next slide, we are reaffirming our full-year business outlook and echoing what Jeff just said, we are encouraged that our business performance has proven resilient overall, and I think it’s fair to say that the economic environment is clearly more challenging than we anticipated when we first provided our outlook at the beginning of the year and that’s particularly true for the ad environment.

In this outlook, we focus on three measures. First, we reaffirm that adjusted OIBDA growth should be in the range of between 7% and 9% this year. As I indicated last quarter, based on current trends we continue to expect to come in at the low-end of the range, and recall please that this includes an estimated $140 million of restructuring charges at New Line, which we also didn’t incorporate into our original outlook, and that represents about one full percentage point of growth. So when you take that into account, we’d actually be tracking right in the middle of the range.

Given our first half actuals, that also means that we do expect our second half OIBDA growth rate to improve versus the growth rate we experienced in the first half.

Next, in addition we reaffirm that free cash flow should be at or above $4.5 billion and in light of the very strong conversion levels so far this year, we’re extremely confident that we’ll be able to achieve this.

Last, we also reaffirm that diluted EPS should be in the range of $1.07 to $1.11. Accounting for items that are affecting year-over-year comparability, this represents solid double-digit growth over last year.

I would also point out that we are reaffirming both EPS and free cash flow outlooks despite the higher financing and other separation related costs that we are incurring this year, tied to the cable separation.

Turning now to our balance sheet, next slide, we ended the quarter with $34.6 billion of net debt. That’s about flat compared to where we were last quarter. Year-to-date, net debt is down about $1 billion. That’s due to $2.9 billion of free cash flow generation offset in part by about $1.3 billion in acquisitions and $450 million in dividend payments.

As you know, in June Time Warner Cable completed a $5 billion bond offering. This allowed them to reduce the amount of bridge financing required to pay the planned special dividend and importantly, that offering also reduced the size of the supplemental loan commitment Time Warner provided to Time Warner Cable beyond the term of the bridge facility. That commitment goes from $3.5 billion to $2.5 billion, so we are very pleased with that.

I am going to move now to briefly cover the key highlights of each of our divisions and so continuing through the slides, beginning with our cable company, as you know, Time Warner Cable held a call earlier this morning to discuss its impressive second quarter results. I hope you were able to listen in to that. OIBDA grew 9% in the quarter and the company continued to generate very strong levels of free cash flow. And as we outline on the next slide, subscriber metrics were very strong across the board. As Jeff mentioned, it’s the best second quarter ever in terms of RGU net additions at 656,000. That’s up 20% from the 546,000 it added in last year’s second quarter and it also posted better year-over-year net add performance in every key RGU category.

And I would also like to mention with regard to the important high speed data product, Time Warner Cable added more than 200,000 net subscribers in the quarter, which is more than the net adds of the top two telco companies combined.

Overall, these are very, very strong results, showing both Time Warner Cable’s economic resilience and continued ability to compete effectively.

I’ll move over now to the content businesses, starting with our network segment. Our second quarter performance here is very, very encouraging and is evidence that our strategies here are working very well. Adjusted OIBDA rose 15%, boosted by another quarter of double-digit subscription and advertising revenue growth. Subscription revenues were up 10%, reflecting solid growth in affiliate fees at both Turner and HBO and subscribers at Turner. Turner has now had five quarters in a row of double-digit year-over-year subscriber revenue growth. Turner’s ad business is also strong, climbing 11% with double-digit growth in both the entertainment and news segments. This growth was driven by healthy audience gains, as Jeff mentioned, as well as higher CPMs, and Turner has now posted double-digit advertising growth four quarters in a row.

In terms of the advertising outlook looking out for the rest of the year, keep in mind that our growth comparisons will become more difficult in the second half compared to the second half of a year ago, so while continuing to deliver double-digit gains may prove increasingly difficult, we do feel very, very good about how things are pacing at Turner. The current scatter market is healthy. We’re still running ahead of up-front pricing levels and we continue to see up-front cancellation rates at normal levels.

We also continue to anticipate that HBO and Turner taken together will deliver strong adjusted OIBDA growth this year and will likely post the strongest growth rate of any of our segments.

Moving to film, where we posted another impressive quarter and things look very good for us here for the rest of the year. OIBDA rose 13% in Q2. This is due in part to the DVD performance of I Am Legend, The Bucket List, 10,000 B.C., and Fool’s Gold. The quarter also benefited from higher TV contributions and solid box office results from Sex and the City and Get Smart. The quarter did also absorb the disappointing results of Speed Racer and as Jeff said, please keep in mind The Dark Knight was released after the end of the second quarter.

Looking to the remainder of the year, if you were to look through or exclude the New Line restructuring costs, we are very confident that we will be posting positive year-over-year growth from the film segment and this will obviously be bolstered by the phenomenal performance of The Dark Knight.

OIBDA growth in the second half of the year should be weighted more towards the fourth quarter, as our third quarter results will be impacted by difficult year-over-year TV and home video comparisons, and by contrast to that, that fourth quarter will benefit from the home video releases of The Dark Knight, Get Smart, and Sex and the City.

Turning to publishing, revenues declined 6% in the quarter as a 1% increase in subscription revenue was more than offset by a 9% decline in ad revenues. OIBDA declined 11%, essentially due to the decline in ad revenues offset in part by lower expenses and as Jeff said, and I’d like to underscore, Time Inc. continues to aggressively manage its costs in an effort to both weather the current economic environment and make sure it is well-positioned to capitalize fully when it turns.

We continue to see softness in print ad demand, particularly in pharmaceutical, auto, toiletries and cosmetics and finance categories. That limits our visibility somewhat into ad growth for the rest of the year and right now, I would mention that third quarter print advertising is actually pacing somewhat below where our second quarter performance was. As a result, we think it will be challenging to achieve OIBDA growth in this segment for the full year but please keep in mind that our current business outlook already takes this into account.

Finishing up with AOL, the dynamics this quarter were very much consistent with what we saw last quarter. In the audience business, we saw very strong usage trends and continued strength in our third-party ad network business. But as expected, display advertising was impacted by the acquisition related integration issues, as we discussed with you last quarter. In the access business, the rate of subscriber declines continued to moderate, as did the year-over-year decline in subscription revenues. And adjusted OIBDA was down a comparable amount year over year as we saw in Q1, but as I’ll explain, we do believe the second quarter is the low watermark for adjusted OIBDA this year at AOL on both an absolute dollar and a growth rate basis.

Focusing first on advertising here, total ad revenues were up 2% to $530 million. Just as a reminder, advertising at AOL consists of display, paid search, and third-party network revenue, each of which makes up about a third of the total.

Walking through the components quickly, display declined, down 14% to $191 million. That reflected more units sold at a lower effective CPM, driven primarily by a mix shift away from higher priced guaranteed inventory to lower priced non-guaranteed network inventory. And as Jeff said, the decline in display was due to the integration issues that I just mentioned, as well as softness in certain key advertising categories.

Paid search revenue improved 10% year over year to $172 million, due largely to new search products and higher revenue per search. And as the performance of AOL’s -- and the performance, excuse me, of AOL’s third-party network remains strong. Revenues were $167 million in the quarter. That’s up 15%. Keep in mind that this figure includes acquisition and the change in the Apollo relationship that we’ve been discussing with you. Excluding the impact of the acquisitions, which contributed $40 million to the year-over-year growth and Apollo, which was down $43 million, third-party network advertising revenues were actually up 26%.

Looking into the second half of the year, we expect both the overall advertising and display advertising growth rates at AOL to improve from the pace we saw in the first half, as we encounter easier year-over-year comparisons and will begin to benefit from the organizational changes made during the first half of the year at platform A.

Moving to the access business for a moment, AOL lost 604,000 subscribers in the quarter. This does represent the smallest subscriber decline in any quarter since the company announced its strategy shift two years ago, and AOL had 8.1 million domestic subscribers as of June 30.

Its adjusted OIBDA in the quarter was $350 million. That’s down 28% versus the year-ago period. That was due to both difficult comparisons in the quarter in our access business and continuing advertising mix shift toward our third-party network, which has resulted in higher traffic acquisition costs, or TAC. We expect to see an improvement in the rate of adjusted OIBDA growth in the second half as comparisons get easier, advertising revenue growth improves, and we continue to tightly control costs.

Finishing up with a quick look at corporate spending on the next slide, as you know, corporate is an area where we have committed to reduce our overall level of spending. During the second quarter, corporate overhead declined 13% year-on-year and as Jeff just mentioned, we are now tracking ahead of our target of reducing corporate expenses by $50 million this year, or about 15%. Beyond this goal, we’re keeping a tight rein on expenses and that will continue to be a way of doing business for us.

So thanks and let me turn the call over to Doug as we’ll start the Q&A portion.

Doug Shapiro

Thanks. Can we turn to the Q&A, and please try to limit yourself to one question so we can get to as many callers as possible.

Question-and-Answer Session


(Operator Instructions) We have our first question from Jason Bazinet, Citigroup. Your line is open.

Jason Bazinet - Citigroup

Thanks so much. You mentioned that you’ve completed the economic split between the access and audience business, opening you up to strategic options and I just had a question on the access part of the business. I think most investors sort of contemplate the dial-up business essentially merging with another dial-up provider and then doing a spin-off. And I was just wondering if you could articulate any alternative to that strategic path that the street is sort of focused on as the most likely outcome. Thanks.

Jeffrey L. Bewkes

We have said that, and of course we will assess all of the options and I think all of you have written or read about pretty much every conceivable one. One that ought to be thought about really as a benchmark against any kind of strategic change in our position in access would just be operating it and seeing if the cash flow from that operation is superior to any yield we can get putting it into alignment with some of the usual suspects that get mentioned.

So we’re just going to view it objectively as a business question and what we are really trying to say is that we have now organized it from an operational point of view to number one, provide the best competitive results out of the access business, assuming it operates under its current structure, and then number two to give us the flexibility to do whatever is in the best interest to maximize the value.

Doug Shapiro

Can we have the next question, please?


Thank you. Next, Jessica Reif Cohen, Merrill Lynch. Your line is open.

Jessica Reif Cohen - Merrill Lynch

Thank you. Jeff, in the beginning when you mentioned your goal, your multiple platforms globally, just curious -- given your balance sheet, what areas of interest on a global basis would you have for acquisitions? I mean, it seems like a lot of cable networks will come up for sale domestically but how hungry are you for something outside the U.S.?

Jeffrey L. Bewkes

Jessica, we don’t like to use the word hungry --

Jessica Reif Cohen - Merrill Lynch

Okay, sorry. Bad terminology.

Jeffrey L. Bewkes

-- when we talk about acquisitions, because I think we were pretty clear about how we look at those. If you just work from our strategy, we’re already one of the leading branded content distributors in the world. Probably, which I sense your question is more from an international perspective, a lot of that is seen if you are living outside the United States in our branded television or online networks.

However, we do have a fairly large film business that supplies a lot of networks everywhere and those are the -- if you look at the weight of Time Warner right now, that’s the weight of most of our international business. There are network -- and I don’t want to call them just television networks because they aren’t any longer, Jessica, but there television network, online network, and content production, branded content production capabilities that are at scale all over the world. And we will look at those to, as we said, from not just a financial point of view but think of those areas in which it can put us in a superior competitive position.

We can’t really be more specific than that. We’re fairly large and fairly global and anything that comes up, you’ll hear us obviously in a disciplined way looking at it. That doesn’t mean we’re going to necessarily go and do any particular thing that comes up.

Doug Shapiro

Next question, please.


Thank you. Next we have Ben Swinburne, Morgan Stanley. Your line is open.

Benjamin Swinburne - Morgan Stanley

Thank you. Good morning. I wanted to ask, Jeff, about the home video and electronic delivery business. You guys gave a decent amount of disclosure in the Q. The first half of the year, both on the television and the theatrical side, that business is growing in the teens and you disclosed also your DVD units, which I think are down globally year over year, so obviously there’s a lot of stuff going on in that revenue line, which is I believe a very high margin line in the film segment, beyond just DVD units. Could you talk about that? What’s driving this growth? Is this something that’s specific to just the releases you’ve had and the success recently, or should we look at this business as this is a double-digit growing business on the top line going out over the next couple of years?

Jeffrey L. Bewkes

I’m going to give it a try. As you can see from our schedules and what John was relating to you, year-to-date our home video sales overall are up about 6%. The overall industry is about flat year-to-date. We think the industry will be flat or slightly up. We think the -- between the combination of standard definition and Blu-Ray sell-through, the market will be up modestly next year.

On the DVD shelf space question, if this is part of what you are thinking, many of the major retailers have increased the shelf space for DVD and they have added incremental shelf space for Blu-Ray high def at the expense of music and accessories. So just in terms of how the distribution at retail is going in front of store displays and the circulars have also not decreased at all, we see -- that’s essentially our outlook. If you take high-def and combine it with standard-def, you may want to ask something about international but that’s our overall look.

If you then go off of packaged home video into VOD, the margins are quite a bit better and so we think those are secular reasons why the margins can go up and the earnings can go up over time in home video. And if you add the final point which we were making in our organized remarks, our relative competitive position out-indexes for any given level of slates how everyone else does, so we essentially plan and we design our operations to outperform.

Doug Shapiro

Thank you. Next question, please.


Thank you. Next, Tuna Amobi, Standard & Poor’s Equity Group. Your line is open.

Tuna Amobi - Standard & Poor’s

Great. Thank you very much. I guess my first question for Jeff, can you reconcile for us your film strategy? On the one hand, you seem to be squarely focused on the event film strategy, yet you are kind of [planning] down on the specialty form, so how does the New Line and Warner Independent and Picture House restructuring kind of tie together into your film strategy in terms of number of films, et cetera? And that’s the question.

Jeffrey L. Bewkes

Basically, we and I think most of the other studios have pursued directionally the same strategy. We have at Warner New Line consolidated our operations. That’s why we put New Line together with Warners, to essentially be more efficient in a cost sense, so we didn’t have dual infrastructures, and secondly to be more efficient in driving revenue by using -- by number one, taking the New Line films and keeping international rights, and number two, putting the New Line films through the Warner distribution internationally, which is stronger than where they had been going before.

To your specific question on film output, we basically have focused the release slates to about -- it was running, if you put New Line and Warners together, up let’s say 40 or so films. And now it will be aiming more in the 20 to 25 side. Much of it Warners, with a very big focus for the economic reasons we told you on tent-poles because those are fairly economically powerful and efficient. We know how to do them and we’ve set up both the production pipeline, the intellectual property of titles in the pipeline, and the distribution position to maximize what we do.

But we also of course have a full film company in terms of all the types of genres of films and what we are going to do with New Line is essentially have that focus on the genres that it has been successful with over time.

Other than that, that pretty much covers what you can say about the range of film development without going -- I mean, I get lost in title-by-title kinds of things.

Tuna Amobi - Standard & Poor’s

Okay, thanks a lot. I’ll take other questions offline.


Thank you. Next, Rich Greenfield, Pali Capital. Your line is open.

Rich Greenfield - Pali Capital

A couple of questions related to AOL; in the first quarter, you said that AOL ad revenues would improve as we go through the year. Obviously that didn’t happen in Q2. I’m just curious why you feel so comfortable about restating that it’s going to improve from here.

And then two, you’ve made somewhere around I think $2 billion plus of acquisitions on the Internet front, supporting AOL. I was wondering if you could give us some sense of what your ROI looks like on those investments that you’ve made over those 18 months. Thanks.

Jeffrey L. Bewkes

I’ll start and John will pick up. The general reason why we think it will improve is that we look at usage as the leading indicator and as we said, we were given some of the usage patterns in the key areas, AOL owned and operated content sites, third-party and how that is trending in economic pricing and so on, so that’s essentially the short answer, and John may want to add some detail to that.

On the ROI on acquisitions, it’s a fairly complicated thing. Most of the acquisitions or a large part before Bebo were acquisitions to fill out the ad platform, or platform A. We think that that is still coming onstream in terms of current dollar yield, but has made platform A a very successful competitor and a very strong asset in terms of the valuation of platform A.

On Bebo, we have a lot of plans and as we said, we are going to integrate it and take advantage of the traffic that we have in AIM and ICQ, but certain of the plans we have for Bebo, we’re not going to trumpet before we do them and you are going to be hearing a lot about that over the next few months.

John, do you have --

John K. Martin Jr.

Just a small bit to add to each, and I apologize, I’m part choking here. Excuse me -- Rich, with respect to the advertising, you’re right. We did expect them to improve and frankly Q2 versus Q1 it did improve, albeit the improvement was modest. Looking ahead, I think there’s a few things to think about on the advertising side in addition to what Jeff said. We also will benefit from just frankly easier comparisons, so that underscores our confidence there.

The only other thing I would add with respect to the ROI, taken as a whole, and Bebo just closed in the middle of May so obviously, as Jeff just mentioned, we’re in the very early stages of our integration plans and development plans, but there is a lot going on there.

As it relates to the platform, assembling platform A with just under $1 billion of acquisitions a year-and-a-half ago and putting that around ad.com, which was acquired for almost $0.5 billion in 2004, we would submit that the ROI in terms of the value of what platform A is worth right now in today’s marketplace is very significant. And so there is the operating side of it, which is still coming online and we are integrating and we’re putting all those assets together but there is the scarcity value of having an at scale online display ad platform which we think those acquisitions were very, very prudent for AOL.


Thank you. Next, Michael Morris, UBS. Your line is open.

Michael Morris - UBS

Thank you. A question regarding videogames, given that you referred to its importance to the company. Can you talk a little bit about where you are right now in terms of your ability to develop or produce videogames with respect to staffing and capacity versus where you would like to be? Is it something that you can grow organically, something you’d make small or large acquisitions on?

And then along those lines, what do you see Time Warner, the existing Time Warner company bringing to the videogame business. Why as an investor do I like the concept of Time Warner owned videogame investment versus a pure play videogame investment. Thank you.

Jeffrey L. Bewkes

We’re pursuing basically two significant changes in the games business. One is we’re going to push to establish ourselves as a third-party distributor, which we’ve already done fairly successfully in the home video business for other people’s product, but it’s less common right now in gaming.

And second, we are using some [felt] type financing to manage the risks, some of which we got, for example, out of Abu Dhabi. But what we are doing strategically is we are leveraging our own IP, the titles coming out of Warners. We’re developing some new IP in partnerships with other games companies, some of whom we have either distribution arrangements with or some we have minority equity positions with. Some we have majority in.

We acquired TT Games, which was the maker of Lego Indiana Jones and Lego Star Wars, and Batman is coming up, as I mentioned. We got the North American distribution rights for Code Masters, which is a U.K. based videogames publisher. We have a small interest in something called Brash Entertainment, which is a videogames publisher, and I mentioned we have the arrangement with our strategic partner in Abu Dhabi who is funding up to $250 million to co-finance the development of up to 75 games over the next seven years. We also have an investment in [Syidos], which is a U.K. games developer, and we distribute all of these.

So there’s co-development, there are game companies that we have different degrees of ownership in, all of it focused on getting the scale and distribution and to your question of whether we have what we need in terms of human talent in our organization inside the company, you know, it’s something we work on all the time. We are developing at a pace with the size of our distribution presence, and we feel that we are in reasonably good shape. If you are asking whether we can attract talent that we need, we think we can.


Thank you. Doug Mitchelson, Deutsche Bank. Your line is open.

Doug Mitchelson - Deutsche Bank

Thanks. I’m just interested in John’s comments on the mix shift at AOL display from guaranteed to non-guaranteed. How far along are we in this mix shift and how much do you think it impacted display ad sales in the quarter?

John K. Martin Jr.

Actually, tough to tell and I think it’s in part because we have so much going on at AOL and there was so much organizationally happening at platform A this year -- this quarter, rather, excuse me, that it’s difficult for us to ascertain how much of it is being driven by the market versus how much of it was happening just as a result of the organizational progress that we are making. So we are going to be looking closely at this in the back part of the year and trying to understand better the organic trends and trying to improve our overall sell-through rates on the guaranteed part of the inventory, so more to come on that.

Doug Mitchelson - Deutsche Bank

And then could I just follow-on? Any concern about the pace of TAC expense increase?

John K. Martin Jr.

I don’t think so. I think if you look at TAC as a percent of ad revenues, it’s held pretty constant, around a third or about 35% and we’ve got a decent amount of visibility on that and obviously we’ve got our own projections as to how fast the third-party network is going to grow and there’s an associated TAC along with that. But I think we’ve got decent visibility on how that’s progressing.


Thank you. Imran Khan, J.P. Morgan. Your line is open.

Imran Khan - J.P. Morgan

Thank you for taking my question. One question about network business -- could you please give us some color what kind of margin improvement opportunity you see in the network segment and where do you think that margin improvement will come from, domestic versus international, Turner versus HBO? Thank you.

Jeffrey L. Bewkes

Yes, we think margins will continue to improve at the network. To your question where will it come, well, we continue to invest in original programming and so essentially what happens -- and this varies a little quarter to quarter, and even slightly year to year -- is when you have a hit, there’s a question of when the hit TV series, let’s say, goes into your syndicated or after-market sales. And then when that happens, you have a big revenue slug coming in and it increases the margin.

That is on top of basically a secular margin increase that occurs because the revenues from affiliate fees both at Turner and HBO and then from ad revenue growth at Turner, which we described at double-digits, outpace the planned cost base increase. Essentially we’ve been having costs growing in the low-single-digits and we’ve have secular subscription revenue, affiliate revenue, and ad revenue growing quite a bit faster than that, so that’s essentially a margin increase and an earnings growth driver before you even get to content [classes] from hit series.

John K. Martin Jr.

If I could just add on, just some of the number mechanics, and I probably should have mentioned this even in my proactive remarks, I think it is worthy of a mention that in the second quarter, particularly at Turner, our margins tend to be lower than the rest of the year because we do carry the NBA play-offs and we carry a significant amount of sports programming amortization in Q2. To put that in context, half of our sports costs get amortized for the year in Q2 and I think two-thirds of our NBA costs hit in Q2 and I think we saw the same trend last year.

Looking out to the rest of the year, and we’ve got good visibility with this, despite the increased investment, or the continuing investment in original programming, we are going to be comping against investment in original programming last year too, so we’ve got good visibility on that and we feel good about the potential for margin expansion in the back half of the year.

And at CNN, margins have been and are continuing to expand there, and the performance of CNN, I think we’ve mentioned in the past it’s been the fastest growing network in the Turner portfolio now for some time, and that’s coming on the domestic as well as the international side.

Doug Shapiro

I think we’re just going to take two more questions, please.


Thank you. Next, Anthony DiClemente, Lehman Brothers. Your line is open.

Anthony DiClemente - Lehman Brothers

Thanks for taking the question. This is for Jeff. Jeff, you talked about how Warner is most aggressive on day-and-date release. Next year you are going day-and-date with every release. Now, last night on the News Corp call, Jason asked Peter Chernin about day-and-date and he said that he remains concerned that day-and-date could cannibalize the existing DVD business. He stressed the need to protect the overall margins of the DVD business. That implies to me that VOD margins are actually lower than DVD margins, so maybe he’s seeing different unit economics.

So even if those margins are up, clearly contribution dollars per unit on VOD are lower, so it would be really helpful to me if you can help clarify some of the unit economics math there and how your strategy on day-and-date could be incremental to film profits and whether or not next year, when you go day-and-date, are you worried that at that point, retailers might start reducing shelf space? Thanks.

Jeffrey L. Bewkes

No. We have not seen cannibalization so far. I don’t think it’s right to think that the margins are lower -- in fact, they are higher by a lot on rental, obviously, and it may not be the right way to look at really the profitability of a film as it goes through DVD in terms of either a physical copy or a VOD, if you’re looking, in other words, per user.

So we think that since we haven’t seen cannibalization on sell-through that it’s going to increase margins and profitability going to day-and-date, and we think it will improve the position of our company and frankly the whole industry, which we believe will follow, on piracy. This is fairly similar in terms of the different views other studios have from what we did in DVD sell-through, which if you’ll recall we led the same way, we got to the same result, and we are sitting today, it’s why we’re able to say that we out-index every other studio in DVD performance, essentially because we committed to it, developed the distribution relationships early, and went to scale early on a global basis. We think pretty much the same here and we essentially don’t agree with the overly cautious view.

Doug Shapiro

Last question, please.


Thank you. We have David Joyce, Miller Tabak & Company. Your line is open.

David Joyce - Miller Tabak & Co.

Thank you. I was wondering if there are any significant cable network affiliate contracts coming up for renegotiation to think about, and also if there are any differences in your up-front selling in this environment on the cable networks -- for example, are you selling more inventory in the up-fronts? Thanks.

Jeffrey L. Bewkes

First of all, on big affiliate agreements, they come up fairly regularly.

John K. Martin Jr.

We tend not to disclose them.

Jeffrey L. Bewkes

We don’t talk about them and we don’t see and I wouldn’t flag any particular different situation or concern about that. In fact, we feel very good, given the strength of the networks, the performance of the ratings, the ad sales, everything that we mentioned in our remarks in terms of affiliate. We knew all our [inaudible].

On the up-front, the results, I think we said it but if we didn’t, please ask us if we don’t answer -- if we haven’t fully answered the question. We were at the top end of the entire TV universe. The CPMs were up in the high-single-digits, [inaudible] up in the double-digits. The current market is pacing ahead of where the up-front was in varying degrees of strength. It’s healthy. We sold the same amount of inventory, a very key point, as we did in last year’s up-front in order to get those pretty significant gains. So that was the up-front. The scatter is moving up from there, not quite as much on the entertainment side as it was in the second quarter but still up.

So it’s a pretty good picture and Turner particularly is performing I think relatively better than pretty much all of the competition.

Doug Shapiro

And with that, thank you very much, everyone, for participating.

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