Time Warner Inc. Q2 2009 Earnings Call Transcript

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Time Warner Inc. (NYSE:TWX) Q2 2009 Earnings Call July 29, 2009 10:30 AM ET


Doug Shapiro – Senior Vice President, Investor Relations

Jeffrey L. Bewkes - Chief Executive Officer

John K. Martin - Chief Financial Officer


Spencer Wang - Credit Suisse

Douglas Mitchelson - Deutsche Bank Securities

Jessica Reif-Cohen - BAS-ML

Michael Nathanson – Sanford Bernstein

Richard Greenfield - Pali Research

Benjamin Swinburne - Morgan Stanley

Michael Morris - UBS

Anthony Diclemente - Barclays Capital

Alan Gould - Natixis Bleichroeder

Jason Bazinet - Citigroup


Welcome to the Time Warner second quarter 2009 earnings call. (Operator Instructions) Today's conference is being recorded. If you have any objections you may disconnect at this time. Now I will turn the call over to Doug Shapiro, Senior Vice President of Investor Relations.

Doug Shapiro

This morning, we issued two press releases, one detailing our results for the quarter and the other reaffirming our 2009 business outlook. Before we begin, there are two items I need to cover.

First, we refer to certain non-GAAP financial measures. Schedules setting out reconciliations of these historical 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 the investor portion of our Web site at timewarner.com/investors. A reconciliation of our expected future financial performance is also included in the business outlook release that's available on our Web site.

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 Form 10-K and 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 for your attention and now let me turn the call over to Jeff.

Jeffrey L. Bewkes

With half a year behind us, I am very pleased with what we've accomplished so far, particularly in light of the obviously difficult economic environment.

The advertising markets where we operate have been more stable lately, but we aren't seeing major improvements and because advertisers are holding onto budgets longer, our visibility remains lower than usual.

Home video sell-through also remains pressured by tough retail trends. Against this backdrop, adjusted OIBDA for our content businesses rose 4% in the second quarter and it's up 3% for the first half. In fact, we expect it to grow for the full year, which should prove to be a considerably stronger performance than most of our media competitors.

As you saw this morning, we are confident that we will achieve our full year outlook. Our performance so far this year reflects both the diversity of our revenue streams and the continuing progress we're making towards our key operating goals.

And as we've discussed before, these goals are: first, to leverage our scale and brands to deliver high quality content consistently; second, to keep improving the efficiency of our operations; third, to expand internationally; and fourth, to continue to develop business models that capitalize on changes in the consumer usage and technology.

Let me give you a few examples of what we achieved this quarter, starting with the success of our content. You all know I've talked before about why hits are growing in value, even as consumption continues to fragment. I've also discussed why our brands and scale enable us to attract talent and consistently make better contact than our competitors, average quarter in and out. In both good and bad times.

Despite conventional wisdom, we're demonstrating that it is possible to institutionalize success in what is thought to be a hit-driven business. Now, no one can make only hits, but even a slightly better, consistent batting average can clearly yield big advantages over time.

Take our film and TV production businesses. Two weeks ago Harry Potter and the Half-Blood Prince set a new worldwide opening record. It generated almost $400.0 million in its first five days. And with this release, Harry Potter has become the most successful franchise in film history, and there are two more installments to go.

Or consider The Hangover, which just became the highest grossing R-rated comedy ever, replacing another great comedy that was in first place, The Wedding Crashers. So, it's sure to be one of the most profitable films of the year, and with those two films, we have number one and two in the category, proving that we are the funniest of the major media companies.

Warner Brothers TV is also having a phenomenal year. During the just completed up-front pick up season, we put 26 shows on the network scales, 12 new and 14 returning shows. That, once again, makes Warner's Television the number one provider of network TV programming and that's a spot we've held for 18 of the past 23 years. And we don't own a broadcast network.

With the success of both our film and TV businesses, Warner is now on pace to grow adjusted OIBDA this year, despite the soft home video environment.

Now go to the networks. Let's look at Turner, another example of how this virtuous cycle of scale, brands, and talent works. As part of our continuing push to close the gap between our CPMs and those of our broadcast competitors, last year we set the goal of airing original broadcast programming Monday through Wednesday on TNT by 20%. We're achieving that goal a year early with TNT's coming season, with new shows from Jerry Brockheimer, Mark Burnette, Ray Romano, and Jana Pinkett Smith. The level of talent on TNT today would have been unthinkable just a few years ago.

And the investment in these original series are paying off. In the sixth season The Closer remains the number one original show on ad-supported cable. And our two new originals, Takar[ph] and Dark Blue, are two of the top three new cable shows this year.

HBO's recent performance also highlights it's synonymous with quality programming. Last month we aired the second season premiere of True Blood. This was the most watched show on HBO since the finale of The Sopranos. Each episode of True Blood now attracts over 11.0 million viewers across linear and on-demand, making it the second most watched show in HBO history.

But there are many new shows coming on HBO and HBO's new show, Hung, which has already debuted, had a great debut and it retained essentially the entire True Blood audience.

And ratings for the premiere of Entourage, which is in its sixth season, more than doubled over last year.

To cap all that off, HBO was just nominated for 99 Emmys. That's the most of any network for the ninth year in a row.

So even as we continue to invest aggressively in programming and production, we're also working hard to achieve the second goal I mentioned, which is running our businesses more efficiently.

Despite higher pension and restructuring expenses this year, our operating costs this quarter declined by more than $600.0 million, compared to the same quarter last year. This reflected not only restructurings we undertook last year at corporate and at Time, Inc. but it also reflected the continued tight cost controls in every division.

This focus on efficiencies is an ongoing way of doing business for us. I think you've seen very steady progress over the last year and a half on that and we are currently seeking additional opportunities across the company and increasing our emphasis on returns, which we look at division by division as well as for the entire company.

Another of our key priorities is continuing to develop new business models. And we have a long history of capitalizing on changes in technology and consumption, whether it were pay TV, VOD, DVD, and today we are as determined as ever to ensure that new models are additive, not cannibalistic.

An important of this is TV Everywhere. For the foreseeable future, we expect that consumers will continue to watch programs mostly on TV. We are all excited about the rise of video on broadband, but as we have seen that dawn of that new business, we have also witnessed continued steady increases in TV watching, TV usage, and subscription levels.

And our own experience with the success of HBO video-on-demand shows that increasingly consumers want to watch the shows when they want to watch, and they want to be able to select what they watch when, and they want to determine where they want to watch the shows, and on which device.

TV Everywhere is the right model for consumers. It will allow consumers who subscribe to a television service at home to watch programs whenever they want, on whichever TV or broadband device they want, at no additional charge.

And at the same time that it's right for consumers, TV Everywhere is right for the industry. It builds on cable programmers successful, dual-revenue stream business model, helping to ensure continued robust investment in high quality programs and allowing every kind of television network, from broad bill to niche, to succeed financially.

While it is still early, we made some important headway this quarter. We announced an agreement with Comcast that established some principles that we think could be fundamental for TV Everywhere and for all distributors on all networks, to set the stage for a technical trial that's getting underway now. And we're in active discussions with a number of other distributors, cable companies, satellite distributors, and telephone companies, to do the exact same thing.

The other big news this quarter, as you know, is our announcement that we plan to spin off AOL. That's another big stride in reshaping Time Warner that we started last year. Spinning off AOL will enable us at Time Warner to focus even more on driving the best possible performance from our content businesses, which have always been the core of our company and our capability.

But it's also the right decision for AOL because it should improve AOL's operational and strategic flexibility and very important, it will make it easier for AOL to attract and retain the best talent. Since the announcement, we have made a lot of progress on this spin off mechanical process.

Three weeks ago we repurchased Google's 5% stake, which should simplify the spin off process. Earlier this week AOL also filed a registration statement with the SEC, which is a critical step and with that process underway, we are on track to complete the transaction around the end of the year.

Before you hear from John, I would like to touch on our capital deployment. We approach capital management with three objectives. This is not the first time you've heard me say this. First, to invest fully in our existing businesses, second, to maintain a strong balance sheet, including operating with an appropriate leverage target and with ample liquidity, and third, to allocate our excess financial capacity optimally, whether by returning capital directly to stockholders, or by making appropriate acquisitions.

I would like to spend a minute on this last objective, allocating our excess financial capacity. We view consistent stock repurchases, along with our regular dividend, as an important part of our capital plan. After we announced our plan at the end of May, to separate AOL, we were able to resume repurchasing the company's stock. As you've seen, we bought back about $350.0 million of our shares over the past two months.

Acquisitions are another potential use of our excess capacity. As we have discussed before, we look at each deal through a rigorous set of filters, including strategic fit, execution risks, and financial return. And the acquisition needs to provide strategic benefits, whether by improving our scale, our efficiency, our competitive position, or by adding important capabilities to our existing businesses that we need.

In addition, any acquisition needs to provide an attractive risk adjusted return as compared to other uses of our capital, which include buying back our own stock.

I would like to close by telling you why I'm so excited about the future of Time Warner as a pure content company. I think we have a sustained competitive advantage and a track record creating and monetizing high-quality content. Our track record of successful innovation in new business models positions us to benefit as technology and consumption methods change by consumers. And we're focused on efficiency and prudent allocation of capital, including direct returns to shareholders.

Thanks again for your interest and now I would like to turn the call over to John.

John K. Martin

I'm going to just briefly go through our second quarter results and there are slides that are now available on our Web site to help you follow along with my remarks, so jumping into it, beginning on the first slide, I'll begin by making a few high-level observations or take-aways.

You know, heading into the year, we aim to deliver financial performance at the top end of our peers, tightly control costs, and meet the objectives of our capital plan, as Jeff just explained. And now that we're half way through the year, I think we're well on our way to achieving all of these goals.

The content group suggested OIBDA was up 4% in the quarter, and that's despite a tough revenue environment. That was a little better than we expected heading into the quarter, and while some of this outperformance was due to timing, much of it was due to better business performance as well as continuing cost efforts.

This morning we reaffirmed our outlook for flat adjusted EPS for the year and we feel increasingly confident that we'll achieve that.

From a capital standpoint, we continued to generate significant free cash flow in the quarter and on a year-to-date basis we have a 59% conversion ratio of adjusted OIBDA. And this has allowed us to increase returns to shareholders while maintaining the strength of our balance sheet and after announcing at the end of May the plans to separate AOL, as Jeff just said, we reentered the market, bought back nearly $350.0 million of stock in just two months. And as Jeff explained, we really do view this as an important ongoing part of our capital plan.

The next slide shows our consolidated second quarter financial highlights and just a couple of things to point out here. Revenues declined 9% year-over-year, which reflects double-digit year-over-year decreases in both advertising and content revenues, as well as a modest decline in subscription revenues.

Keep in mind, however, that about half of the overall revenue decline was due to difficult foreign currency translation comparisons as well as continuing decline in AOL subscription revenues.

Total adjusted OIBDA declined 2% despite an almost 700 basis point drag related to pension, FX, and restructuring charges, and as I just mentioned, the content group's adjusted OIBDA was up 4% in the quarter and has posted 3% growth in the first half of the year.

Margins were up 200 basis points in the quarter as foreign currency on costs continues to pay off and we managed to lower our operating expenses, which include both cost of revenues as well as SG&A by more than $600.0 million compared to the second quarter of last year, with costs being lower in virtually every division and margins were flat or better at every division with the exception of publishing.

Lastly, adjusted EPS was $0.45 and we've now generated $0.90 year-to-date.

So continuing on and just looking briefly at each of our divisions, I'll begin with networks. And here we saw adjusted OIBDA up a very, very strong 14% in the quarter. With expenses relative flat, solid revenue growth drove significant margin expansion here and the networks division represented over 70% of our content groups profits in the quarter.

Subscription revenues grew 8% and that reflected higher affiliate fees at both turner and HBO. The consolidation of HBO Latin America also contributed here while unfavorable FX was a drag.

Advertising revenues were down 3% and that's a little better than we expected coming into the quarter, and while our domestic entertainment networks actually grew advertising low single digits in the quarter, the decline was principally due to softness at Turners International networks, which were down due to lower demand and unfavorable FX.

Advertising also declined at our domestic news networks and that's partly due to the difficult comparison against the U.S. presidential election coverage last year.

In addition to the network's revenue growth, adjusted OIBDA benefitted from lower news gathering costs as well as the consolidation of HBO Latin America.

Programming expenses increased modestly during the quarter as higher original programming expenses were offset by lower NBA costs. And keep in mind that relative to what we were originally planning, we have about $20.0 million of OIBDA in the quarter that reflected favorable timing of certain expenses, including marketing, which we expect will likely reverse in the second half of the year.

In terms of the advertising environment, scatter pricing is about flat to up front levels and business continues to be booked very close to air date.

Heading into the third quarter, Turners advertising trends look relatively similar to the second quarter, with the exception that our domestic news comparisons will get meaningfully more difficult as the year progresses. And I just wanted to put that in some perspective. Last year in the third quarter domestic news revenue grew 19% and it grew 25% year-over-year in the fourth quarter. One more comment on advertising. In addition, we are seeing some softness in the kids market.

While focus on our costs will continue this year, we don't expect to experience the same degree of margin expansion in the second half of the year as we saw in the first. This is by design, as we will continue to increase investment in our original content. And based on the timing of our slate of original programming, we anticipate higher growth in programming expenses in the back half of the year.

Turning to film, Warner Brothers posted another quarter of adjusted OIBDA growth, and this growth was driven by the phenomenal performance of our film [inaudible]. It was also driven by lower P&A and lower overhead as a result of our ongoing cost initiatives.

It also reflected a roughly $40.0 million benefit from the reversal of certain home video returns reserves and that's due to better than expected catalogue performance over the past several quarters.

Revenue was down year-over-year primarily due to tough home video comparisons, general softness in the home video trends, as well as unfavorable FX. We had five key home video releases in the second quarter led by Grand Torino, Yes Man, and He's Just Not That Into You, and that compared to ten titles in last year's second quarter.

Comparisons were also challenging in our video games business due to last year's release of the very successful Lego Indiana Jones.

Looking ahead for the rest of the year, in our film group, despite the record breaking opening of Harry Potter and the Half-Blood Prince, we expect second half results to be more heavily weighted toward the fourth quarter than in most years, versus the third quarter. In fact, the third quarter will likely be down year-over-year. And again, that's just timing. It doesn't reflect business fundamentals per se.

The third quarter is going to be affected by tough comparisons against our theatrical slate and video game releases in the third quarter of last year, as well as higher television production spending tied to new shows for the upcoming season.

In addition, our successful summer films, including Harry Potter, The Hangover, and Terminator Salvation will all be released on home video in the fourth quarter.

Moving on to publishing, second quarter ad revenues were very soft, down 26% over the prior-year quarter. That's consistent with what we indicated it would be on last earnings call and it actually improved slightly from the first quarter.

The year-over-year decreases were driven by the continued decline in print advertising as well as unfavorable FX.

Subscription revenues also showed continued softness. Over 40% of this year-over-year decline was driven by unfavorable FX but domestic newsstand sales and renewals were also down. It's worth noting that we have seen an uptick in subscription renewals in recent weeks and that's back to pre-credit crisis levels so that's somewhat encouraging.

We've reduced operating expenses here 15% in the quarter but this was more than offset by the revenue decrease resulting in meaningful year-over-year OIBDA declines.

Looking ahead, visibility still remains limited here but we have seen some signs of stabilization in advertising. Moreover, with easier comparisons in the second half of the year, we do fully expect to see improvements in both revenue and OIBDA trends in the second half.

Moving to AOL, and I'll begin by focusing on their advertising results, the dynamics this quarter were very similar to what we saw in the first quarter and were in line with what we had expected. Advertising revenues continued to experience pressure across display, page search, and the third-party network, falling 21% in the quarter.

AOL media, which includes both display and page search, declined 19%. Display was down in line with our overall advertising revenues due to continued pricing pressure as a larger proportion of inventory was purchased through lower priced sales channels compared to a year ago.

And page search revenues from Google decreased 17% due primarily to lower query volumes and lower click-through rates on the AOL client.

Additionally, cost-per-click continues to be adversely affected by algorithmic changes made by Google, and we've talked about that in the past.

Third-party network revenues declined as higher pricing was more than offset by lower demand.

Looking ahead for the rest of the year, we are not yet seeing signs of a recovery in demand at this division and therefore we expect similar pressure on advertising revenue relative to what we saw in the first half.

Shifting quickly to the rest of AOL's results, subscription revenues continued to decline as AOL lost about 0.5 million subscribers in the second quarter. This is a slight improvement from the first quarter and is the lowest quarterly subscriber loss since the start of the transition to a free service back in 2006.

OIBDA declined in the quarter due to lower revenues and management continues to actively manage the cost base here in the face of revenue declines and therefore were able to keep margins flat.

Through the first half AOL incurred $73.0 million of restructuring costs, including $15.0 million in Q2.

The next slide highlights that corporate expenses once again declined year-over-year as the cost savings efforts that we put in place last year continue to have a positive impact. And we clearly remain committed to managing corporate costs and we continue to look for additional efficiencies.

Turning to our outlook on the next slide, as both Jeff and I mentioned, we are reaffirming the full year outlook and while the environment remains challenging, clearly our first half performance increases our confidence that we will achieve our goals here of around flat adjusted EPS in 2009 compared to 2008.

Going into this year, frankly, at the beginning of the year we knew that the second and third quarters would be our toughest from a year-over-year growth perspective and while we expected that the second quarter would wind up being almost challenging, due to the strong performance of our releases at Warners, a more stable advertising environment at our networks, and the timing of certain revenue and expenses, it was clearly better than what we had expected and therefore we now expect that the third quarter will exhibit the most challenging year-over-year trends and again I would just reiterate, that that's a matter of timing and not a change in business fundamentals.

We continue to expect the strongest OIBDA growth quarter of the year quarter to come in the fourth quarter and that's in part due to easy comparisons against some pretty big charges that we incurred in the fourth quarter of last year. It also reflects our expectations of easy FX comparisons as well as the strength of our home video release slate.

Let me turn to free cash flow. Next slide. Our cash generation remains robust and in the first half of the year we've generated about $1.8 billion of free cash, which is a 60% conversion ratio. This highlights both the relatively low capital intensity of our businesses as well as a continuing focus on working capital management.

Relative to last year, our conversion ratio was pretty comparable as we offset higher taxes with lower interest expense. And as you know there is significant seasonality in the timing of tax and interest payments as well as working capital which causes conversion rates to vary over the course of the year. And consistent with our usual pattern, we expect the conversion ratio to be lower in the second half of the year versus the first half of the year.

Moving forward, looking at our capital structure and capital deployment initiatives, we ended the second quarter with about $10.5 billion in net debt. That's up slightly compared to last quarter but down more than $10.0 billion since year end. And balance sheet changes during the second quarter reflected returns to shareholders through dividends and share repurchases, as well as our investment in CME. And this was offset by continued free cash flow generation.

Our leverage ratio is now about 1.6x based on the last 12 months of adjusted OIBDA and as you think about the rest of the year, there are at least five things that could somewhat impact our balance sheet.

First, we fully expect to continue to generate strong levels of free cash. Second, we will pay Google $283.0 million for their 5% stake in AOL. Third, we will likely use $2.0 billion of cash on hand to satisfy some debt maturing prior to year end. And this won't change net debt in total but it will serve to reduce our cash balances. Fourth, we will return capital to shareholders through our committed dividend and we still have an existing share repurchase authorization. And fifth, we intend to spin AOL.

So with one caveat being that we haven't yet decided how AOL will be capitalized, the net-net of all the items I just mentioned will be that our leverage ratio and our net debt balance will likely move a little higher in the near term.

We fully expect, however, that we will continue to maintain attractive capacity and attractive flexibility against our stated long-term leverage targets.

So that's the quick review of the quarter. Thanks everybody for listening in, and now we'll be happy to answer to answer your questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Spencer Wang - Credit Suisse.

Spencer Wang - Credit Suisse

Jeff, it seems like the upfront is pretty close to getting wrapped up at this point, so I was wondering if you could talk about the results for Turner in terms of CPM pricing and inventory sell out.

And John, can you talk a little about how you plan on balancing share buybacks with the dividend and if boosting the dividend is something you're contemplating.

Jeffrey L. Bewkes

On the Turner up front, it's not quite over so I'll just give you general view how it's shaping up. We think we'll take share from the broadcast networks, basically due to the scale of all of our brands, led by TBS TNT. And the huge reach of TBS TNT as a replacement devices for the big four broadcast networks.

And so consistent with the business booking closer to air time and air date and scatter, it looks as though the overall dollars going into the upfront will be down a bit as clients look for flexibility.

We do think that they will come back in scatter and we are seeing in the discussions the clients are quite aware that they'll have to pay for this flexibility of moving a little bit of their purchasing from upfront to scatter.

All of this though, we think Turner and our networks are going to be at the top of the heap on total revenue performance but we do think that it could make the upfront a little less of an indicator for the health of the ad market than it usually is.

So I think you will all have to look carefully at how much of the advertiser spending budgets are actually going into the upfront and then take a look at that in relation to both pricing trends and what networks do in their upfront sales price and how much volume goes where.

John K. Martin

I think it's fair to say that providing a direct return to shareholders is an important component of our capital allocation plan and our capital deployment plan. And we're pleased that we're in a year where we actually can strengthen our balance sheet, increase investment in our businesses, as well as increase returns to shareholders directly.

And oftentimes those three are in conflict but we're in a year that's pretty unique and we can do all three.

As we sit here today, we think steady return to shareholders through a mix of dividends and share buybacks is preferable and we are taking somewhat of a measured approach to our capital deployment, which we think is prudent in light of the economic environment.

The only other thing I would add is we already have a meaningful dividend today of about $900.0 million annually. It's a meaningful yield. Having said that, we're always going to revisit the level over time and we're hopeful that the dividend can grow in line with our business growth going forward.


Your next question comes from Douglas Mitchelson - Deutsche Bank Securities.

Douglas Mitchelson - Deutsche Bank Securities

John, a clarification. Is the softness you are seeing in the kids marketplace related to share losses or a soft kids marketplace overall?

And Jeff, I'm wondering if I can narrow you a little bit on the upfront. I think you were talking about dollar share when you said Turner would take upfront share. Is that going to be the same for price? We're seeing networks pricing down 3% to down 8% in the CPMs. Is that consistent with what you're seeing? Should we expect Turner to be at the end of that range or above that range, since you're usually a leader in rate increases?

Jeffrey L. Bewkes

We will be toward the higher end of the range. As you know, that's a bit of a decision on how you want to handle your amount in upfront. [inaudible] scatter. I can't give you the precise answer of exactly what we're going to do but we think some of our decisions will put at the high end on price.

John K. Martin

You're clarification question, I was really referring to more of a comment on the soft kids marketplace in general and not intending to reflect share losses in any way whatsoever. We do think Cartoon network is well positioned. Recently ratings have been growing. But it's not doubt a challenging year for the kids market due to weakness in toys as well as cut backs in food and beverage.

And as a result one of the things that the management team is trying to do at Cartoon network is address this by aging up the audience somewhat and there's been a change in strategy there that's underway. And we're hoping over time that that's going to help open up new advertising categories that thus far we don't participate in.

Jeffrey L. Bewkes

I would like to add to that. On that channel [inaudible] and that's quite strong in ratings and ad performance.


Your next question comes from Jessica Reif-Cohen - BAS-ML.

Jessica Reif-Cohen - BAS-ML

Jeff, you mentioned at the beginning of the call that one of the corporate goals is to expand internationally. I was wondering if you could elaborate on is the strategy to build or would you have to continue to buy? CME is pretty small but if you could elaborate on that it would be helpful.

And then for John, on the cost side, you've managed your costs down incredibly well. What's your expectation as revenue comes back? Can you keep costs at these levels or do you think you'll have to increase some spending?

Jeffrey L. Bewkes

We don't have any specific goals that we can articulate publicly here. We just think that international markets, and you can't look at the whole world and identify which ones, have some long term sector with trends of potentially higher growth than the developed world, which is quite attractive for a big global media company.

And if you look at Time Warner, we have about 27% of our revenue coming from international markets. That's higher, as a percentage, than I think all of our competitors except News Corp.

And when you look at that you have to look at what sector are you in? Are you in movies and television, are you in newspapers? What makes up your international? We think we're in very good sectors in development networks and as we look at certain international markets that we think have long-term growth, particularly Eastern Europe, South America, Latin America, India, and as we look at sectors of the developed countries that particularly local channel television networks and production that we think have good long-term growth, those are just of interest to us.

Now to your question of whether you buy them or build them, we do have a very good worldwide position of strength, both in film and TV sales of American export product and of international TV networks. And you've seen us expand that at HBO, which is number one wherever it operates in the world. Like in ownership positions at HBO, you've seen us expand by in certain cases in Latin America and Eastern Europe, buying other broad leading network positions in order to distribute and program them adjacently with our American networks.

So we really look at those in a fairly long-term strategic sense and we will both build and acquire so long as in the case of acquiring that it fits the criteria that we discussed when I was going through our return and what we need in terms of returns to make investments.

And so that's essentially our plan for international.

John K. Martin

On the cost side, and I appreciate the comment, I do think we've done a pretty good job sort of across the board, really improving the efficiency of our operations. It's not in any way meant to suggest that we're doing austerity cost cutting. Because a lot of what's happening is based on designs that have been put in place for at least a year or so.

Having said that, I think that we're going to constantly look for more and more opportunities. It's an ongoing way of operating for us and just one example, no formal restructurings have been announced at Turner yet. They're on track to reduce SG&A by over $50.0 million this year. And it's just the way that we need to continue to operate to address Jeff's focus on returns. And we're looking to free up resources in capital and put it to work in more productive and more useful ways.

And so I do believe, and we do believe, that there is margin expansion possibilities in every one of our divisions going forward. And quarter in and quarter out it can bounce around but longer term that's going to be the goal and I think we've got a good shot at achieving it.


Your next question comes from Michael Nathanson – Sanford Bernstein.

Michael Nathanson – Sanford Bernstein

I wonder if you could differentiate for us, if you look at your margin expansion in networks year-to-date, what's been the expansion trends between HBO and Turner? Are they expanding at similar rates? Or can you give some background, which businesses are showing the better margin expansion this year?

John K. Martin

In terms of the margin expansion year-to-date, we have seen margins expand at each of the areas and I'm not going to go into great detail differentiating the two. I think Turner, over the near term, has expanded more and there have been specific things that we highlighted, which is that there was lower news gathering at CNN, lower NBA programming amortization, and lower marketing at Turner. And that's been the thrust year-to-date. And as I said, that's going to change a little bit in the back half of the year, although I do think for the full year will be improved margins at Turner.

And at HBO, they've been on a consistent long-term architecture to improve margins year in and year out. And really this year should be no different and this year year-to-date I would say one of the big contributors, in addition to cost containment, has been increased content profit at HBO.

Michael Nathanson – Sanford Bernstein

Jeff, you have a really strong TV business, as you've talked about, in terms of syndication. But I wondered are there any concerns you have looking at the state of the local station business system, the bankruptcies you've seen, whether or not this business can keep growing in light of kind of the difficulties that some of your end users are having.

Jeffrey L. Bewkes

I can understand the question. I think the local TV broadcasting groups, there are some of them that have gone bankrupt, and there are some that will.

Having said that, we're not particularly concerned about it. It's not a terribly large part of our business. About less than 10% of our television series sales comes from off [inaudible] syndication. It's really less than 5% of the revenue in the whole film segment.

And even if you look at that, about 60% of it is from stage and 40% comes from cable, which isn't a question and it's not in your question. So you're looking really, if you had pretty severe problem on the local stations buying syndicated product, you're looking at in effect, it could be 1% or 2% in revenue. And that is not hard to move around to other buyers.

So we don't see a particular problem in the kind of ongoing profitability or growth of profit. You could always in a given quarter, let's say this year, see some people going bankrupt and off revenue adjust a little but it would be material.


Your next question comes from Richard Greenfield - Pali Research.

Richard Greenfield - Pali Research

You've been cutting down for the last 18 months the size and scope of our film business. Are there any areas or genres of the business that you would actually be interested in expanding into which you don't have a presence in today, given the strength of your balance sheet.

And Sony did a deal with Red Box last week. I was wondering how you think about Red Box, working with them, not working with them and the impact on your overall film business.

Jeffrey L. Bewkes

On the scope of the film business and which segments are we in, since Warners is the largest studio, we don't need to expand into any additional genre.

Having said that, if we saw opportunities to build or acquire new capabilities at the right return, we would look at it. There are several kind of usual suspects that float around in that category. But we always look at the benchmarks that I described in my big remarks.

Sony on Red Box. Sony did a deal with Red Box last week. We can't really comment on specific deals or deals that other do. We weren't in that deal obviously. In general, we think that there may well be a role for $1 rental kiosks or pricing in that range. Just like there are $1 movie theaters. We think it's a question of the right window. So we think it can be additive. And to the extent it's competitive, we're not unduly concerned about it.

Richard Greenfield - Pali Research

But you would like to see a window before Red Box titles come out versus the current day and date that they're making them available at?

Jeffrey L. Bewkes



Your next question comes from Benjamin Swinburne - Morgan Stanley.

Benjamin Swinburne - Morgan Stanley

Jeff, just taking that home video question out sort of bigger picture, there's been a lot of commentary about DVD sales being weak this year. I think your view is it's mostly related to the cycle or in retail pressure. But rental has been growing nicely. Probably Red Box but also Netflix. Video-on-demand has been growing although it's been a little tepid recently. How do you look at these changes in consumer behavior, sell-through versus rental? Do you think this is business model change that you can exploit and want to address from a windowing perspective, pricing perspective, across all these platforms, or is this purely just sort of bumps in the road as the economy move around?

Jeffrey L. Bewkes

There are a lot of pieces to that. It's important to look at the whole category. Physical DVD, Blu-Ray high def, electronic sell-through, rental, etc. And if you start with the total picture of consumer activity, because they don't care how they see the movie, they want to watch it through one of those elements I just talked about.

Consumer spending is improving. It's down only 4% this quarter, which is quite a bit better than the 7% drop in the fourth quarter or the 5% drop in the first quarter. Those are aggregated numbers, so if you look at the best titles, they're still performing well. And the continued shift to digital has positive margin implications, which I think was in your question, because a number of these new electronic and digital delivery systems have high margins.

Having said that, we are seeing some shift to rentals and we're monitoring it closely. But basically, and I think you had it as a premise in your question, the digital margin and profitability of the new forms versus the old physical forms, whether it's in sell-through or rental, they're more profitable in digital.

So as this all moves to digital and as we try to lead and speed that along, it actually means more convenience, better pricing at retail and higher margins. So it's good for the business overall. The question is okay, that's all good but if in the midst of all that some of the activity moves more to rental than sell-through, rentals being essentially a bit less of a purchase transaction than sell-through, does that affect at the end of the day the net contribution to film product?

I doubt that will happen. We've been there before and we saw rental as the chief means of everybody watching films back in the days of Blockbuster VHS rentals and yet again it moved to sell-through because it was more convenient for people to keep it and have it when they want and so forth. So I think it's early to say that we should be overly concerned about rental versus sell-through in terms of what it does to overall profitability.

But we've got a fair amount of flexibility on how to price these and make them available. And I think that our long-term view is that it's actually a set of positive developments and should make the business healthier.

Benjamin Swinburne - Morgan Stanley

And John, on the publishing, your opex fall in has been pacing down, sort of low teens first half of the year. Is that something that you think continues in the back half or is there a sizeable variable component? I know there is a currency element, too, so that should moderate a bit.

John K. Martin

I think generally speaking, it should continue, you're going to start lapping some of the cost savings that they achieved in the back part of last year, although we think that could be somewhat mitigated by easing FX comparisons.


Your next question comes from Michael Morris – UBS.

Michael Morris - UBS

Jeff, you mentioned at the beginning of your comments that ads were more stable. Can you share with us a bit of what you've seen on a category basis in terms of trends over the last quarter. Which categories have maybe firmed up a bit and contributed to that stability?

And John, with respect to your guidance, I can't help but think it looks a bit conservative given the second quarter. It sounds like second quarter is a bit of a surprise for you relative to where to were when you set the guidance and your comments for the balance of the year were cautiously optimistic. So in the decision to leave the guidance unchanged, have you taken things down in the second half in your expectations or is it just general conservatism?

John K. Martin

I will take the second one first. Look, just to go back and briefly reiterate what both Jeff and I were saying on our proactive remarks. The second quarter did end up being better than what we had expected coming into the quarter. And some of that was timing, some of it was just better business performance. And we are pleased against what is a tough economic backdrop. We're very pleased with the performance that our businesses have shown on a year-to-date basis through June.

And I'm reminded of the fact that even if we achieve our guidance of essentially flat or flat adjusted EPS it's going to set us apart from virtually all of our peers and competitors this year, who are experiencing meaningful year-over-year declines.

Looking at the back half of the year, we are cautiously optimistic but we are sensitive to the fact that we are continuing to operate in a tough and challenging environment that is somewhat limiting our visibility.

There are certain things that we, ourselves, are going to do in terms of actively managing investment levels in our businesses and we'll do that opportunistically where we think we can improve our business positioning and extend our competitive position.

So with that all wrapped up together, we'll continue to monitor how the operations pace for the rest of the year, but we feel really good about how we performed and we feel good about expectations for the rest of this year.

Jeffrey L. Bewkes

If your question was on which advertising categories are stabilizing and which ones are weaker, let's go through networks then publishing then AOL. I met networks at Turner, the best performing categories are quick service restaurants and wireless teleco and movies. The weakness areas for TV cable network ads are auto, financial, and food and beverage.

In the publishing company, basically the resilient areas are food and beverage, media, movies, tech, and telecom. The weaker areas are fashion, retail, financial, and jewelry.

At AOL the resilient categories are health and marketing services, telecom and travel and the weaker sections are auto, financial, and retail.


Your next question comes from Anthony Diclemente - Barclays Capital.

Anthony Diclemente - Barclays Capital

On those categories I think you're referring to Q2 but I'm curious as to whether you've seen any recent uptick in automotive spend activity in association with the government's Cash for Clunker rebate program.

My second question is for you Jeff. I'm wondering if you would ever, or how strongly you would ever consider doing a subscription video on demand deal with another distributor, like Netflix or Apple, for new release cable TV content. I know that would be outside of a kind of a TV Everywhere test and deal that you're doing with Comcast, but assuming that another third-party aggregator could offer you a good price for that content and then window it in an intelligent way, is that ever something that you would consider doing?

Jeffrey L. Bewkes

Are you saying when you ask that whether we would sell movies to it or are you saying that [inaudible] would take it over?

Anthony Diclemente - Barclays Capital

I'm more referring to the cable TV, I guess what I'm getting at is are we ever going to evolve to a point where your TV content, I guess I'm thinking more about Turner, are we going to get to a point where your TV content is truly available everywhere? And truly available in places outside of just the owned and operated cable sites like Sancast.

Jeffrey L. Bewkes

First of all, the answer is yes, like tomorrow. Maybe it's not understood what TV Everywhere is. It would mean that you could go watch any cable network you wanted on any device you wanted, on VOD in your house or on broadband. Using any broadband connection you want. You don't have to go to any cable distributor's Web site. You want to go to TNT.tv or CNN, you could go there because you can do it. You won't have to pay anything. You don't need a subscription model, you've already got one which is already paid—92% of Americans are already paying for it. They've already got all these networks.

That's why we're saying it's so powerful. And it will bring the advertising right along with it in that it multi-platforms sales should have the premium aspect to it because you'll be selling ads across TNT on tv, TNT on broadband, TNT on VOD, using any broadband connection. So please don't think of it as restricted to the Web site of any video distributor.

That will be one place to get it if you want to go there because it will be easy. It'll also be easy to go to CNN.com, which by the way, if you go there today, it's the number one site for TV electronic or broadband news across the world.


Your next question comes from Alan Gould - Natixis Bleichroeder.

Alan Gould - Natixis Bleichroeder

In the past you said Turner CPMs are about two-thirds of broadcast. Given these recent results and what you see in the upfront, do you think that number is going to be significantly increasing this year, or has been increasing?

And John, can you just remind us the economics, when I look at Harry Potter versus Dark Night, I believe you own 100% of Harry Potter and owned 50% of Dark Night. Will Harry Potter this year be more profitable than Dark Night was last year?

Jeffrey L. Bewkes

Let me start with the long term outlook. As the cable, as the multi-channel networks like TNT, TBS, USA, the ones with big reach and high quality programs, as those continue to have viewers go there and watch longer broadcasts, the fact that you can buy the same eyeballs for two-thirds the cost on cable is going to bring some volumes in the long run to those either [inaudible] or the sell out and the volume.

In the long run, not just looking at this quarter in the middle of a recession, any network, and we've got several of them, that has scale retrading from quality programs with a good environment of good shows, is going to continually be able to increase the attractiveness of its sales, and therefore raise pricing and it's volume of sales.

So over time, the CPM gap should and will close. And basically you've seen that steadily. There has been a prospect. It hasn't closed as fast as any of us have expected. If you just look at it quantitatively. But these things do get to tipping points where things start to move faster and I think that will happen in the near future. Not this year but in the near future.

John K. Martin

Regarding your question Dark Night versus Harry Potter, we don't provide any particular detail or guidance on a title by title basis. I think generally speaking, any film is going to be a tough comp to the Dark Night, which as you know, is the number two film domestically of all time and the number four film internationally.

But you're right in that the Dark Night was a shared relationship with Legendary whereas Harry Potter is wholly-owned. So in those types of situations you would rather have the wholly-owned for those wildly profitable films. I would just leave it at that.


Your final question comes from Jason Bazinet – Citigroup.

Jason Bazinet - Citigroup

Do you think that TV Everywhere, the efficacy of that strategy is dependent on other content owners setting up a similar business model or do you think you can go solo and still have it be quite viable?

On the financial side, at the very end of John's comments he mentioned the capitalization of AOL is still being determined. My question is, has a final decision been made regarding whether or not the dial up business will be part of that spend.

Jeffrey L. Bewkes

We don't think there's any need for us to wait for other programmers, network, content, operators, in order to make our decision and establish what we think is the direction. We do think that most other programmers will come to the same conclusion that we have and we think from discussions with our distributors, cable, telephone, and satellite and even wireless, that all of them are coming to that conclusion. So we think it's a very powerful and actually pretty obvious natural evolution of what will happen and what consumers will easily embrace.

And it's essentially because it is so convenient for consumers and it gives them basically the networks they clearly love which are gaining in popularity and usage and makes them more useable. And we've seen it. We've seen in on HBO. It's a proven trial. You put VOD capability onto a network and you increase its attractiveness and the ease of its use for consumers. And we want you to always focus not just on the broadband infrastructure, which is part of this, but also the VOD infrastructure that connects to your television set. All of it can go together and make it easier for consumers to watch whatever network, whatever show they want and not worry about is on and not having to worry about paying for it.

John K. Martin

And the answer to your second question is a very quick answer. Yes, the dial up subscription access business is in.

Doug Shapiro

That will wrap it up and thanks for joining us.


This concludes today’s conference call.

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