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Time Warner Cable Inc. (NYSE:TWC)

Q3 2008 Earnings Call

November 5, 2008 8:30 am ET

Executives

Tom Robey - Senior Vice President, Investor Relations

Glenn A. Britt - President, Chief Executive Officer, Director

Robert D. Marcus - Chief Financial Officer, Senior Executive Vice President

Landel C. Hobbs - Chief Operating Officer

Analysts

Doug Mitchelson - Deutsche Bank

John Hodulik - UBS

Rich Greenfield - Pali Capital

Spencer Wang - Credit Suisse

Jessica Reif-Cohen - Merrill Lynch

Ben Swinburne - Morgan Stanley

Craig Moffett - Sanford C. Bernstein

Vijay Jayant - Barclays Capital

Bryan Kraft - Banc of America

Jason Bazinet - Citigroup

Operator

Hello and welcome to the Time Warner Cable third quarter 2008 earnings. (Operator Instructions) Now I will turn the call over to Mr. Tom Robey, Senior Vice President of Time Warner Cable Investor Relations. Sir, you may begin.

Tom Robey

Thanks, Shirley and good morning, everyone. Welcome to Time Warner Cable's 2008 third quarter earnings conference call. This morning we issued two press releases, one detailing our 2008 third quarter results and the other updating our 2008 business outlook.

Before we begin, there are several items I need to cover. First, we refer to certain non-GAAP measures, including operating income before depreciation and amortization, or OIBDA, and adjusted OIBDA. Adjusted OIBDA excludes the impact of any non-cash impairments of good will and tangible and fixed assets, as well as gains and losses on asset sales.

For the year-to-date results and for full year 2008 outlook, adjusted OIBDA excludes the impact of non-cash pretax impairment loss of $45 million, triggered by our previously announced agreement to sell certain non-core cable systems.

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 our trending schedules. All of these reconciliations, as well as today’s releases, trending schedules, and the presentation slides are available on our company’s website at timewarnercable.com/investors.

A replay will be available beginning approximately two hours after the call has ended and will run through midnight Eastern Time November 7th.

Second, today’s announcement includes certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, which are based on management’s current expectations and beliefs and are subject to uncertainty and changes in circumstances. Actual results may vary materially from those expressed or implied by the statements herein due to various factors, including the planned separation from Time Warner Inc. These factors are discussed in detail in Time Warner Cable's SEC filings, including its most recent annual report on Form 10-K and quarterly reports on Form 10-Q.

Time Warner Cable is under no obligation to, and in fact expressly disclaims any such obligation to update or alter its forward-looking statements, whether as a result of new information, future events, or otherwise.

With all of that covered, I’ll thank you and turn the call over to Glenn. Glenn.

Glenn A. Britt

Thanks, Tom and good morning, everybody. I am pleased to report that we delivered another strong performance in the third quarter. We delivered 8% revenue growth and 9% OIBDA growth in the third quarter, driven by our subscription business. We achieved this strong growth despite continued economy related weakness in our advertising business, which comprises only about 5% of our revenues but around double that amount of OIBDA.

We had another quarter of terrific free cash flow growth. Year-to-date through September, we have generated nearly $1.3 billion of free cash flow. That’s 64% more than the same period last year.

We also had another quarter of strong subscriber net additions. We added as many RGUs this quarter as we did in last year’s third quarter, which is quite impressive given the increasingly challenging competitive and economic climates. We added net consumer relationships, even as basic video subs declined slightly.

Our strong third quarter residential HSD net additions of $214,000 were more than each of Verizon and AT&T’s, despite their larger footprints. That provides further evidence that customers value the speed and reliability of cable over DSL.

In video, we performed substantially better than we did in the third quarter a year ago. Our voice services continued to offer consumers a great value and voice has remained a source of growth for us, even after the systems that we launched last year moved beyond their initial ramp.

Underlying these individual product trends is our longstanding focus on selling bundled services. Bundles provide more value to our customers, which we think is important in this uncertain economy. Notably, our triple play penetration reached 20% customer relationships in the third quarter.

Let me turn for a minute to the current challenging economic environment. Historically, cable has done relatively well in economic downturns and that shouldn’t be a surprise to anyone. We sell subscription services to millions of people and these services are essential to people’s lives. In fact, our customers spend on average 10 hours a day with our services.

However, by all reports, the current economic environment is unprecedented, certainly in my lifetime. If people continue to lose their homes and jobs, it would be naïve to assume that there would be no impact on our business, and in fact as we moved into the fourth quarter, we saw a significant slowdown in subscriber growth compared to last year, particularly for our video and voice services. In addition, we have experienced a slow-down in some of our premium video services, including pay-per-view, ATV services, and DVRs.

Rob will walk you through the details but given these recent trends, we are modestly reducing our expectations for revenue and OIBDA growth for 2008. However, we are reaffirming our earnings per share and free cash flow outlook for the year.

We can and we will manage our business and balance sheet through the downturn and the eventual recovery. We have a strong balance sheet, including more than sufficient committed liquidity to fund our separation from Time Warner, as Rob will also discuss. We expect we will complete that deal by early 2009 and we are excited about the future of an independent Time Warner Cable.

So in summary, we delivered good results in the third quarter. Our competitive position is strong and we are ready for our separation from Time Warner. While we, like everyone else, are well aware of the challenges presented by the economy, we have a strong balance sheet, stable free cash flow, and we are confident in our long-term strength.

Now Rob will give you some additional insight into our financial performance. Rob.

Robert D. Marcus

Thanks, Glenn and good morning, everyone. As Glenn mentioned, we had a strong quarter both in terms of subscriber performance and financial results. Let’s turn to the first slide and I will discuss the highlights of the quarter. We added $522,000 net RGUs in the quarter. That’s essentially flat versus Q307, in spite of the more challenging market place. This was the 14th consecutive quarter in which RGU net additions exceeded $500,000 and as of quarter end, our total RGUs stood at approximately $34.2 million.

We added 13,000 net customer relationships in the quarter, bringing our total to $14.75 million. We did this despite a net decline in basic video subscribers, which means we continued to see gains in HSD only and HSD digital phone double play customers. We’ve added customer relationships in each of the first three quarters of this year, adding 124,000 customer relationships year-to-date.

We ended the quarter with 7.8 million customers and bundles. That’s nearly 53% of our total customer relationships, an increase of 219,000 bundled subscribers. This growth was fueled by 168,000 triple play net additions, pushing triple play penetration over 20% of total customer relationships. As you’ve heard us say before, triple play customers typically have lower churn and higher ARPU.

On the financial front, revenues grew 8% over the third quarter of last year, while OIBDA increased 9% year over year. Free cash flow in the quarter was more than double the Q307 amount, while nine months free cash flow has increased more than 60% year over year.

Finally, I want to point out that we also continue to make progress in our commercial business. Commercial revenues exceeded $200 million for the first time this quarter, growing more than two times as fast as residential revenues.

Turning to slide number four, let’s review our third quarter subscriber metrics. We ended the third quarter with $13.3 million basic video customers. That’s 49% of homes passed. During the quarter, we lost 31,000 basic video subscribers, but that’s a significant improvement over the 83,000 subscribers we lost in the third quarter of last year. Approximately 70% of the loss came from our lowest tier video customers who pay us around $13 per month.

Digital video subscriber net additions were 124,000 and penetration reached nearly 65% of basic video subscribers during the quarter. That’s yet another quarter in which we have added at least one percentage point of digital video penetration.

HD capable subscribers climbed to 4.1 million, or nearly 48% of our total digital subs. DVR growth continued to moderate somewhat, with DVR subs increasing by 150,000 in the quarter versus 211,000 in last year’s third quarter.

Total DVR subscribers were just under $4 million at quarter end. That’s nearly 46% of our digital video subscribers.

We had another strong quarter in residential high-speed data, adding 214,000 subscribers. This was the fifth consecutive quarter in which net adds exceeded 200,000, a benchmark we have achieved in 12 of the last 13 quarters.

Residential HSD penetration exceeded 31% of homes passed as of September 30th. We also continued to experience gains in our turbo HSD service, with net adds making up about one-third of the total HSD net adds in the quarter.

Residential digital phone net additions were 200,000. This was the eighth quarter in a row at or above that level. While our digital phone net adds were lower than in the third quarter of last year, remember that we were just beginning to offer digital phone in L.A. and Dallas in Q307, so those results benefited from pent-up demand in those markets.

Residential digital phone penetration increased to 14% of service-ready homes. As with HSD, we continued to experience meaningful penetration gains in some of our most highly penetrated markets. We now have five divisions with digital phone penetration exceeding 20%, including one division that’s over 30%.

Moving on to our financial results on the next slide, third quarter revenues of $4.3 billion grew $339 million, or 8% over the third quarter of 2007. Subscription revenues increased 9% while ad revenues grew just 1%. On the subscription revenue side, the 9% increase was driven by an 8% year-over-year improvement in RGUs and a slight improvement in subscription revenue per RGU.

Broken down by product line, we had 4% video revenue growth, 12% increase in HSD revenue, and 37% voice revenue growth.

On a dollar basis, growth was relatively evenly split across all three services. Cut another way, residential subscription revenues grew 8% while commercial revenues grew approximately 20%.

Advertising revenues reflected a year-over-year decline in our local and regional ad business, offset by higher political advertising and some changes that occurred during the last 12 months that we previously discussed, including our taking over management of [Charter’s] local ad sales business in L.A.

Total ARPU per basic subscriber increased 9% year over year to approximately $109, with subscription ARPU also up 9% to about $103.

Looking at product ARPUs, video ARPU increased year-over-year, driven primarily by higher basic video ARPU and increased digital video penetration. HSD ARPUs declined slightly compared to the prior year but was up marginally compared to the second quarter of 2008. That’s the second consecutive quarter of sequential HSD ARPU improvement and that was driven by pricing and mix, including increased turbo penetration and gains in our commercial HSD subscribers. Voice ARPU was modestly lower both year over year and sequentially.

Turning to OIBDA on the next slide, third quarter OIBDA of $1.55 billion grew 9% year over year with our margin improving 10 basis points to 35.8%. OIBDA growth remained healthy despite continued softness in our high margin advertising business.

Third quarter OIBDA included a $10 million negative impact from Hurricane Ike, which hit our systems in Eastern Texas and Ohio, and that reflects both system repair costs and customer credits for service outages.

Third quarter OIBDA also included $8 million of restructuring expenses, which compared to $4 million of merger related and restructuring expenses in the third quarter of last year. Those two negative impacts were largely offset by a $13 million benefit from a reduction in our casualty insurance accrual estimates during the quarter.

Turning to earnings per share, basic and diluted EPS in the quarter were $0.31, a 24% increase from last year’s third quarter. This quarter’s EPS included $53 million of pretax transaction financing costs associated with our planned separation from Time Warner. These costs reduced EPS in the quarter by approximately $0.03.

On the next slide, before I move on to the balance sheet, I would like to take a minute to update you on our commercial business, where we continued to see success across our service offerings.

As I mentioned earlier, commercial revenues exceeded $200 million for the first time this quarter. That’s about 20% more commercial revenues than we generated in last year’s third quarter.

It’s worth noting that although our commercial business continues to represent a relatively small portion of our overall company, less than 5% of total revenues, it made up about 10% of our total year-over-year revenue growth in the quarter.

Looking first at commercial RGUs, we added 8,000 commercial HSD customers this quarter, bringing our total to just under 300,000. We also added 7,000 commercial voice customers and ended the quarter with 23,000. Average lines per commercial voice customer increased to 2.7 at the end of the quarter, up from 2.2 at the end of 2007.

In terms of revenue, as you can see from the chart, approximately two-thirds of the total commercial revenues in the third quarter came from data. Video comprised much of the remainder, while we had a small but growing contribution from voice.

Drilling down one more level, over half of our commercial data revenue comes from our traditional commercial HSD service. Another quarter is made up of metro ethernet and dedicated Internet access services, while the remainder includes web hosting, carrier transport, and a variety of other services.

As you can also see from the chart, our cell backhaul business, which is included in our data revenues, was about $3 million in the quarter.

Turning to capital spending on slide number eight, our third quarter CapEx was $874 million, essentially the same as last year’s third quarter. Residential capital spending actually declined year over year but that decline was offset by the increase in our commercial capital spending.

CapEx as a percentage of revenues declined to 20.1% from 21.6% in the third quarter of 2007. Taking a look at the specific CapEx categories, line extensions decreased approximately 20% year over year due to lower residential spending. CPE capital increased modestly as a reduction in SD and HD DVRs was more than offset by year-over-year growth in HD only boxes.

Through the first nine months of this year, our total capital spending of $2.6 billion puts us right on track for full-year CapEx to be approximately $3.5 billion.

Looking at free cash flow on the next slide, we generated a very healthy $1.3 billion of free cash flow in the first nine months of 2008. That’s 64% better than last year. During that period, we’ve converted 28% of our adjusted OIBDA into free cash flow, up from 19% in the same period last year.

Free cash flow growth was driven by higher adjusted OIBDA, favorable working capital comparisons, and lower net tax and interest payments. These items were offset in part by higher pension contributions, as well as higher CapEx.

Free cash flow for the first nine months of 2008 benefited from a couple of items. First, lower cash interest payments resulted from lower net debt levels and the timing of interest payments, and second we benefited from approximately $300 million of cash tax savings year-to-date from the economic stimulus act of 2008. The full-year 2008 benefit is expected to be around $400 million.

It’s important to note that the benefits we receive in the current tax year are expected to result in higher cash tax payments in the future, essentially a reversal of the benefits spread over the next five to seven years.

Moving on to leverage and liquidity on the next slide, at September 30th, our net debt and mandatory redeemable preferred equity totaled $13 billion, which puts our leverage ratio at 2.1 times. As you can see on the slide, we have upcoming funding needs of approximately $11.4 billion related to our $10.27 per share special dividend and our pending investment in Clearwire. To fund these items, we’ll have more than $12.9 billion of committed sources of funds, including $3.3 billion of cash, $3.8 billion committed under our bridge facility, and $5.7 billion of availability under our revolving credit facility. Therefore, after payment of the special dividend and the Clearwire investment, we will have at least $1.4 billion of committed availability. I say at least because our liquidity will be further enhanced by any free cash flow we generate after September 30th and up to $240 million of additional funds we expect to receive in redemption of our investment in the reserve primary money market fund.

As we’ve said before, maintaining our solid investment grade rating is a strategic priority for us. Although somewhat dependent on when we close the transactions, we expect our post-transaction leverages ratio will be around 3.8 times, and we anticipate that we will be back down to around 3.25 times within about a year after completing the transactions. That’s comfortably within the rating agency’s guidelines.

Moving on to the last slide, let me review our 2008 outlook -- as Glenn said earlier, while we remain confident that we are well-positioned to weather the downturn in the economy, we recognize that we are not entirely immune from its effects. And although our third quarter results were largely in line with our expectations, a few recent developments have caused us to revise our business outlook. We now expect our 2008 revenue and adjusted OIBDA growth to be approximately 8%.

I want to highlight a few key items that led to these moderated expectations. First, as I mentioned, Hurricane Ike reduced third quarter OIBDA by $10 million and we expect the full-year impact to be around $15 million. Next, our core non-political advertising trends have continued to deteriorate further than anticipated. And third, over the last four or five weeks since the end of the quarter, we’ve begun to feel the effects of the difficult economic environment on our subscription business. In particular, during the month of October, we witnessed a dramatic slow-down in net additions across all RGU categories, and that’s the product of both lower connects and higher disconnects than in October of 2007. We’ve also seen signs of weakness in some of our premium services, such as DVR and pay TV.

Landel will highlight some of the specific things we are doing but in short, we are extremely focused on operating our business as efficiently and effectively as possible during these challenging times.

Before I finish up, I do want to highlight that we are reaffirming our free cash flow and diluted EPS guidance. We continue to expect that free cash flow will grow at least 40% compared to 2007 and that diluted EPS will be between $1.10 and $1.15 per share.

With that, I will turn it over to Landel.

Landel C. Hobbs

Thanks, Rob and good morning, everyone. Our operations performed well again in the third quarter, reflecting strong execution in an increasingly challenging environment. As a result of very cautious consumer behavior we’ve seen, particularly since the end of the third quarter, we are focused more than ever on three aspects of our strategy.

First, we are focused on giving our customers what they want; second, we are competing aggressively; and third, we are structuring the business to maximize effectiveness.

Ninety-percent of our revenues are derived from consumer subscription services, so we are committed to listening to our customers and delivering what they want, when they want it. So let me give you some examples.

We continue to [blunt] any HD advantage competitors may have once had. In three cities, we now have 60 or more HD channels and in Brooklyn, Staten Island, and Queens, we have 83, and we are on track with the all digital conversion in Manhattan, which will enable us to offer 100 HD channels throughout New York City in the next several months. As Rob indicated, we now have more than 4 million HD capable subscribers and by our estimates, we continue to maintain HD share.

In uncertain economic times, customers also want more value. We make it easy for customers to choose Time Warner Cable. Again, let me give you a few examples.

First, unlike other providers, our customers don’t have to pay more for HD programming. This can save consumers $10 a month or more.

Second, we are planning to add power boost to all roadrunner standard subscribers or subscriptions, providing download bursts as high as 16 [down].

And third, we are making it easy for the over-the-air households to continue to receive their favorite local channels after the DTV transition.

In Wellington, North Carolina, we offered a couple of different things -- 12 months of basic cable for $7.95 a month and a year of free basic cable to new customers who subscribed to either roadrunner light or digital phone local for $24.95 a month. By the way, I am pleased to report that we did in fact gain new subscribers in the Wellington transition.

In uncertain times, consumers also value packages that lock in savings over the longer term. We have had tremendous success with our price like guarantee, or PLG, as we call it. In fact, PLG adoption accelerated in the third quarter with almost 300,000 net additions. More than 5% of our customers now have PLG.

In addition to our residential subscription services, we are also focusing energy on our rapidly growing commercial services. In the past 12 months, we have given small and medium-sized businesses a new choice in phone services. And as Rob indicated, adoption of our business class phone service continued to accelerate in the third quarter with 7,000 net additions.

Last month we introduced business class ethernet, which again is designed primarily for small- to medium-sized businesses for those without access to fiber networks. Our new business class ethernet is carried over our HSC network.

We recognized that in addition to meeting our customers’ needs, we need to beat the competition and we are up to the challenge. You can see this most clearly at our residential high-speed data net adds. In the quarter, as Glenn indicated, we had net additions of 214,000 subscribers, which exceeded each of Verizon’s and AT&T’s, despite our smaller footprint. The net result, we continued to take significant broadband share from both companies. We believe that we have a fundamentally better product than DSL.

In video, we estimate that not only have we stopped the share losses to DVS but actually gained some share in the third quarter. This is extremely positive and speaks to our ability to compete.

And in the third quarter, we continued to compete well against Telco TV offerings, although with the expansion of their marketable footprint, we have seen slightly more subscriber defections.

A third focus for us is structuring the business for maximum effectiveness. In fact, focusing on effectiveness is nothing new for us and 2008 is no exception. So let me give you an example -- we historically have been organized in a relatively decentralized structure with lean staff at the corporate and regional levels. However, remember we have six major geographic regions. But the vast majority of our resources were in local communities. In 2008, we focused on a process in which we began moving most non-customer facing functions, like finance, marketing, and engineering, to the regional level. Our objective here is to establish deep, functional expertise in the region that will be critical to maintaining our strong position in an increasingly competitive environment and better leverage critical and limited resources.

As you might expect though, we will continue to concentrate our customer-facing functions close to our customers in local communities. Year-to-date, we have spent $14 million on restructuring, including $8 million in the third quarter. And as we move into 2009, we are committed to continuing our focus on structure, effectiveness, and associated expenses, especially in view of the tough economic environment.

To summarize, we are in a fortunate position to have close subscription relationships with nearly 15 million customers. We recognize that we have to continue to earn their loyalty by providing great value and services while maximizing RGUs and ARPU in an increasingly competitive and challenging economic environment.

We are committed to delivering each of these while responsibly managing the resources entrusted to us.

Thank you and with that, I will turn it over to Tom for the Q&A portion of the call.

Tom Robey

Thanks, Landel. Shirley, we are ready to begin the Q&A portion of the call. We would ask each caller to ask a single question so that we can accommodate as many callers as time permits, and please remember that -- well, I guess we’ll leave it at that. Shirley, why don’t we take the first question, please.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Doug Mitchelson.

Doug Mitchelson - Deutsche Bank

Tom, I wanted to be democratic and ask everyone a question today but Glenn, you spend a lot more time in Washington than just about anyone I know. What’s your view on the impacts on cable from the election? I know that key committee members in the House and Senate are unchanged. And maybe if I can just throw a quick one in for Rob -- how many low-end video subscribers do you have left, since that’s been the primary source of losses? Thanks.

Glenn A. Britt

I think some of us stayed up late watching the election returns. It’s probably premature to speculate what the election means. I think as you point out, most of the key committee members and chairs will be the same people as they have been. Congress remains in democratic control.

I think in terms of Congress that issues related to our business and telecommunications in general are somewhere on the list of things but not particularly high on the agenda, which given what is going on in our society, in our economy, I think that’s a good thing.

Robert D. Marcus

I don’t have the specific number handy. It’s still in the zone of about 10% of our total basic subscribers.

Doug Mitchelson - Deutsche Bank

Great, and then can I just ask a follow-up for Landel then? On the cost side, I mean, Cox is announcing that they might cut 2% of their workforce. What percentage of costs do you think you can address if you were really aggressive in 2009?

Landel C. Hobbs

Doug, what we will continue to do, as I indicated, is look at our structure and say are we appropriately positioned for this environment, and let me give you some further examples of what we gave -- the ad sales this year, we continued to look at that workforce and reduce it based on what we are seeing in the economy. We’ll do something similar to that next year. But while we continue to focus on our structure, we’re going to make sure that we’ve got the right resources locally to contain and keep a good customer experience. So I’m not going to give you percentages right now but we will continue to focus on it as we have done in 2008.

Doug Mitchelson - Deutsche Bank

All right. Thank you.

Operator

Your next question comes from John Hodulik.

John Hodulik - UBS

Just a quick follow-up, I think, Rob, on the comments about the October slow-down. If you could add just some more color to that -- is it more on the growth side, so less sort of new RGUs from data and voice? Are you seeing increased defections from competition? And just if you could say -- I know November is early but do you expect things to turn in November or just how do you look at those numbers going forward?

Glenn A. Britt

John, let me jump in and say one thing before Rob responds -- there’s lots of companies reporting during this period and I think it’s important to put us in context. Lot of companies like GM reported and they sell automobiles and they were way down year to year in their sales.

In our case, we have a big outgoing subscription business and we have ongoing relationships with millions and millions of people. And that’s in place and it’s a really solid base. As I said before, we -- on average, people use our services 10 hours a day. So there’s enormous strength in that.

So what we are talking about signaling is a change in the growth of the subscribers. It’s quite different than what you are hearing from some other businesses. So having said that, Rob, I’ll let you --

Robert D. Marcus

John, there’s only a little bit of color I can really share with you but it’s a combination of lesser connects and greater disconnects, so it’s a combination of both, relative to what we saw in the same period of time last year. And it really is coming pretty broadly across all RGU categories.

John Hodulik - UBS

Okay, and so you don’t -- it’s more of an economic issue and you are not seeing the effects of increased competition from AT&T or --

Robert D. Marcus

It’s always hard to differentiate between the two but given the timing of when this occurred relative to the timing of world and national economic events, I think it’s reasonable to tie it to the economy.

John Hodulik - UBS

That makes sense. Okay, thanks.

Operator

Your next question comes from Rich Greenfield.

Rich Greenfield - Pali Capital

Just a follow-up on Rob’s comments about the dividend -- is there any chance that you would consider, just given the slow-down you’ve seen in October, that you’d think about trying to work towards a slightly lower level of dividend just to free up flexibility for next year?

And then two, the comment about programming costs in the press release is that it rose to 8% growth in the quarter versus 6% last quarter. Given what happened with [LIN] and some of your other ongoing negotiations, should we assume that 8% is -- you know, that number broadly is on the rise heading into next year? Just how should we think about it? Thanks.

Glenn A. Britt

Let me take the first one and I’ll let Rob take the second one -- on the separation transaction, we continue to think that the transaction structure is good for all of our shareholders and that implies good for the company going forward. So we are committed to doing that.

As Rob said, we have adequate liquidity and we are quite comfortable given our cash flow generation with what that all means.

Robert D. Marcus

On the programming side, Rich, there’s a couple of specific things going on in Q3’s programming number that drives the growth to be higher than what you’ve seen in recent quarters, in addition to the normal incremental digital penetration, which obviously has an impact.

We’ve got a couple of new services in the mix that are costing us additional programming dollars, probably most notably the Big 10, which we picked up for a small portion of Q3. And we also, I think as I mentioned in the Q2 call, had a reset in our Fox News rates, which had a meaningful impact.

Given that those increases will actually roll through the next few quarters before they lap themselves, I think it’s reasonable to assume that even from those items alone, you are going to see an up-tick in programming costs. I’m not really going to speculate as to what the implications of any of the retrans agreements that we’re in the process of negotiating are going to do to programming costs. I think you should wait and see how those play out.

Operator

Your next question comes Spencer Wang.

Spencer Wang - Credit Suisse

I guess my first question is for Rob -- you know, in 2008 you will probably finish with EBITDA margins in the 36% area, which is flat with ’07. I was wondering if you could just talk about where you see margins going over the next two to three years, as you further integrate the acquired systems? And just one housekeeping question -- can you just talk about the taxability of the one-time dividend for non-TWX shareholders? Thank you.

Robert D. Marcus

Let me do them in reverse order -- the treatment of the dividend, I think I’ve said in the past that as a mechanical matter for non-Time Warner Inc. Shareholders of Time Warner Cable, the special dividend would be treated as a dividend for tax purposes to the extent of earnings and profits, and thereafter would be treated as a return of capital up to the basis that the individual shareholder has in his shares and then thereafter would be a gain on sale.

When I last talked about this, we hadn’t yet done any calculations around what -- how significant earnings and profits were. We have recently completed a preliminary calculation of that number and we now believe that the special dividend will be treated somewhere between 35% and 40% as a dividend. That number is in part dependent on when we close the actual results between now and closing and we are still refining the calculations a bit but that’s where we are currently at on that one.

As for your Olympic question, we’re not in the position really to give guidance for ’09 and beyond yet, and I think I want to hold off on making any statements about where I see margins going until we’ve completed our work in that regard.

Spencer Wang - Credit Suisse

Thank you.

Operator

Your next question comes from Jessica Reif-Cohen.

Jessica Reif-Cohen - Merrill Lynch

I have a question on the quarter venture -- given what’s happened in the market, is there any possibility to change either the dollars committed or the terms?

And secondly on the broadcast digital transition, when do you expect the timing -- what do you think the timing will be on the impact of subs? Will that be a first quarter impact when you see either basic or some combination?

Robert D. Marcus

On the wireless venture, we’re still committed to closing the deal on the terms that were originally agreed upon. I assume that your question is inspired by the fact that the Clearwire stock has been trading below the collar price for some time now, and I think it’s important to think about this as the strategic venture that we initially intended it to be, so we are still enthusiastic about the transaction. We think it gives us a lot of flexibility as to how we approach the wireless business going forward.

Landel C. Hobbs

Jessica, on the DTV timing, you know, it’s interesting -- if you look at Wellington and you’ll probably see something similar as you approach February of next year, we didn’t see some kind of big pop right at the day. You saw DTV transitions occur over time, so you saw it come in in kind of dribs and drabs as people began to understand the transition and what’s happening. So I mean, you are actually seeing some of that in our numbers even now. You’re seeing some people converting.

So right now, based on what we’ve learned, we don’t think we’ll see some big pop but you will probably see some acceleration as you get closer to the date. But it’s something that kind of happens over time, as people learn more about the transition.

Jessica Reif-Cohen - Merrill Lynch

Thank you.

Operator

Your next question comes from Ben Swinburne.

Ben Swinburne - Morgan Stanley

Landel, I wanted to ask if you could talk a little bit more specifically about the voice, the residential voice business -- give us a sense for how sell-in rates have trended and if there has been any movement in churn. I guess where I’m headed with this is how much of the net adds decline is a function of gross adds, which are impacted by the housing markets. Since your opportunity to sell voice is primarily when people move and call you guys to sign up for video and other services, and how much of it is that you’ve started to sort of saturate the population who want land line phone, at least at $35 to $40 and either the product has to get cheaper or it’s going to continue to sort moderate from here.

And then if I could just throw in a quick one to Rob -- the rating agencies, have they made any changes to what they have told you? You made some comments earlier but I just wanted to zero in on the investment grade ratings because obviously the rating agencies have been a little squirrelly lately so I just wanted to get a sense, I wonder if there’s been any change in their view of what investment grade means for cable.

Landel C. Hobbs

I’ll take the voice business first -- a couple of things. First of all, you know, roughly still 90% of our phone business is selling in to the unlimited nationwide product, which are beginning to see some mix change there and starting to see because we think of the economy, some different mix down to a local in-state. You are seeing this particularly as we move into the fourth quarter impact on the gross connect and disconnect side.

So a couple of things we think are actually affecting the phone business -- we think it’s absolutely economy. You are starting to see that, even though we still -- there will be steady growth moving ahead but the economy is affecting phone, and another thing that is beginning to affect it, based on our research, is cord cutting. So we are beginning to see that as well.

Hard to pinpoint exactly how much is directly related to cord cutting because the economy also a factor in there, but you are beginning to see a couple of different affects on phone, the economy, and cord cutting, not to say that we don’t see growth ahead but right now we are seeing those two things affect this business.

Robert D. Marcus

Before I get to the rating agency question, just as you look at voice net adds, just so you get your comparability right, don’t forget that when you look at Q3 of ’07, we were still migrating circuit switch customers to our digital phone product and we also are still just launching the digital phone product in certain markets, including L.A. and Dallas, so that just makes it a little bit apples and oranges when you compare the net adds in those two periods.

As far as the rating agencies, no, no reason to think that they have any different point of view today then they did when we originally got our confirmation that they would give us the triple B plat.

Ben Swinburne - Morgan Stanley

Thanks a lot.

Operator

Your next question comes from Craig Moffett.

Craig Moffett - Sanford C. Bernstein

Good morning. I wanted to dig in a little bit more into retrans -- having just completed the renegotiation with [LIN], I know LIN very publicly said that they received cash. Can you just provide any additional color on -- I know you can’t say what the number is but the nature of that cash, was that -- was there a direct cash payment, separate from the purchase of advertising or was the purchase of advertising either all or most of the negotiation? And then what else happened during the negotiation? Did you lose subscribers during that period in the markets, Austin and elsewhere? If you could just provide any additional color on what happened.

Glenn A. Britt

Craig, those are all great questions and I hesitate to comment on any one particular negotiation. Obviously we are going through one of these retrans cycles. We’ve been through them before. Perhaps unlike some other companies that I’ve never claimed that we didn’t pay for retrans in various ways, shapes, and forms, so I don’t see this as a big departure.

I do think what’s going on is that the local broadcast industry is in particular distress and in addition to that -- because of the economy but in addition to that, a number of broadcast groups have been put together over the last several years with high leverage. So they are kind of desperate. And I would also point out that their terms of trade with the big network companies has changed dramatically over the last 15 years or so.

So all of that is creating this pressure on their part, saying we have to go get retrans money and that’s why you are hearing about it. This is perhaps not the right place but we are talking with people in Washington about the whole retrans regime. This law was originally passed in 1992 and if my memory is right, the world was very different then. I believe that the majority of people in America still got their TV off air, and cable had less competition than it does now. So fast forward to now, you have the vast majority of people in America get TV from a multi-channel provider, not off air, and there’s obviously a lot of competition.

So if you go back to the law, Congress was worried about supporting free over-the-air TV with its public obligations, news and what have you, and it may still be valid to have that support, which is in effect a tax on everybody else, but I think that the mechanism for arriving at that amount is perhaps broken and this situation where you have confrontations and people dueling in the press, stations coming off, whatever, is clearly not in the consumer’s interest and I don’t think in the interest of the companies involved, either, so more to come on that.

Craig Moffett - Sanford C. Bernstein

One quick follow-up, and this is just a quick procedural question, but with respect to the timing of the dividend, you had said in the past there were three things you needed -- the IRS letters, some local franchise approvals, and the FCC vote. Have we gotten the IRS letter and the franchise approvals and we are just waiting for the FCC to schedule the vote now?

Landel C. Hobbs

The franchise approvals are almost -- not completely done but almost done. We do not have the IRS letter yet and since the FCC proceedings are public, they had a meeting yesterday and we were not on the agenda and I’m not sure when that might be forthcoming.

Craig Moffett - Sanford C. Bernstein

Okay. Thank you.

Operator

Your next question comes from Vijay Jayant.

Vijay Jayant - Barclays Capital

If I may, two questions -- the FCC recently ruled against you guys on moving several channels to [search] video I think in Hawaii. That ruling, does that change your HD strategy at all in that deployment?

And second, I think advertising growth in the quarter was up modestly. Can you sort of ex out political? And I think there’s one extra week this quarter. What was the true organic growth and obviously now with the end of the general election, can you give any color on how that is tracking in the fourth quarter? Thanks.

Glenn A. Britt

Let me deal with the FCC one and Landel can deal with the advertising question. On the FCC, there’s been actually a lot of rulings come out of the various bureaus at the FCC on cable related issues. And we are -- we’re not sure we agree with a lot of them. We are responding appropriately, appealing as appropriate and we will see where each one of those goes. But in general, it’s not having any big impact on our strategy.

Landel C. Hobbs

I’ll start on the advertising question and Rob may jump in and give us some details -- remember yes, political is big for us in the third quarter and it’s been basically buoying that business, underlying that you are seeing definite weakness in advertising sales. Remember, we are primarily local. We’ve been hit hard, of course, automotive, financial services. Not really going to lean into the fourth quarter but as you can see, I mean, you know what’s happening in the world out there. Advertising is continuing to be extremely soft, so if anything, as Rob indicated, that is impacting our outlook on the rest of the year because advertising actually has gotten worse in the third quarter, but it is primarily -- political buoyed it. That will be gone. Underlying trends in primarily all of the advertising sectors for us are very weak.

Robert D. Marcus

Vijay, if you want to carve out the impact of political and then also the changes we keep referring to relating to among other things our management of Charter’s ad sales business in L.A., if you want to pull those things out, that accounts for about $19 million in the quarter. So if you back those out, you can kind of get to where you want to be on what is happening with core ad sales. By the way, we did not have a different calendar this year than past.

Vijay Jayant - Barclays Capital

Thank you.

Operator

Your next question comes from Bryan Kraft.

Bryan Kraft - Banc of America

I guess first, how far along are you with the switch digital rollout in terms of percentage of completion? And can you talk about how well it’s working, how many channels you are currently switching, and also how the cable card compatibility issue is going to be resolved? And also, how long until you can offer say 100 plus channels across most of the footprint?

And then just a real quick follow-up to some of the previous comments on the slow-down in subscriber growth -- I mean, are we talking about something in the neighborhood of say a 50% decline in RGU net adds, or are we talking about more something in the neighborhood of a 10% to 15% decline in net adds? Thank you.

Tom Robey

That’s the longest single question I have ever heard.

Glenn A. Britt

Let me deal with the switch digital part and I may not get each and every one of those items but I will try -- and then we will let Rob talk about the subscriber one. On switch digital, we are moving along quite rapidly and it’s a little hard to give you a definitive answer because you don’t -- in one geography, you don’t flick the switch and the whole geography is lit up, so it gets introduced gradually.

But I think it’s safe to say that by the end of this year, we will be not completely done but almost done and as you get into early next year, there’s only a couple of markets of any size that will enhance switches.

On the cable card issue, just to frame it, the idea of cable cards comes from another old law that was trying to encourage the retail availability of set-top boxes, and what cable cards do is decrypt those of our signals that are encrypted, so it’s a security thing. And we actually have those in each of our set-top boxes now. That’s been required.

The cards you are talking about were designed for one-way vices and for a while, a number of manufacturers were producing TVs that you could put these cable cards in, and not have a set-top box except you could only get the one-way services, so you couldn’t get video-on-demand, you couldn’t get our program guide, and you couldn’t get some other things.

As a result, those TV sets proved to be fairly unpopular and I may not be completely correct but I believe most if not all of the manufacturers have stopped making those, so they are not on the market anymore.

So the other company that produces devices that use these cards is TiVo, and of course TiVo has a business selling set-tops and DVRs with a program guide that some people find very attractive.

If you add up all the TiVo devices and all the other TVs that use these cable cards, the numbers are very, very small compared to our total footprint, and this is true generally of the industry.

So the issue that’s been raised is as you put it, more and more two-way services because switching and more video-on-demand require two-way capability. What do you do about these devices that are not inherently two-way? And it really doesn’t have much to do with cable cards. Remember, they just decrypt the signals. The real issue is that the devices themselves don’t have radios in them and they are not two-way devices, and there’s no simple way to make those two-way devices.

So what we are doing in general is offering people other pieces of equipment to create, to give them that capability if they want to get those signals. And this may be in the form of something called the resolver, if you are a TiVo customer, or maybe a set-top box if you are just a cable card customer with a regular TV.

But again, I want to emphasize this as a very minor problem and very small numbers of people, and somebody is going to talk about subscriber growth.

Landel C. Hobbs

One of the things, Brian, you hit is first of all, the getting to 100 HD channels, for example, sits behind the switching that Glenn already talked about, so the ability to reach more and more HD channel capacity sits behind once you’ve got the switch in the market. Actual number of channels switching varies market to market but listen, the technology works. We have seen no problems in switching standard digital as well as switching HD channels. So we’ll switch as many as we need to to develop a capacity to add HD our customers want when we need to, so we are seeing no problems in the technology working or adding channels into the switching fabric.

Tom Robey

Shirley, I think we have time for just one more question.

Robert D. Marcus

Let me --

Tom Robey

Oh, there was another question in that. Sorry, there were so many I lost track.

Robert D. Marcus

Brian, I’m not really going to provide a specific quantification on what we mean when we say a dramatic slow-down in the growth of RGUs in the month. I am really hesitant to start breaking our results down by months. There’s not a lot of accuracy, it’s -- I just want to be careful about that.

But I guess from my perspective, I don’t think about a 10% decline in a slow-down in growth as being a dramatic slow-down, so I’m going to leave it at that.

Bryan Kraft - Banc of America

Okay, that’s helpful. Thank you.

Operator

Your next question comes from Jason Bazinet.

Jason Bazinet - Citigroup

Historically, most of the large cable companies have been adverse to sort of this a la carte regime that’s been kicked around in Washington. With your pending separation from TWX and the telco entry into video, do you see the potential for that to change where essentially the distributors begin to support a la carte? Thanks.

Glenn A. Britt

I think the reason that people have been against a la carte historically is one of simple economics and it’s not immediately apparent, which is one of the difficulties. But we -- and when I say we, it’s everybody in the multi-channel video distribution business -- we provide two economic functions. One, which is the obvious one, is that we have a physical distribution mechanism. In our case, it’s a cable system that might be telco plant or it could be satellite, so that’s pretty apparent and there’s economic value of that.

The thing that’s less apparent is that by creating these packages, there’s huge economic benefit and most of the studies that have been done point to that benefit. There’s savings in marketing costs, there’s savings in billing, there’s all sort of savings involved in it. And perhaps more subtly, we in effect guarantee revenue to programmers and that allows them to take the risk to have programming created, which is why as a society we have this tremendous wealth of programming.

So the whole economic ecosystem works well and a la carte would clearly result in higher cost in the system, which ultimately would result in higher costs to most consumers, which is what the original GAO study said. And it would also result in less programming, most people think. So that’s really why we have all been against a la carte, not for any other reason.

Jason Bazinet - Citigroup

Okay. Thank you.

Tom Robey

Jason, thanks and Shirley, I think that’s all the questions we have time for today. Thank you all for joining us. We’ll have a replay available shortly and please don’t hesitate to call if you have follow-up questions.

Operator

Thank you, and this does conclude today’s conference. We thank you for your participation. At this time, you may disconnect your lines.

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