Time Warner (TWX) Q2 2013 Earnings Call August 7, 2013 10:30 AM ET
Douglas Shapiro - Senior Vice President of Investor Relations
Jeffrey L. Bewkes - Chairman of the Board and Chief Executive Officer
John K. Martin - Chief Financial & Administrative Officer
Alexia S. Quadrani - JP Morgan Chase & Co, Research Division
Douglas D. Mitchelson - Deutsche Bank AG, Research Division
Michael C. Morris - Davenport & Company, LLC, Research Division
Anthony J. DiClemente - Barclays Capital, Research Division
Vasily Karasyov - Sterne Agee & Leach Inc., Research Division
Jason B. Bazinet - Citigroup Inc, Research Division
Barton E. Crockett - Lazard Capital Markets LLC, Research Division
David Bank - RBC Capital Markets, LLC, Research Division
Tuna N. Amobi - S&P Capital IQ Equity Research
Welcome to the Time Warner Inc. Second Quarter 2013 Earnings Call. My name is Dawn, and I will be your operator for today's call. [Operator Instructions] Please note that this conference is being recorded. I will now turn the call over to Mr. Doug Shapiro, Senior Vice President of Investor Relations at Time Warner. Mr. Shapiro, you may begin.
Thanks, and good morning, everyone. This morning, we issued 2 press releases, 1 detailing our results for the second quarter and the other raising our 2013 business outlook.
Before we begin, there are a few things I need to cover. First, we refer to certain non-GAAP financial measures. Schedules setting out reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measures are included in our earnings release and trending schedules. These reconciliations are available on our website at timewarner.com/investors. Reconciliations of our expected future financial performance are also included in the business outlook release that's available on our site. 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 the subsequent quarterly reports on Form 10-Q. Time Warner is under no obligation and, in fact, expressly disclaims any obligation to update or alter its forward-looking statements, whether as a result of new information, future events or otherwise.
And lastly, in the second quarter, we began accounting for investment in Central European Media Enterprises as an equity investment. Due to the accounting rules, we have recast our historical financials as though we had accounted for it as an equity investment since we first invested in CME in May 2009. Because CME has historically produced net losses, this accounting change reduced full year 2012 adjusted EPS by $0.04 and our first quarter 2013 adjusted EPS by $0.06. In the second quarter, the impact was a $0.02 reduction.
Thank you, and let me turn the call over to Jeff.
Jeffrey L. Bewkes
Thanks, Doug. This was another really successful quarter for us, financially and operationally. It puts us in great position to post another year of strong growth in 2013 and beyond. In the second quarter, we grew revenue of 10%, we grew adjusted operating income 25% and we increased adjusted earnings per share almost 50%. During the first half of the year, we also generated $1.8 billion in free cash flow. That's triple the amount we generated in the first half of last year. And over the last few months, we bought back almost another $1 billion worth of our stock.
This morning, we also increased our guidance for adjusted EPS growth this year. That's a reflection of our performance in the first half and our confidence about how we're positioned for the rest of the year. John will discuss our financial results and outlook in detail in a few minutes.
I'd like to point out some of our key operational highlights this quarter, starting with the networks. At Turner, we saw a continuing evidence of the growing value of our brands and programming to our viewers, our advertisers and our affiliates. TNT and TBS finished the quarter as the #1 and the #3 networks in prime time for adults 18 to 49 on all of cable. At TNT, the story again was sports and originals. The NBA playoffs on TNT were the third most viewed in the 29-year history of the NBA on Turner, outdelivering all networks, broadcast and cable, among adults 18 to 49 during May sweeps.
And Game 7 of the Eastern Conference Finals was the highest-rating NBA game on TNT ever. As you know, we're steadily increasing the amount of original programming on TNT and we're airing originals year round. We had about double the number of original hours in prime time this quarter compared to last year and it's paying off, led by shows like Falling Skies, Rizzoli & Isles, Major Crimes and Dallas. Ratings on our prime time originals during the quarter more than doubled compared to the same period last year.
At TBS, The Big Bang Theory was again the #1 sitcom on cable and Cougar Town was the #1 original sitcom on cable. In fact, our original programming on TBS was up over 50% compared to our originals in the second quarter last year. As you know, we've recently made a number of changes at CNN and we're seeing real progress. This quarter, CNN was up almost 70% in its key demo during total day, while both of its cable news competitors were down. In fact, CNN surpassed MSNBC to finish as the #2 network of the quarter in both total viewers and adults 25 to 54 for the first time in almost 4 years. That was partially driven by a high volume of breaking news events, but we saw strength across almost every daypart and every show, even away from breaking news coverage. For instance, in June, CNN's new morning show, New Day, was up over 50% in the key demo over last year and Anthony Bourdain: Parts Unknown is an unqualified hit. Our brands and programming are resonating with our advertisers, too. We just completed negotiations for the 2013 to '14 upfront and our portfolio of entertainment-oriented networks, TBS, TNT, truTV and Adult Swim, obtained CPM increases in the high single-digits. Once again, that was at the high-end of the range for all TV networks, broadcast and cable.
Our affiliates also recognize the value of our networks. As you may recall, last year at this time, we first told you that we expect Turner's domestic subscription revenue to grow at double-digit CAGR between 2013 and 2016. Last month, we completed a contract renewal with a top 5 distributor and got the affiliate fee increases we were seeking. This gives us even more confidence that we'll achieve our long-range targets.
At HBO, our programming lineup is as strong as it's ever been, which is saying a lot. Game of Thrones finished its third season with an average of 14 million viewers per episode. That's up more than 20% from last year and firmly establishes it as the second most popular series ever on HBO. True Blood recently launched its sixth season and is averaging over 10 million viewers per episode. And in its second season, The Newsroom is averaging 7 million to 8 million viewers. Last, but not least, our made-for-HBO movie, Behind the Candelabra, starring Michael Douglas and Matt Damon, was the most-watched HBO film in 10 years. And HBO received 108 Primetime Emmy nominations this year. That's the most of any network for the 13th consecutive year and it's more than double the nearest competitor. It's also the most that HBO has received in 9 years. That included nominations for Outstanding Drama Series for Game of Thrones, Outstanding Comedy Series for both Girls and VEEP and Outstanding Miniseries Or Movie for Behind the Candelabra and for Phil Spector. We intend to build on this success.
HBO remains the port of first call for distinctive-airing television. And right now, we have more pilots in development at HBO than in any time in its history, including projects for Mike Judge, Damon Lindelof, David Milch and Ryan Murphy, among others.
We also had a fantastic quarter at Warner Bros. Warner Bros. TV wrapped up one of its most successful upfront seasons ever. It received orders for 31 shows on the 5 broadcast networks for next season, including 18 that are returning shows and 13 new shows. That's the highest number of total orders in years and it's the most returning shows in over 30 years. Importantly, we have orders for 10 comedies, which as you know, have the greatest potential value in syndication.
We also had a really strong theatrical quarter, led by the performance of Man of Steel and The Great Gatsby. Notably, Man of Steel, our Superman reboot, is on track to generate almost $700 million at the worldwide box office. That's obviously a great start to the franchise. A few weeks ago, we revealed exciting plans for a Man of Steel sequel that will bring together Superman and Batman, which is scheduled for 2015. We have a lot more plans for DC that we look forward to sharing when the time is right.
Looking out into the third quarter and through the rest of this year. The Conjuring is well exceeding our forecast. It's on track to reach $130 million at the box office domestically, putting it among the top 5 horror films of all time. We're optimistic that We're The Millers, starring Jennifer Aniston and Jason Sudeikis and opening tonight, has the makings of a sleeper hit. And we're particularly excited about our biggest remaining release of the year, The Hobbit: The Desolation of Smaug.
I want to touch on some significant personnel changes we announced recently. After leading Turner Broadcasting to great success for over a decade, Phil Kent recently approached me with a decision not to renew his contract after it expires next year. I'm very excited that John Martin has agreed to take on the CEO role at Turner, starting January 1. We'll miss John's leadership here at corporate, but he'll been in an even better position to drive Time Warner's success from that seat. Howard Averill, current CFO of Time Inc., will move over to Time Warner to replace John. Howard has been a steady hand during a period of tremendous change at Time Inc. and I'm confident he'll prove a great addition to the senior management team at Time Warner. We also announced that Joe Ripp, a veteran of Time Warner and an accomplished media executive, will return to lead Time Inc. as CEO. Having someone of Joe's caliber in place is a key component of our plan to spin off Time Inc. into an independent, publicly traded company.
I'll also update you on the timing of the Time Inc. spend. Our top priority in the spinoff is to make sure that we put Time Inc. in the best possible position to succeed. So rather than rush to complete the transaction this year, we've decided that it's prudent to give Joe some time to further refine Time Inc.'s strategic direction and as a result, we now expect to complete the spinoff early next year.
So in closing, with more than half the year behind us, we're very proud of what we've achieved. We're also very confident of how we're positioned, both for 2013 and the years to come.
With that, I'll pass it to John.
John K. Martin
Thanks, Jeff, and good morning. I'll begin by referring to the first slide, which is now available on our website, and starting with our consolidated results. We're halfway through the year and we couldn't be more pleased with our performance to date. We've delivered strong results in the first quarter and even stronger results this quarter. In fact, through the first half of the year, our adjusted operating income is up 15% and we've grown adjusted earnings per share by almost 30% year-over-year. That's a result of healthy underlying trends across nearly all of our businesses.
In the second quarter, our revenues grew 10% and that included a nearly 200 basis-point drag from our Publishing division. We had a terrific quarter at Networks, which posted its highest quarterly revenues and profits ever. And company-wide, international revenues grew almost 20% in the quarter.
Adjusted operating income grew 25%, making it our highest second quarter ever for profits. Margins expanded over 230 basis points and that included margin expansion at each of our reporting segments. And that's despite double-digit growth in programming, production and marketing expenses, which we were able to offset partially by reducing other cost of revenues and other SG&A expenses. And this discipline has allowed us to produce very strong financial results even while we're investing aggressively for the future.
Continuing to move down to P&L. Adjusted EPS grew even faster than adjusted operating income, climbing 46%. And that's the 12th time in the last 15 quarters that adjusted EPS has grown double digits, along with our strong operating performance that was helped by a lower effective tax rate and our ongoing allocation of capital to share repurchases.
Since we last reported earnings, we've repurchased almost $1 billion of common stock, which is an acceleration from the first quarter, and we also paid over $270 million in dividends. So year-to-date, we returned almost $2.4 billion to shareholders, including more than $1.8 billion in share repurchases and $500 million in dividends. And as Jeff mentioned, in light of this strong performance and our confidence of our ability to execute in the back half of the year, we're raising our 2013 full year business outlook for adjusted EPS and we now expect growth to be in the mid-teens year-over-year.
Let me now turn to the specific segment highlights and let me begin at our Networks segment where each of HBO and Turner grew adjusted operating income double-digits. Advertising revenues were up 11% year-over-year and that's our highest quarterly growth rate in 2 years. And please recall that we benefited from the timing of the Final Four this quarter. But if you look through that, domestic ad growth was also around 11%. And that includes solid growth across all of our categories. That's domestic entertainment, that's kids and that's news.
International advertising declined in the low single-digits, but without the prior year closure of TNT Turkey and the impact of foreign currency movements, it would have been up mid single-digits. And that was a result of mid-teens growth at international entertainment, which was partially offset by declines at international news.
Looking ahead to the third quarter, we continue to see very solid trends here with scatter pricing up double digits over the upfront. So as of now, we anticipate mid to high single-digit growth in total Networks advertising in Q3.
Moving on. Subscription revenue growth was 4% in the quarter, which was relatively consistent with the mid single-digit growth that we saw in the first quarter. This quarter, the mix of subscribers at HBO and a stronger U.S. dollar both somewhat weighed on Subscription revenue growth. And as we look ahead to the rest of the year, we continue to believe that Subscription revenue growth will be up mid single-digits. And as Jeff mentioned, with Turner recently securing a new deal with a top 5 distributor, we have even more confidence that we'll see significant acceleration in Subscription revenues beginning in 2014.
Adjusted operating income at the Networks segment was up a very strong 13% in the quarter, with margins increasing almost 180 basis points year-over-year. And please note that growth this quarter did benefit from an adjustment through a receivable allowance, but even without that, adjusted operating income would still have been up double digits. And that reflects both of the revenue growth as well as our ongoing focus on constricting non-programming costs, as programming expenses increased 8% in the quarter. So in the first half, programming expenses at the Networks were up 4%, which is consistent with our expectation of, in any given year, programming expenses being up mid to high single-digits.
Looking ahead, we continue to anticipate margins are going to be up here at this group for the year. And that's despite continued growth in our programming investments. So 2013 should be another very, very strong year for the Networks segment. And we're positioning ourselves to grow at attractive levels for the foreseeable future here.
So now let me turn to our Film and TV production group at Warner's, which had another really terrific quarter with revenues up 13% and adjusted operating income up 34%. The increase in adjusted operating income was largely driven by the strong performance of our Film slate. And that included films such as Man of Steel, The Great Gatsby and The Hangover Part III. In Television, we faced a very difficult comparison against the domestic syndication sale of The Mentalist in the year-ago quarter. And despite this difficult comparison, the underlying trends remain really strong here. In addition to the really successful upfront season that Jeff described, we also saw higher international license fees and very healthy demand for our television product from SVOD services, both domestic and international. We recognize just under $70 million in SVOD revenue at Warner's in the second quarter and that's up significantly from a year ago.
And if you look at Time Warner, we've recognized now year-to-date about $150 million of SVOD revenues. And we continue to expect that SVOD distribution channel will be a strong contributor to our results this year. Across theatrical and TV, Warner's Home Entertainment revenue was up 3% in the quarter. And while the industry was down slightly in the quarter, it grew modestly for the first half of 2013. And we're particularly encouraged by the growth in the electronics sell-through area, which was up over 50% for the industry in the first half. And while there's still work to do on improving the consumer experience here, we think it's a very positive sign for the future of the Home Entertainment business.
Looking ahead, we expect second half results to be strongly weighted to the fourth quarter at Warner Bros. In the third quarter, we face very tough comparisons against last year's theatrical release of The Dark Knight Rises. In addition, we anticipate recognizing SVOD revenues from certain CW availabilities in the fourth quarter of this year versus recognizing them in the third quarter of 2012. And while we've already released the majority of our larger movies this year, we're optimistic about the rest of this year's theatrical release slate. And We're the Millers, which opens this evening, is a particularly funny film.
Similarly, we feel very good about our position going into the new TV season due to Warner Bros.' industry-leading performance during this year's upfront. And we have very, very high hopes for the fourth quarter games release, including Batman: Arkham Origins. So we remain confident that Warner Bros. profits this year should be at least as good, if not better, than what they were last year. And we've been saying that now for some time.
Let me move on to Publishing. At Time Inc., advertising revenues were down 5% in the quarter and that was due to declines both here as well as outside the U.S. Domestically, we saw softness at the sports and news groups. We also finally lapped the transfer of SI.com and Golf.com back to Time Inc., which contributed to advertising trends appearing somewhat worse than what they were in the first quarter. Subscription revenue fell 7% in the second quarter as we continue to see softness in newsstand sales. And looking to the back half of the year, we expect the decline in Subscription revenue to look somewhat similar to what we experienced in the first half of the year. But note, that we will see some shift of Subscription revenue to the third quarter from the fourth quarter due to the frequency of certain titles in each quarter. Despite lower revenues, adjusted operating income was up a pretty strong 28% in the quarter. And that was primarily a function of cost savings initiatives including the restructuring actions that were taken earlier this year.
As we look to the rest of 2013, our comparisons as compared to last year become somewhat more challenging. So while we remain focused on cost controls at Time Inc., we don't expect that will be sufficient to offset revenue declines in the back half of this year.
Now let me turn to the next slide, which looks at our full year 2013 business outlook. As I just said, we had a great first half of the year. And that's given us a tremendous amount of confidence to raise our full year 2013 outlook to mid-teens growth in adjusted EPS. And despite higher losses from our investment in CME than we originally anticipated at the beginning of the year, the absolute numbers implied by our new current guidance are nicely higher than our previous outlook. Clearly, our updated outlook implies that growth will slow somewhat in the back half of this year. And that's the result of difficult comparisons, particularly at our Film and TV and Publishing segments. And this is consistent with what we expected coming into this year and it certainly doesn't suggest any change to the health of the businesses. I'll also point out that our effective tax rate was a bit lower in the first half than we normally anticipate, as a result of settling a couple of audits with taxing authorities. And excluding those settlements, our effective tax rate would have been somewhere in the mid-30s, which is more in line with our longer-term expectations. So we feel good about raising guidance. We feel good about our performance. And we believe that we are set up for both a very good year and continued attractive growth in the longer term.
Let me now turn to cash, free cash. We're having a big year for free cash flow generation. We've generated, through the first 6 months of the year, $1.8 billion of free cash flow. That's more than triple the year-ago period. And that's mostly due to an improvement in working capital, which we expected, and the strong growth of profits, which I've been just discussing. Capital expenditures and cash taxes are also lower year-to-date. The favorable working capital variance accounted for more than 1/2 of the improvement in free cash flow year-to-date. And the biggest drivers there were reimbursements for prior co-financings and the timing of payments for sports programming at Networks. The decline in cash taxes was primarily a result of tax law extenders that were passed by Congress in January this year. So with our solid performance through the first half of the year, we're on track for a really, really strong year of free cash flow generation in 2013.
Turning now to the final slide which looks at our net debt. We ended the quarter with a little less than $17.4 billion in net debt. That's up about $350 million from year-end 2012. And that's largely due to the almost $2.1 billion of capital we allocated in the form of dividends and share repurchases in the first half. Providing stockholder returns remains a critical component of our capital plan. And as you can see, the amount of capital we've returned well exceeds the free cash flow we've generated year-to-date. That's consistent with how we've been allocating capital for a number of years now. And since 2008, we've generated about $13 billion in free cash flow. And over that same time period, we've repurchased almost $13 billion of stock or almost 30% of our float and, at the same time, we paid more than $4 billion in dividends. So our leverage ratio is now only 2.3x, which is a little bit below our target of 2.5x. And we still think that our target leverage ratio of 2.5x strikes the right balance of maintaining a balance sheet strength, while giving us the flexibility to invest in our core businesses, make acquisitions and return capital to our stockholders. So we'll continue to manage the balance sheet to stay close to that target over the course of the year.
And with that, let me turn the call back to Doug so that we can begin the Q&A portion. Thank you.
Thanks, John. Dawn, let's get the Q&A started. [Operator Instructions]
Earnings Call Part 2: