Time Warner (TWX) Q3 2013 Earnings Call November 6, 2013 10:30 AM ET
Michael Kopelman - Senior Vice President of Investor Relations
Jeffrey L. Bewkes - Chairman of The Board and Chief Executive Officer
John K. Martin - Chief Financial & Administrative Officer
Benjamin Swinburne - Morgan Stanley, Research Division
Michael Nathanson - MoffettNathanson LLC
Douglas D. Mitchelson - Deutsche Bank AG, Research Division
Jessica Reif Cohen - BofA Merrill Lynch, Research Division
Richard Greenfield - BTIG, LLC, Research Division
Alexia S. Quadrani - JP Morgan Chase & Co, Research Division
John Janedis - UBS Investment Bank, Research Division
Michael C. Morris - Guggenheim Securities, LLC, Research Division
Vasily Karasyov - Sterne Agee & Leach Inc., Research Division
Welcome to the Time Warner Inc. Third Quarter 2013 Earnings Conference Call. My name is Richard, and I'll 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. Michael Kopelman, Senior Vice President of Investor Relations at Time Warner. Mr. Kopelman, you may begin.
Thanks, and good morning, everyone. Welcome to Time Warner's third quarter earnings conference call. This morning, we issued 2 press releases, one detailing our results for the third quarter and the other reaffirming our 2013 business outlook.
Before we begin, there are 2 items I need to cover. First, we refer to certain non-GAAP financial measures. Schedules setting out reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measures are included in our earnings release and trending schedules. These reconciliations are available on our website at www.timewarner.com/investors. Reconciliations of our expected future financial performance are also included in the business outlook release that's available on our website.
And second, today's announcement includes certain forward-looking statements, which are based on management's current expectations. Actual results may vary materially from those expressed or implied by these statements due to various factors. These factors are discussed in detail in Time Warner's SEC filings, including its most recent annual report on Form 10-K and subsequent quarterly reports on Form 10-Q. Time Warner is under no obligation, and in fact, expressly disclaims any obligation to update or alter its forward-looking statements, whether as a result of new information, future events or otherwise.
Thank you, and I'll turn the call over to Jeff? Jeff?
Jeffrey L. Bewkes
Thanks, Mike, and thanks for listening in this morning. We had another great quarter and we're on track for another very successful year.
In the third quarter, we grew adjusted operating income 8%, adjusted earnings per share increased 20%, and we returned over $1.3 billion to our stockholders through buybacks and our dividend.
So it was a very strong quarter from a financial perspective. And just as important, we continue to perform at the top of our game operationally and to lay the foundation for continued growth.
For example, at Turner we're seeing a significant payoff from the investments we've been making to bolster and refresh our program. That was evident in advertising revenue, which was up double-digits again this quarter, and it was evident in ratings, where TBS was the #2 cable network in prime across adults 18 to 34 and 18 to 49 in the quarter.
The ongoing strength of the Big Bang Theory is a big part of that success, both in drawing audiences and as a launching pad for original programming.
TBS recently renewed 3 of its originals, Sullivan & Son, Men at Work and Deal With It for additional seasons. And in the fourth quarter, TBS is continuing to build out its lineup of original series with the launch of 3 new shows including a show called Ground Floor. That's a comedy from Warner's.
TBS investment in Major League Baseball is also paying dividends. The National League Championship Series grew prime time viewers by 14% over 2011, which is the last time it aired on TBS.
TNT has also continued to benefit from investments in programming, finishing the quarter as the #2 network on cable among adults 25 to 54 in total day. Its growing slate of hit originals included 4 of the top 10 scripted shows on cable this quarter: Rizzoli & Isles, Major Crimes, Falling Skies and Perception. Over the next month, TNT will bring back Major Crimes and Boston's Finest, and it will premiere 2 new shows: Marshall Law: Texas, which is an unscripted show from Jerry Bruckheimer, as well as the highly anticipated miniseries, Mob City from Frank Darabont.
Last week, the NBA also kicked off its regular season on TNT. That marks its 30th year with Turner. The season-opener between the Miami Heat and Chicago Bulls was the second highest-rated opening night in TNT history, and Thursday night's doubleheader grew viewership by 14% over last season's first Thursday night telecast.
We're also continuing to make gains at CNN. This quarter, CNN grew total day ratings in its key demo by 15%, while its 2 principal competitors showed year-over-year declines. And it finished ahead of MSNBC in both total viewers and adults 25 to 54 for the second straight quarter. Well, there's still lots of work to be done, but CNN is showing real progress, particularly in revamped programming blocks like the morning show, where New Day drove viewership up almost 30% over the year-ago quarter.
Adult Swim is having a great year as well. It just finished the most-watched quarter in its history, growing over 20% with adults 18 to 34 in total day. It was the #1 ad-supported cable network in total day among 18- to 34-year-olds for the 22nd straight time, and for the first time, it was also #1 in prime time among adults 18 to 34.
Across the board, the Turner networks continued to deliver great value to our customers, our advertisers and our distributors. That was evident in our recent affiliate renewal with another top distributor. During this affiliate renewal cycle, we've now signed renewals with 4 of the top 10 U.S. distributors, reinforcing our confidence in Turner's ability to accelerate its domestic subscription revenue growth starting next year.
Turning to HBO. We're also benefiting from our investments in great programming. You don't have to take my word for it. The rest of the industry is saying it for us. HBO won 27 prime time Emmy Awards this year. That's the most of any network for the 12th straight year. That included 11 awards for Behind the Candelabra and 5 for Boardwalk Empire, making them the 2 biggest winners this year.
And the distinctiveness and the excellence of HBO's programming is apparent in its subscriber trends, which have been very positive both here in the U.S. and around the world. Outside the U.S., HBO is on track for another year of double-digit growth in subscribers. And on that front, we recently acquired the interest in HBO Asia and in HBO South Asia that we did not previously own. By wholly owning these ventures, we think HBO will be able to better capitalize on the growth opportunities in the region.
Let me turn to Warner Bros., which is hitting on all cylinders. In television, Warner's is once again supplying more shows to the broadcast networks than any other studio. That includes the top 2 series on television, The Big Bang Theory and The Voice, which have both seen ratings growth over the last season.
Beyond the broadcast networks, we continue to see very strong demand from cable networks, SVOD services and international territories for both originals and off-net syndication.
Looking across cable and broadcast, Warner Bros. TV is producing 63 shows this season. That's up from 55 last season. And that includes the highest number of returning series in more than 30 years.
In syndication, Warner's benefited from the domestic cable sale of The Middle this quarter, and added to its pipeline with the sale of Person of Interest, which will premiere on cable in 2015.
At the film studio, Warner's released 2 sleeper hits in the third quarter, The Conjuring and We're the Millers, which have grossed over $300 million and $260 million, respectively, at the global box office.
Warner's followed that up with the release of Gravity, which is a phenomenon, both in terms of critical acclaim and commercial success. As most of you know, Gravity set an October record for an opening weekend domestically, and it's on track to gross over $0.5 billion at the global box office.
Thanks to those titles and other global hits like Man of Steel and The Great Gatsby, Warner Bros. is #1 at the domestic box office so far this year and, of course, the second installment in The Hobbit franchise will storm into theaters next month.
In September, Warner Bros. also took a major step in securing its franchise pipeline with the announcement of an expanded creative relationship with J.K. Rowling. As the centerpiece of that relationship, she will write a series of original films that revisit the magical world she created in the Harry Potter novels. Like the many millions of fans of her great work, we're excited to see what new adventures Jo has in store for us.
Before I finish, let me take a minute to update you on the timing of the Time Inc. spin. Joe Ripp and his team have been in place for a couple of months now, and they're making great progress in preparing Time Inc. to become an independent publicly traded company. We anticipate making the initial filing of our Form 10 in the next few weeks. That should put us in a position to complete the spinoff during the second quarter of next year. As many of you know, the separation of Time Inc. will be the culmination of the process we started over 5 years ago to refocus Time Warner on being a pure-play content company, with an emphasis on video and television in particular.
I think you can see the positive impact that focus is having on our results. At the same time, we know that capital allocation could be as important to stockholder returns as operational excellence. So far this year, we've returned almost $4 billion to stockholders through share repurchases and dividends, and we remain committed to maintaining an efficient capital structure and to providing direct returns to our stockholders going forward as well.
In closing, I'm really pleased with our results so far this year. We still have a lot of work to do, but I'm more confident than ever in our strategic position and our ability to maintain attractive growth and returns for many years to come.
With that, I'll turn it over to John for his final earnings call as our Chief Financial & Administrative Officer. John's leadership has been a key ingredient to the success of Time Warner in recent years, and I'm confident that will continue to be the case in his new role as CEO of Turner. 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 had another really great quarter, and off of flat revenues, adjusted income rose 8%, making this our most profitable third quarter ever. And that was mainly due to solid double-digit growth at the Networks segment and company-wide, adjusted operating income margins expanded almost 180 basis points year-over-year, and that's the eighth time in the last 9 quarters that margins have expanded year-over-year.
We've been able to do that by staying very, very focused on costs, and continued cost discipline has been critical to our ability to invest aggressively while also increasing margins and it remains a significant focus for the company.
Adjusted EPS grew 20% in the quarter, and that marks the 13th out of the last 16 quarters that adjusted EPS has grown double-digits. And, once again, we were able to grow adjusted EPS faster than adjusted operating income, and that was helped by a lower effective tax rate, as well as our ongoing share repurchase program.
The acceleration in our share repurchases this quarter is evidence of our continued commitment to providing returns to stockholders. Year-to-date, we've returned almost $4 billion, and that includes $3 billion in buybacks and $811 million in dividends. And that's almost 25% more than we returned during the same period in 2012, and it includes $1.2 billion in share repurchases since we last reported earnings.
Our year-to-date operating results have also been really, really good, with adjusted operating income up 12% and adjusted EPS up 25%. And that's despite an almost 300 basis-point drag on growth in adjusted operating income from Time Inc. and the inclusion of foreign exchange movements, as well as incremental equity losses associated with the company's nearly 50% investment in CME.
Given the strength in these year-to-date results, let me just touch on our outlook for a moment, which calls for mid-teens growth and adjusted EPS for the full year 2013, which we reaffirmed this morning.
Just doing the math, that implies a fourth quarter adjusted EPS to be about flat relative to last year, which is obviously a significant deceleration from the first 9 months of this year. And that's due largely to decisions that we've made about our programming schedule, as well as related marketing spend at the Networks segment. I'll discuss that more in detail in a few minutes.
Our outlook for the fourth quarter also reflects very difficult comparison to Warner Bros., continued pressure at Time Inc. and higher expected equity losses related to CME. And for the year, we now assume about a $0.10 negative impact to adjusted EPS as a result of our equity accounting at CME, and that's an obvious disappointment.
But putting this all in perspective, we fully expect 2013 to mark the fifth consecutive year of double-digit adjusted EPS growth, and it's going to be another record year for the company. So we feel really good about the underlying trends in virtually all of our businesses, and with the momentum we saw in the third quarter, we've got even more confidence about our ability to drive further growth in years to come.
So let me now turn to our divisional segment highlights, and let me begin with the Networks segment. Adjusted operating income here in the third quarter was up a very strong 12%, and it's been up double-digits through the first 9 months of the year. Advertising revenues once again grew double-digits, and that was largely due as a result of very positive trends at both domestic entertainment as well as our international networks.
Domestic advertising was up high single-digits in the quarter. And that included double-digit growth at the entertainment networks, which included kids and young adults, and that was somewhat offset by a slight decline at domestic news.
International advertising increased high-teens despite a several hundred basis-point drag from foreign exchange. And that reflected very healthy growth across all regions, with particular strength in Latin America.
And while it's somewhat difficult to measure, we believe both domestic and international advertising trends were helped on a year-over-year basis this year by the absence of the Olympics in the third quarter.
Looking ahead to the fourth quarter, scatter pricing at the entertainment networks is up double-digits over the upfront, and we anticipate high single-digit advertising growth at domestic entertainment including kids.
Domestic news is likely to be down double-digits year-over-year, however, and that's because of the comparison against the U.S. presidential election last year, as well as ongoing softness in the news advertising marketplace in general.
Similarly, we are seeing a sequential deceleration in international advertising growth in the fourth quarter, and that is owing partially to difficult comparisons against last year's fourth quarter, specifically in Latin America and Europe.
So in total, we would expect advertising growth at Turner to be somewhere in the mid single-digits in the fourth quarter, when you take into consideration the ups and downs that I just went through.
Moving on, subscription revenue growth of 4% in Q3 was consistent with the mid single-digit growth in the first half of the year, and was perfectly in line with our expectations. A stronger U.S. dollar continues to weigh on growth here in the quarter, and we expect that that is going to continue to be the case in the fourth quarter as well.
However, we continue to see healthy underlying subscriber dynamics in international territories, particularly at Latin America. And as Jeff just mentioned, Turner recently secured an affiliate renewal with an additional top 10 U.S. distributor.
We've also seen some encouraging subscriber trends at HBO, so we remain confident that we're going to see a real acceleration in subscriber revenues beginning in 2014.
Adjusted operating income at the Networks was up 12% in the quarter, with margins increasing 220 basis points year-over-year, and that's the sixth quarter in a row of margin expansion at this segment.
In addition to Networks segment revenue growth, margin expansion was helped by an extremely modest increase in expenses of less than 2% in the quarter, and that was largely a result of the timing of programming spend, which was down versus last year's third quarter.
Looking at the fourth quarter for a moment, we anticipate a pretty big year-over-year ramp in our original programming investment and related marketing spend. And that's a result of more than an 80% increase in original episodes at Turner, as well as an increase in spending on both original series and original films at HBO.
We're also investing at CNN, and that's part of a strategic decision to broaden the programming beyond merely breaking news and politics. Anthony Bourdain: Parts Unknown and Morgan Spurlock's Inside Man are 2 early efforts in this area, and they're among 2 of CNN's highest-rated shows this year. And their success suggests that there are meaningful opportunities for CNN beyond merely breaking news and politics. Programming investments such as these will likely put some pressure on CNN's margins in the near-term, but they will also open up a new pool of advertisers to CNN, and they could position the network for a return to attractive growth over time.
For the fourth quarter, there are just a couple of other items to keep in mind here at the Networks segment. First, we anticipate a drop in content revenue as a result of continued soft demand for catalog product and fewer home video releases at HBO. In addition, we recently acquired the remaining interests in HBO Asia and HBO South Asia, so we now own 100% of each and will start consolidating for accounting purposes their operating results in the fourth quarter. This is part of an ongoing effort to accelerate HBO's international growth, and that leaves HBO Latin America group as the only significant international HBO joint venture that we do not consolidate.
The consolidation of HBO's properties in Asia will benefit subscription revenue growth, but it's actually going to be a slight drag on operating profit in the fourth quarter, mostly as a result of seasonality. But together with HBO Nordic, which we started consolidating earlier this year for accounting purposes, we expect the negative impact on adjusted operating income to be around $15 million for the fourth quarter. And, obviously, these ventures are still in investment phases, and we fully anticipate that they're going to pay off and become really attractive investments for us over time.
But taking that all into account, we anticipate the network's adjusted operating income will be approximately flat in the fourth quarter of 2013, and that's, obviously, not a typical quarter for us from a year-over-year growth rate perspective, which is why we wanted to share a little bit more detail with you.
Still with 1 quarter left to go, we remain absolutely on track for another year of margin expansion and some pretty strong growth in adjusted operating income at the Networks group.
And with the investments we're making in these businesses, we're positioning ourselves to grow at very attractive levels for the foreseeable future.
Turning now to Film and TV production at Warner's. We knew coming into this year that we had very tough comparisons in the second half of the year in both the third and the fourth quarter, and in line with our expectations, revenue was down 7% and adjusted operating income was down 8% in Q3. But year-to-date, Warner's is having a terrific year and its adjusted operating income is still up double-digits.
Despite the declines in the quarter, we're very, very pleased with Warner's operating performance. And, as Jeff noted, some highlights, We're the Millers and The Conjuring were both extremely successful releases at the box office.
On the TV side, the third quarter benefited from the domestic cable sale of The Middle, and we continue to see very good demand for our product globally. This is evident in the number of new shows we have on broadcast this season and the strong pricing we're getting when we're selling those shows in international territories.
Across theatrical and TV, Warner Home Entertainment revenue declined 9% in the quarter, and that was principally due to the timing of SVOD availabilities at the CW, which shifted from Q3 to Q4 this year as a result of the later start of its season.
In addition, we have seen some softness in the home entertainment sales of our television product as of late, including catalog.
For the industry, however, home entertainment sales fell just slightly in the quarter and they actually remained up for the year. And electronic sell-through grew more than 50% in the quarter and year-to-date for the industry, and we think that's an extremely positive sign for the future of the Home Entertainment business, and we're focused on improving the consumer experience in order to further accelerate the shift to digital ownership.
Looking ahead, Warner's has very difficult comparisons against last year's fourth quarter, which happened to be an all-time record quarter for Warner Bros. So year-over-year growth may be tough, but we expect profits to significantly exceed the third quarter of this year. And we're off to a great start with the success of Gravity, and we'll also benefit from the next Hobbit film. We'll benefit from the recognition of the CW SVOD revenue and the games release of Batman Arkham Origins. So it should still be our biggest quarter of the year and among the largest-ever for Warner's in terms of adjusted operating income. And that's going to put Warner's firmly on track to grow profits this year and potentially have its best year ever. So we're quite pleased with that.
Moving over to Time Inc. Advertising revenue was down 2% in the quarter. Domestic print advertising increased, but that was due largely to a shift of an issue of both People and Sports Illustrated into the third quarter from the fourth quarter. And without this shift, domestic print ad revenue would have been up marginally in the quarter, but overall, advertising would have declined by over 3%. And that's due to softness in non-magazine as well as international advertising.
Subscription revenues also benefited by more than 200 basis points as a result of the additional issues in the third quarter. Despite that, subscription revenue was down 4% in the quarter, and that was principally due to continued softness in newsstand sales.
Looking ahead, we expect both advertising and subscription revenues to be negatively affected in the fourth quarter by the shift of the issues that I just mentioned into the third quarter. In addition, the improvement in trends in domestic print advertising that we experienced in the third quarter doesn't seem to be continuing yet in the fourth quarter.
Adjusted operating income was down 8% in Q3, as ongoing cost control efforts weren't enough to offset the revenue declines. And given the continued revenue pressure that we expect, we think adjusted operating income is going to be down in the fourth quarter at Time Inc.
Let me move on and talk for a minute about free cash flow. 2013 is going to shape up to be an absolutely terrific year in terms of free cash flow generation. Year-to-date, we've generated almost $2.9 billion of free cash. That's up almost 50% versus the same period in 2012, and is almost as much as we generated in all of last year. And that's mostly due to the strong growth in adjusted operating income as well as an expected improvement in working capital.
Capital expenditures and cash taxes are also lower year-to-date. The biggest drivers of the change in working capital have been lower payments for certain license programs, the timing of sports programming payments and higher reimbursements from prior film co-financings.
The decline in cash taxes was primarily a result of tax law extenders that were cast by Congress in January of this year. And that's been a positive for us all year.
So with our solid performance year-to-date and with just a few months to go, we're fully on track for a really, really strong year in 2013 as it relates to free cash flow.
So let me move on and just talk for a minute about the balance sheet and net debt. We ended the third quarter with a little bit more than $17.5 billion in net debt. That's up about $570 million from the end of last year and that's mainly due to the, roughly, almost $3.5 billion of capital returned to shareholders in the first 9 months of the year through dividends and share repurchases. And that includes an acceleration in our share repurchases in the quarter to almost $1.1 billion. Consistent with recent years, the amount of capital return significantly exceeds the free cash flow we've generated year-to-date.
On a transaction front, I do want to highlight that Warner Bros. entered into a multi-year agreement to co-finance as many as 75 movies with RatPac-Dune Entertainment. Along with its existing co-financing arrangement with Village Roadshow, we think this provides Warner's with very attractive flexibility to manage the risk of its film slate while optimizing its return on investment. So we feel really good about that and we're pleased with that development.
Balance sheet leverage remained steady at about 2.3x. That's a little bit below our target of 2.5x, and that's despite the acceleration in our share repurchase program that occurred during the quarter. And that was a result of the continued strong free cash flow generation that I just mentioned a few minutes ago.
So that concludes my remarks. With that, let me turn it back over to Mike and we'll start the Q&A portion of the call.
Thanks, John. Richard, can we please start the Q&A? [Operator Instructions] Richard?
Earnings Call Part 2: