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Cox Radio, Inc. (CXR)

Q2 2006 Earnings Conference Call

August 2, 2006 11:00 am ET

Executives

Robert Neil - CEO

Neil Johnston - CFO

Analysts

Victor Miller – Bear Stearns

Jonathan Jacoby - Banc of America Securities

Anthony DiClemente - Lehman Brothers

Marci Ryvicker - Wachovia Securities

Eileen Furukawa - Citigroup

John Blackledge - JP Morgan

John Klim - Credit Suisse

Mark Wienkes - Goldman Sachs

Laraine Mancini - Merrill Lynch

Jim Boyle - CL King

Stuart Kagel - Janco Partners

Lee Westerfield - BMO Capital Markets

Presentation

Operator

At this time, I would like to welcome everyone to the Cox Radio second quarter 2006 earnings conference call. (Operator Instructions) It is now my pleasure to turn the floor over to your host, Robert Neil, Chief Executive Officer. Sir, you may begin your conference.

Robert Neil

Thank you, operator, and good morning. Welcome to our second quarter 2006 conference call. As always, I'm joined today by Neil Johnston, our Chief Financial Officer. We'll start by reviewing the second quarter operating performance, and then Neil will provide his financial overview, and then we'll be available to take your questions.

Before we again this morning, let me remind you that today's call may contain forward-looking statements that are subject to risks and uncertainties that could cause the actual results to differ. Please refer to our recent 10-K filing for the list of risks and uncertainties that could impact the actual results.

Our second quarter results once again highlight the radio business' very profitable business model, and more specifically Cox Radio's ability to generate strong bottom line performance even in a challenging and competitive environment.

This is clearly demonstrated by our 11% free cash flow growth for the quarter. Our top line revenue growth was flat at $117 million for the quarter, but this performance compares favorably to the industry, which was down 1%. That performance is even more remarkable given the difficult comps we have in the first six months of this year.

Our results for the quarter were impacted by weakness in some of the larger categories, including Auto, which was down 8%; Restaurants and Food down 17; Home Improvement down 9%; and Telecom down 5%. Offsetting those declines were gains in Real Estate, which was up 119%; Utilities up 99%; and Education up 52%.

For the quarter, some of our strongest growth markets, Miami and Orlando, both up 7%, and Houston, which grew its revenues 5% during the quarter. Revenues in Atlanta, our largest market, were up 1%. These results demonstrate the strength of our station portfolio, which is positioned in the mid to large markets, located primarily in the sunbelt.

To give you an update on the spring ratings, the majority of the spring books are in for us and we're pleased with the results, especially in our largest revenue markets. We'll start off with Houston where the Country Combo was the number one station 25-54 in the market non-ethnic, KHPT had it's strongest showing in over a year, and right after the book we shifted our Oldies station, KLDE to Classic Hits, as we evolve the station to target more lucrative demos.

In Atlanta, the River which we launched in January continues to exceed our expectations. The station ranked fourth overall 25-54 compared to 21st a year ago. WSB AM ranked second 25-54, and WALR, our urban AC ranked fifth, with its best 25-54 shares in over a year. Those stations give Cox three of the top five stations 25-54 in the very competitive Atlanta marketplace.

WSB-FM continues it's market's leading AT 25-54, and WBTS, our CHR, is the number one CHR in the 12-34 target. In Miami, Hot 105 again was the number one station 25-54. EDR our other urban station, number one 18-34. WFLC, our AC had another good book. So, three of our four FMs are in the Top seven 25-54 in South Florida. In WEDR's case that really is not even their target. WHDR, our rock station, was again the number one station for non-ethnic men 18-34.

Long Island had an excellent book with our two stations there, WBAB and WBLI both growing. BAB ranked second 25-54 and number one in men. BLI was third 25-54 and looked very strong in its female target.

Orlando continues to do very well with WCFB again number one 25-54 in the market, and K92, our country station, jumping to third. Five of our six stations were in the Top 10 25-54. The only one that wasn't, WPYO was a younger targeted CHR that ranked third 18-34, just five-tenths of a point out of first place, following a very strong winter performance, as well. I would also like to point out strong results for us in New Haven, for WPLR and WEZN, and in Tulsa for our cluster there.

Overall our ratings results continue to prove our ability to consistently develop and maintain top-rated radio stations, and we expect these solid ratings to help support our top line as we enter the back half of the year.

Looking ahead, notwithstanding the challenges our industry is facing, we remain intensely focused on implementing our strategy. Every day we're taking steps to better position our stations and brands, while seeking opportunities to attract new audiences, new advertisers, and new revenue streams.

We remain a solidly profitable company with a balanced approach to delivering near-term financial results as we've demonstrated today, while continuing to invest in the right areas and secure our growth for the future.

As we invest in the content and promotion that drives audiences to our stations, we're also moving forward and investing in our digital resources, including our online assets and our HD radio properties. A reminder to you that Cox was one of the first big station operators to commit to streaming all of our radio stations on the web way back in 2001. Our station website portfolio while still a small contributor to our overall results, continues to produce substantial revenue growth, up almost 50% in the second quarter, as advertisers seek to reach our targeted audience.

Today we continue to successfully tap new advertisers, welcome old advertisers, and target new categories of advertisers, to increase the growth of the potential of our websites. These results are promising, and we expect to see incremental benefits as we continue to execute our web strategy, and drive more of our listeners to the Internet for music, news, and information.

Turning to HD radio for a moment. As we noted in our last call, we launched seven new HD2 subchannels in total in our Atlanta and Tampa markets, we expect to launch additional channels in our other larger markets in the near future. We believe this measured strategy is appropriate, and will best position us to capitalize on the emerging interest on HD radio, and anticipated penetration of consumers in the years ahead.

We also continue to review potential M&A opportunities, our recent acquisition of WBGB-FM in Jacksonville, Florida, represents an opportunity to expand our operating footprint in a key growth market. We expect to close on that acquisition before year end and look forward to integrating that station into our existing cluster.

In conclusion, we're optimistic about the back half of the year, driven by our strong ratings, and we expect some influx of political spending in the fourth quarter this year. And we remain committed to implementing our strategy, to position our Company for growth over the long term.

With that, I'll turn it over to Neil.

Neil Johnston

Thanks, Bob. Good morning, everyone. Before I begin, let me point out that in accordance with SEC Regulation G we've provided full reconciliations of all non-GAAP financial measures in our earnings release. These reconciliations include station operating income to net income, and free cash flow to net income. Net income is the most comparable GAAP measure to both.

For the second quarter consolidated net revenue growth was flat at $117 million, local revenues were flat, while national revenues were down 5.6%. As Bob noted, we saw solid growth in our larger markets, including Miami, Orlando and Houston, as well as positive strength in Atlanta, Honolulu, and Tulsa. Also of note were Internet revenues, which increased 49% in the second quarter. Internet revenues currently represent about 2% of our total revenues.

Operating expenses for the quarter, which includes cost of services, selling, G&A, and corporate G&A increased 2.5%, primarily as a result of higher non-cash long-term incentive plan costs, which totaled approximately $2.2 million, versus $1.1 million last year. Excluding these costs, operating expenses were up 1%, primarily as a result of higher levels of marketing and promotion activity during the quarter versus prior year. Station operating income for the quarter decreased 1.7%.

Interest expense for the second quarter decreased 11.6%, to $6.1 million, attributable to lower overall outstanding debt, which totaled $421 million at June 30, giving us a leverage ratio of 2.5 times.

Our effective tax rate for the quarter was lower than normal at 25%, consisting of a current effective rate of 19%, and a deferred effective rate of 6%. Our income taxes were lower than expected, primarily as a result of a decrease in current income taxes, resulting from a favorable state income tax audit settlement and a decrease in deferred income taxes resulting from state income tax law changes enacted during the current quarter. Excluding the impact of these two items, our overall effective rate would have been 40%, 26% current, and 14% deferred.

Earnings per share for the second quarter was $0.27 versus $0.20 per share in the prior year, an increase of 35%. Capital expenditures were $2.2 million, and we generated approximately $0.32 per share of free cash flow, an increase of 19% over the prior year. In accordance with our Board-approved $100 million share repurchase program announced in August of 2005, as of June 30, 2006, we have repurchased 5.6 million shares at an aggregate purchase price of $79.9 million. $20.1 million remains approved under that plan.

For the third quarter and full year, we expect station operating expense growth excluding long-term incentive plan costs to remain in the low to mid single-digit range, depending on how the revenue picture that shapes up. Additionally we expect our long-term incentive plan costs to be approximately $7.5 million for the full year, corporate G&A expenses will be approximately $20 million for the year.

Total interest expense for the year is still expected to be around $26 million. Third and fourth quarter income tax effective rates should be around 40%. 25% current, and 15% deferred. Capital expenditures for the full year will be approximately $12 million, as we continue to roll out our HD radio platform.

One other item of note before we open the floor for questions. In late July, we closed on a new five-year revolving credit facility, which replaces our prior facility. The new revolver is $600 million in size, has substantially the same terms and covenants, and includes slightly better pricing reflecting current debt market conditions. That concludes the financial overview. At this point, Bob and I would be happy to take any questions.

Question-and-Answer Session

Operator

(Operator Instructions)Your first question is from Victor Miller - Bear Stearns.

Victor Miller - Bear Stearns

Good morning, thank you for taking the question. Bob, first quarter down one, second quarter essentially flat. Could you give us a sense of what you're seeing in the early read for third quarter?

Secondly for Neil, your general expense comments looking back on the transcripts, have been kind in the 2.5% to 3.5% range for the year, I know it's based on what you expect on revenue expectations, but it seems like mathematically you would have to spend a heck of a lot of money in the second half to get to that range. Could you just comment on what you see in terms of maybe revising that expectation for the year? Thanks.

Robert Neil

Victor, what we're seeing on the revenue front, and it was evident in second quarter was again, a movement to a very late placement of business. If we looked at the quarter for us, April was the month that was the worst, and then we had some sequential improvement in May and June.

In July, as of right now we're pacing up about 2 and change. And that business is continuing to come in very, very late. We booked a substantial amount of business in the last week of July.

So as you look out into August and September, just as we did a few months ago, looking out to pacing, it can look a little dire and get quite a bit better as you get closer to the month. Again, that just reflects late placement of a lot of business.

I think you that you could interpret that fairly logically as you think about the Automotive category right now. The dealers are tending to place that money much later than they were, as are some of the retailers, because folks that are running their businesses are also looking at very difficult visibility. It's hard for them to know how to place their advertising.

But that's where July is right now and you know, we'll see what happens in August and September. I don't expect to see much in the way of any real political fireworks, and, of course, our dollars are always lower than television, most of that is going to come as we start getting closer to the general election. The impact on that will more likely be a fourth quarter event, more so than a third quarter event.

Victor Miller - Bear Stearns

Bob, can you talk about how did April/May/June build? April was the worst month of the quarter?

Robert Neil

April was down, May was up a little, and then June was up a little more.

Neil Johnston

On the expense side, you correctly said some of the expenses do depend on what happens on the revenue line. There is a certain amount of cost of sales, and depending on what we see on the revenue side, will have some impact on what happens on the expense side. Expenses in third and fourth are expected to be a little bit higher, and some of that's driven by the timing of some research projects we've got going on, and some promotions. Some of it's a shift from second to third. Expenses in the second quarter were a little lighter than expected.

One of the reasons for expenses being up in third and fourth, is we do also build on the expenses of The River in Atlanta. That station is now a real radio station. You know we've put on a morning team and the revenues there are doing very well. As those build, we'll start spending money as that goes forward. That really is what's driving the expenses, still expected to be in terms of our guidance for the full year.

Victor Miller - Bear Stearns

Thank you.

Operator

Thank you. Your next question is coming from Jonathan Jacoby - Banc of America Securities.

Jonathan Jacoby - Banc of America Securities

Good morning, nice results. A few questions here. The first is the $9 million of non-traditional revenue that you guys booked, it's about $1 million ahead of last year, can you break out sort of what percentage of that is the Internet business from that level of the million-dollar delta?

Secondly, what are you seeing in terms of commercial inventories levels in the marketplace, and is there any demand for the shorter length spot? Thanks.

Robert Neil

I'll let you take the break out on the non-traditional revenue because I don't have that right in front of me.

Neil Johnston

Essentially, Jonathan, I don't have the detailed numbers there. Most of the growth we're seeing in NTR is from the Internet. Overall, we expect it Internet is about 2% of the revenue, so you can do the math in terms of how much our NTR is the Internet. Most of the growth there is being driven from that.

The rest is essentially the events that we do throughout the year. That has remained pretty stable, we have looked at each of the events to make sure they're profitable, there's been a big push. Some of the events have large revenues, but also have large costs associated with that. We have been focused on trying to focus on those events that actually improve our margins, rather decrease our margins.

Robert Neil

Jonathan, on the commercial inventory side, I think that, you know, one thing everybody needs to think about for a second is, as much as we've seen in the airline industry when you have a lot of capacity in the marketplace, obviously that makes it more difficult in a pricing environment.

The reality is that even though less is more, decrease the number of commercial minutes that might be in the inventory stream, it actually in most of our markets at least -- and you can probably check with some of the other operators on this -- but in most of the markets it's actually increased the number of units that are available for sale. In my opinion, that's not a great environment. It's not a great environment in two ways.

One is from a pricing standpoint it's basic supply and demand issues. We actually have more units out there than before less is more was implemented. And then on the second side of this, I wonder what the implications of that will be in terms of the perception of audiences, as they start to realize maybe there's a lot of units there and the minute count doesn't really matter. Those things I think are open for question.

I've said on previous calls and I'll say it again, I still think the better solution for Clear Channel would have been to set their minute and unit loads the same. So if it's 10 minutes, its 10 units, that would have effectively reduced capacity in our business, and I think would have firmed up pricing more for everybody, but obviously I'm fairly opinionated on that, as you guys know. That's where it stands as far as commercial inventory.

The smaller unit spots, again, continue to be a little more active than they were just because someone is out there pitching them. But again, the way we sell our time is unit based, not slicing and dicing. So hopefully that answers your question.

Jonathan Jacoby - Banc of America Securities

Neil, just a quick follow-up on the Internet business. As you look out and maybe it's too early to tell, where do you see that growing as a percentage of total revenue?

Neil Johnston

It's very difficult to know. At a pace of growth currently around 50%, I would expect that to moderate slightly, but I still expect it north of 30% for at least the next three years. So, you know, it could be a sizable chunk of our business within the next three years.

Jonathan Jacoby - Banc of America Securities

Thank you.

Operator

Thank you. Your next question is from Anthony DiClemente - Lehman Brothers.

Anthony DiClemente - Lehman Brothers

Hi, two questions. First off, clearly your stock has dramatically outperformed the rest of the sector this year, and frankly part of it is on speculation of buy-in, or Cox Enterprises buying in the company. Can you provide the rationale for your being a public company? I know you just did an acquisition and you did it for cash, not for stock.

Given the lack of growth, can you help us with why this wouldn't be a private company? Or would it be a private company two to three years from now?

Second question, looking for a little bit of color on the number of advertisers on average in your given markets. Is the number of your advertisers growing or contracting? In any given year, what would the turnover be on the advertiser base? Thank you very much.

Robert Neil

On the first question, obviously, you know, you would have to ask that question of the Cox Enterprises people probably, not us. We're a public company right now. That's the way we're running it, and again, many people ask us about this, and all I can tell you is call the Cox Enterprises people and ask them those questions, because we're running the company as it stands right now.

I don't have specific numbers for you on numbers of advertisers or turnover, but we can get that for you, and give you the info offline if you would like.

Anthony DiClemente - Lehman Brothers

Okay. Thank you.

Operator

Thank you. Your next question is from Marci Ryvicker - Wachovia Securities.

Marci Ryvicker - Wachovia Securities

Bob, can you update us on your thoughts on electronic measurement, especially now that several groups have signed up with Arbitron's People Meter, despite the fact that Clear Channel's RFP process is still outstanding?

Robert Neil

Marci, I think that process is ongoing and to me it's very simple. A large group of radio broadcasters got together and came up with a consensus on what they wanted out of electronic measurement. I don't have to tell you how hard it is, not just for the radio business, but I guess for any business to get together, and come up with a consensus on something as important and complicated as electronic measurement.

But we did, we sat down, we came up with those things. Not everybody agrees with every single one of them. But it did come out as a consensus. We took that consensus and gave it back to Arbitron, and asked for a response.

The first response we got, to put it mildly, was not very helpful, and they're in the process as I understand it now, of trying to do a better response to those questions.

So I think from the general perception of the industry, is that until we can get these issues solved -- and after all we are the customers, we have a right to express what our expectations are in a product that we're going to have to pay a lot of money for, and we've done that, and now we're waiting for the vendor, either Arbitron or someone else, to come back to us and show us how we can meet those needs.

Marci Ryvicker - Wachovia Securities

Thank you.

Operator

Thank you. Your next question is from Eileen Furukawa - Citigroup.

Eileen Furukawa - Citigroup

Is your local continuing to outpace your national in the third quarter?

On expenses, longer term, do you think your long-term run rate say beyond '06 is going to stay in that sort of low to mid single-digit range? Within that, do you expect programming expenses to be in-line with the rest of the expense growth? Or do you think it's going to need to be higher due to a need to increase the velocity of your format changes?

Finally, having recently announced an agreement to buy the station in Jacksonville, and given stations that are currently up for sale by CBS and others, do you think that the private sales multiples are declining from the levels we saw with the ABC/Susquehanna deal? Thanks.

Robert Neil

Eileen, I'll take the first two questions first, and then I'll give Neil a minute to look up, give you some color on the local versus national. On a longer term note in terms of the expense run rate, I think we're pretty comfortable with the way that we've projected it out.

You never know in our business because it's so fluid. You can go to bed tonight and have two format competitors in a market, and wake up tomorrow morning with three. So you can never predict with any large degree of certainty whether or not you may have a competitive challenge that you may have to deal with.

But when it happens, you have to deal with it so, trying to predict a basic run rate as where we have it, I think makes sense and then if something happens, it's going to knock that out of whack, we would tell you. Hey, we've got a competitive situation, we need to respond to it, whatever.

But the best way to project it is kind of assume a static course. As far as Jacksonville is concerned, what prices get paid for stations are so dependent on a number of factors. In our case, obviously, this station would complement existing stations we already had in Jacksonville. I think, as always with any acquisition, beauty is in the eye of the beholder in terms of what kind of multiple you are willing to pay.

As I've often said on these calls, we don't pay attention to multiples, we could care less what anybody says the multiples are. We look at each station individually, we try to see what we can do with it, and then we decide whether that meets the kind of goals that we have for internal rates of return, and what we think we can do with the station.

So honestly, multiples are kind of fun for you guys, and for the industry to track, but they don't factor into our planning at all.

Neil Johnston

Eileen on the local versus national question, you know, dividing the revenues into local and national is never an exact science. A client can be local and then can move national, it can be national and can move local, depending on what happens with the agency.

As we look to July and the third quarter, actually the national business is stronger than the local business. But August and September is still very early, and that swings about tremendously, so I don't think you can really read anything into that, the difference between local versus national. Essentially, it's different to what happened in first and second quarter, but it can change on a weekly basis.

Eileen Furukawa - Citigroup

Okay, and just a follow-up. Are you seeing an increased number of format changes from your competitors above that you used to see in the past?

Robert Neil

I don't think so. I certainly don't perceive that. I think there's always some flow and ebb in the marketplaces, in terms of format adjustments, and it doesn't seem to me to be any more now than it has in the past.

Eileen Furukawa - Citigroup

Okay. Thank you very much.

Operator

Thank you, your next question is from Lee Westerfield - BMO Capital Markets.

Lee Westerfield - BMO Capital Markets

Thank you, gentlemen. Good morning. Two questions, first is on the Internet radio side, and the second one is some specifics about HD radio.

Bob, this may be specific, but on Internet radio right now, commercial webcasters and the record companies and artists are engaged in the first round of the recording performance royalty proceedings under the Copyright Royalty Board. To the extent that you're up to speed on all of that, can you fill us in as to the status of those discussions? And furthermore, what impact on Internet radio revenue and margins that those proceedings may ultimately play out?

The second question is on HD radio. Right now if memory serves, you're in approximately 29, upgraded approximately 29 of your stations, two markets, Atlanta and Tampa are multicasting, what are the targets by the end of this year specifically? For HD and the number of stations, and specifically also in multicasting?

Robert Neil

On the first question, Lee, as you clearly know from a lot of the trade press, that the performance right fees for the Internet streaming is a very, very contentious issue. The radio broadcasters take the position that that should be basically covered by our licensing agreement that we already have for over the air radio. Obviously the performers don't necessarily agree with that.

So at the moment, we pay a performance fee for Internet streaming. All of us, I mean virtually every radio broadcaster, thinks that is not a good number right now, that it's unfair. And that it's not helpful to the growth of the Internet streaming, which ultimately is good for the performers. The more exposure they get, the more opportunity they're going to have to sell their product. So what we have is a bit of a standoff right now.

Both sides continue to have discussions, but I don't see an easy resolution to this one coming any time soon. Again, it's one of those extremely complicated issues that challenges your ability to wrap your arms around it and stay awake even, when some of the finer points are being described to you. So we're working our way through it, and I just don't see an easy resolution to that coming any time soon.

On HD radio by the end of this year, over half of our radio stations will be converted to HD broadcasting. We're committed to that and we're on-track to do it. In fact, I know a few more stations just went in the last week or so.

On the multicasting front, we're really taking a proportional response approach to that. At the moment, we have the multicast stations that are up in Atlanta. We had three of them up in Tampa, the rest of the Tampa radio stations just converted to HD. So their multicast will start up shortly. Then we have two more markets, which I'm not really prepared to tell you which ones today, but two markets scheduled to go by September 1 on their multicasting.

We'll continue to roll this out in a way that makes some economic sense, in terms of rolling out the formats, rolling out the stations, but making sure that we're being prudent in managing our capital expense and the expense that it takes to get one of these things up and running right now, given that obviously there aren't a tremendous amount of listeners for it.

Lee Westerfield - BMO Capital Markets

Thank you very much.

Operator

Thank you. Your next question is from John Blackledge - JP Morgan.

John Blackledge - JP Morgan

On the electronic measurement side, do you have any sense of timing of when we're actually going to see it happen? Is there an urgency on the side of radio broadcasters to see this through, considering all the factors that are involved with Arbitron and the RFP process?

The second question would be, you know, what kind of IRR do you look for, when you're looking at acquiring a station? Thank you.

Robert Neil

I really don't know the timing on this because frankly, at least on one side, it's in Arbitron ballpark. The letter that was sent from the RFP Committee goes back several months now, and we're just now hearing that we might get an acceptable -- I don't even know if it will be an acceptable answer -- but certainly a more detailed answer than we got. We're not really in control of that process. We're trying to get these issues on the table, we're trying to get them resolved, but I can't tell you what I think the timing necessarily is going to be.

There are other vendors that are interested in providing service to the radio business. There's consideration of whether or not the radio broadcasters want to run their own rating service, as is done in some other countries. So there are a lot of things that are on the table being discussed right now.

We have a very clear set of expectations that we have given the incumbent right now of what we want. We'll see if they come back to us and meet those needs. If not, then I would expect us to continue to explore these other options in deeper detail.

On the IRR side, we've typically, historically looked at IRRs and assessed 20% over the five-year plan, and nothing's changed on that.

John Blackledge - JP Morgan

Thank you very much.

Operator

Thank you. Your next question is from John Klim - Credit Suisse.

John Klim - Credit Suisse

Hi two quick questions. Have you seen any impact on the Auto category from the decision by GM, Ford, and Chrysler to implement new incentive programs?

Then a broader-based question, do you feel as though there are any particular formats that are more or less defensible than others? If so, which formats? Thanks very much.

Robert Neil

Well, I can tell you that the impact has not been as chilling as it was last year, when the employee pricing was announced. We all know that that really cut into the margins of the automobile manufacturers, and for the most part, they have been very disciplined about not doing that again this year.

So the incentives that they're offering now, I would call them more typical, in terms of what we've seen in the past prior to employee pricing, some of those incentives have been helpful, in terms of some national advertising that's come down, some of them have been more locally focused, in terms of dealer groups.

I guess I would say the impact from this round of incentives is fairly neutral. I don't think it has really done anything to necessarily stimulate the category for us, in terms of advertising, nor has it done anything to chill it off more than it already had. Again it just comes down to each dealer. How many cars are they selling every month, and what they're trying to get accomplished. I really don't think there are any formats that are necessarily more defensible than others.

Obviously if you have a strong local news talk radio station, that's the kind of radio station that's very difficult for someone to duplicate, particularly if you have strong talent. But I think you can look at virtually any music format and think that that's fairly easy for somebody to duplicate if they wanted to. So I guess the talk formats would be the most defensible, in terms of someone just being able to come in and copy your product.

Operator

Your next question is from Mark Wienkes - Goldman Sachs.

Mark Wienkes - Goldman Sachs

Good morning. The momentum across satellite radio is really seeming to fade lately, wondering what your current thoughts are on that business. Any comment on the Google/dMark deal announced this morning? Or have you guys had discussions, I'm sure with Google and is there any chance that you would contribute inventory to that system?

And a follow-up on the question on HD radio, what do you think with satellite fading a little bit, what do you think the best case scenario is for getting digital radios into the cars? Thank you.

Robert Neil

On satellite radio, I guess I would say it's about time. Over a year ago, I think I said those guys were going to get theirs in due course, and they have. Because there's some major problems with their business model, those major problems are starting to be exposed. I find it at least humorous that a year ago they were saying that they were going to be free cash flow positive in 2006, earlier this year they thought it might be 2007, and now as every quarter goes by they're losing $100 million or $150 million more than they were the previous year. And I didn't see any headlines in the trade press today about when we would expect Sirius to be free cash flow positive.

So, again, I think it's just overdue. If people really look at that business carefully, and look at the fundamentals of it, they're going to see it's a very difficult prospect at best. The prospects of those companies delivering any large amounts of cash any time soon, just aren't very good.

I still find it mind-boggling that they are allowed to count cars sitting in car lots unsold as subscribers. If I could count every radio on the shelf that is unsold as a listener, I could probably have a field day. So again, why Wall Street lets them get away with that, I really don't know. But that's someone else's business, not mine. Like I said, overdue I think.

Mark Wienkes - Goldman Sachs

The fundamental problem you are saying with the business model, is it subscription pricing, or do you think it's just that model doesn't work, or you're saying that the churn will eventually catch up?

Robert Neil

I just don't think it's a real business. I just don't think they offer something that people are willing to pay for. Sure, there will be some people that are willing to pay for it, but I don't think enough people are willing to pay for it, to make it a large generator of cash. When last I looked, when you strip everything off, that's what business is all about, generating more and more cash.

So, is there a need for their product? I really question whether or not there is. We do not plan to contribute any inventory to the dMark system. We believe that we're the better sellers of our inventory rather than someone else. With our lower commercial load, we don't tend to have a lot of excess inventory to spread out to someone else to sell anyhow.

As for HD getting into the cars, again, I think this is just a matter of time before that becomes a standard. It's a digital world, people are going to expect digital quality, they're going to demand that of the OEM manufacturers as time goes on, because that is going to be the expectation. And as that happens, HD will make it's way into cars, and into other receivers, as well.

But again, it's going to take time for a receiver penetration to happen. I think on the broad front, which is the HD2 channels, where the multicasting comes in, it's going to be quite a while before any of those stations can have any kind of a major impact on any ratings at all.

Mark Wienkes - Goldman Sachs

Okay. Great. Thank you very much.

Operator

Thank you. Your next question is from Laraine Mancini - Merrill Lynch.

Laraine Mancini - Merrill Lynch

Morning. Two questions. On the Internet side, are there any particular categories of business that are embracing that more than others? And why do you think that is, if there are ones?

Second, on Auto last quarter you said foreign wasn't as strong as you would have like to have seen, because their cars were selling without really promoting their brands, is that still going on? Or is that picking up?

Robert Neil

Laraine, foreign is up a little bit in the quarter right now, and I think one of the reasons that's occurring is that, you know, a number of the foreigns, Toyota for one, just off the top of my head, they're doing their year-end promotions, year-end sales. So they're tending to be a little more active.

On the new car front though, they continue to outpace the domestics, so they're not quite as active as you would hope that they would be. Because again, if you're looking for fuel efficient cars, the foreigns have the perception advantage in that, whether it's real or not. So a lot of people that are out there, concerned about $3 gallon gasoline, and are going to start maybe with some of the foreigns first.

Interestingly enough, one of the categories that has shown huge growth in the web is Automotive. Automotive is up, I think, the last time I saw it was up over 45%. Now we're dealing with a smaller pool of dollars, obviously, that that 45% is against. But again, I think it's at least helpful that we were very early in getting our websites up and running.

So I think we're ahead of the curve, in terms of how we use those sites to provide additional solutions to advertisers. That will be continuing to be important to us as we go forward. But it's interesting that Automotive is up so much on the web. The dollars don't necessarily cancel out the loss of the main advertising dollars, because that pool of money is so much bigger.

Laraine Mancini - Merrill Lynch

Your new bank agreement, does that have any provisions in it that would limit or make it easier for your participate in radio station M&A?

Neil Johnston

No, the terms are pretty much exactly the same as the previous revolver. Other than a covenant in terms of overall leverage, there's nothing else specific to M&A.

Laraine Mancini - Merrill Lynch

Okay. Thank you.

Operator

Thank you. Your next question is from Jim Boyle - CL King.

Jim Boyle - CL King

Good morning. Bob, is the Internet part of NTR, is that all from advertisers, or is a portion of it directly from listeners and customers? Neil, is the Internet margins higher or lower than your traditional spot business margins?

Robert Neil

The Internet is strictly advertising. I'm not sure that I understood where would the other revenue have come from in terms of listeners.

Jim Boyle - CL King

If you sell any music or any other items that they would pay you for.

Robert Neil

Okay. We get a very small cut of things that we sell, like CDs, but it would inconsequential to the total number. The vast majority of it is advertising.

Neil Johnston

On the margins, we look at the Internet exactly like we do a developing radio station. At this stage margins are probably in the 20% range. They are growing very rapidly as the top line grows. We've taken a proportional response to the Internet. Any investment is commensurate with revenue dollars that we are getting. We expect those margins to grow up just as a developing station would to grow up to our overall margin over time.

Jim Boyle - CL King

Bob, a quick follow-up, you mentioned that with the shorter units there's seemingly more inventory, even if it's less minute length, do you see that changing in any way in 2006 or 2007?

Robert Neil

No, Jim, I don't. I wish that I did. I wish that I did feel that was going to change because in essence, again, it's a classic supply/demand issue. I see some parallels to how the airline business has improved over the past six months or so, and firmed up its pricing, and it's all been through a reduction of capacity.

I think we all know anybody that's been on an airplane that's traveled for a lot of years. If you've had one airplane and at one point it was configured for 100 seats, and now I scrunch the seats all closer together, and now I can get 130 people on that plane, that's an increase in capacity. Unfortunately for the people that are traveling on the plane, it doesn't make things very comfortable for them.

Potentially the overcapacity of units could make things not good for advertisers, because if people are running more units, in essence, they're going to be buried in the middle of more advertising, whether it's a 10, a 5, or a 15.

Again, I would hope that people would take a look at that, and realize that a capacity increase is not going to help firm pricing up and perhaps look at it. I wish I could say that I thought people we are going to do it, but I really don't see any indication of that.

Jim Boyle - CL King

Thank you.

Operator

Thank you. Your next question is from Stuart Kagel - Janco Partners.

Stuart Kagel - Janco Partners

What sort of road map would you propose to the industry to stimulate stronger demand for radio advertising? What changes might you propose to enhance the pricing power? To follow on to Jim's question, why do you think it is people have been so slow to embrace the notion of reducing inventory?

Robert Neil

Well, I think it's a very difficult, a very difficult notion for people to embrace, because it can run a little counter-intuitive to the sales process. If you're in sales, you always want more things to sell. The more things you have to sell, the more revenue you think you can bring in.

But this business did not really get out of control with its inventory until the mid to late '90s. A typical FM radio station in the early '80s, late '70s when I got into the business, and on up until the mid-'90s was really running a maximum of 8 to 10 minutes of time, and those minutes were broken up as 60-second units. So in most cases you had someone running 8 to 10 60s per hour.

In the late '90s, folks that bought stations, big acquisitions, had to monetize and justify the prices that they paid for those radio stations, and a temporary inflation of demand that was created by the Internet, encouraged that expansion of inventory, and just about every operator took their unit loads way up beyond 10 minutes, 10 units. Some of them are pretty famous that we talk about.

Some stations that we bought in the late '90s that were running 18, 19, 20 minutes of commercial time. Again, most of those were 60s. So once that capacity gets out of hand, it is very, very difficult to reign it back in.

Again, I don't know what process the people at Clear Channel went through, they decided that they needed to reduce the amount of commercial time, which was a worthy goal. But I think part of that process was we need to do this, but we need to figure out a way to not hurt ourselves on the revenue side and as a result, what they came up with was well let's have as many or more units to sell as we do right now, even if we have to reduce the time.

To me, there's a simple solution to that, again, it's a simplistic solution. But it is just to get back to what the commercial loads in radio were, 8 to 10 minutes, 8 to 10 units. That would take a tremendous amount of capacity out of the system. There's enough demand in the system right now, to allow rates to rise based on that scenario.

But as long as we're always scheming, if you will, to figure out how to get more units to sell, we won't have a reduction in capacity. I suppose I could cut, you know, the 10 minutes of time down to 5-second units, and sell however many of them that would be.

The problem is, each one of those units competes with all of the other units that are out there, from the Internet, television, cable, all of these folks and you end up with an oversupply of, if you think about it, ad units -- just a unit that is available for sale as an ad. Whether it's the newspaper, radio, television, cable, Internet, what have you. So it's a difficult issue to deal with.

I think that the smart thing to do is to bring the minute and unit counts down, that's a good thing not only in terms of pricing, be it's also a good thing, in terms of our perception with listeners. I don't know that cutting the minutes down to 10, if the units are up at 15 or 16 really helps the listeners feel that there's less clutter on their radio.

Again, I realize it's a fairly simplistic solution. But again, I think it's textbook supply/demand.

Stuart Kagel - Janco Partners

So, I guess as a follow-up to that, do you think that the demand on your inventory has remained fairly consistent, and that this is just totally a function of pricing power? Then the question is, are you still always going to be susceptible to your weakest competitor?

Robert Neil

The answer to the question is yes, I do think that demand has been fairly steady. Automotive has been tough, but some other categories have stepped in to that. There was an artificial demand level that was created in the late '90s, mostly from the Internet companies that were out there launching, but it was also a pretty hot time for the economy in general. I think that was a bit of a false read on where demand was going to be.

As demand slowed down going into 2001 in that recession we got back to a more realistic demand situation.

But I honestly believe that the demand that's out there right now is fairly consistent with the way that it's been over the years. It's just that the pricing power is very difficult in a world where there are more, and more, and more units out there, than there were even five years ago.

Stuart Kagel - Janco Partners

I apologize for following on to that, but I guess, can you opine on what you think the relative importance of the media buyers, and their increased relevance to the agencies has done, in terms of that impact, in terms of booking later and later and trying to leverage their leverage that they have?

Robert Neil

Well, I think a good media buyer is trying to deliver the best outcome that he or she can get for their client. They're trying to buy as much as they can, as inexpensively as they can. That's what they get paid to do. That's what they've always gotten paid to do.

We have made it easier for them, because of an increased situation on the supply side, that puts the equation more in their favor. In terms of being able to negotiate, more units is going to mean more pricing. That's just the way it is. Again, pretty basic supply and demand.

Stuart Kagel - Janco Partners

Thank you.

Operator

(Operator Instructions)Your next question is from Victor Miller - Bear Stearns.

Victor Miller - Bear Stearns

Thanks, just two follow-ups. You have already $80 million through your first buyback program, you didn't announce anything in what your intentions are to increase that. And I believe your revolver part actually increased from $400 million to $500 million on your bank agreement, so certainly the money is there to borrow on a very flexible basis. Maybe you could talk about that.

Secondly, Bob, it does feel like over the last two years, Media Monitor is suggesting that inventory units down 7%, minutes down 11%. If we look out a year from now, I doubt that's going to change much. Do you agree that we've kind of reached an inventory consensus right now? Do you agree on the composition of 30/60s.

What's interesting is the 12 plus commercial shares, for example, if you add up the commercial radio shares in Tampa went from an 81.4 last spring to an 84.8 this year, that's a 3.4 share point increase for radio commercial listening. Atlanta went from an 84.6 to an 86.8, that's up 2.2. Houston went from 82.6 to 84.2, that's up 1.6%.

Could you argue that maybe perhaps these decreases in units are actually starting to have some effect of maybe driving some audience back to commercial radio, and that maybe combined with some inventory stability, that that could help, maybe next year? Thanks.

Robert Neil

Victor, I don't know enough about Media Monitors to know whether they track some of the smallest units that are out there. I actually hear radio stations doing something in large markets that I never used to hear, except in small markets, and that's like selling an hour. This hour is brought to you by whoever, which is just, you know a very short mention, and which probably wouldn't be picked up as any kind of major unit. But it is a unit that's for sale out there.

Again, I think you have to consider the total number of ad units that are available for sale. So I don't know, I can't tell you what Media Monitors picks up or doesn't pick up, because I haven't really looked at it in detail. I just know in our markets that there's more units for sale out there now, than there was a year ago. I know that from talking to our folks.

As far as the audience levels, I think you have to be so careful with Arbitron when you look, just even in their margin of error. I would tell you that whether the number was going up, or in some cases where, some of the numbers were shown to go down at some point. The margin of error just gets to be very, very huge, when you slice and dice the numbers. I'd be careful trying to judge any major trend from the numbers that you were given, because the numbers are fairly small increases on a percentage basis.

I don't know. I think that if people think about the supply and demand issue, then in a logical way, they're going to see that that's a problem.

On the other hand, we have some people that are under tremendous pressure, and when you get under tremendous pressure, then sometimes you make decisions that you think you have to make for the short term, and the ultimate short-term decision is to try to, you know, add inventory to make your numbers. So you know, will it change a lot in the next year or so? You know, I can't honestly tell you.

I will also tell you that I think the units this year versus last year are up, as a result of the fact that the Clear Channel sales teams have a better handle on how they can slice and dice the time up, and again I go back to my airplane analogy. If the airplane is the minutes of time, and it was originally configured for 100 seats, and now I can slice it and dice it up to 130 seats, I still have the same amount of time, but I have a lot more passengers, and a lot more inventory that's available for sale out there, that perhaps could cause you to outstrip demand, and then cause prices to come down. I realize I'm giving long and involved answers, and it's a difficult issue to try to deal with.

Victor Miller - Bear Stearns

On the buyback?

Neil Johnston

On the balance sheet side, Victor, you are correct, we have about $20 million of capacity left under the current plan, and we have not announced a follow-on plan. In terms of the revolver, our old revolver was $500 million, but we did have fixed notes of $250 million.

Those fixed notes rolled off earlier this year, and so all of that bank debt just rolled on to our revolver, giving us the full, just over $400 million on that revolver, so our actual debt capacity was less than $100 million.

When we renegotiated our revolver, taking advantage of market timing, improving our conditions, we just upped that from $500 million to $600 million. Just giving us a little more room under that revolver. There certainly is nothing more to it than that, other than making sure that we have enough bank debt to be able to give us the flexibility we need.

Victor Miller - Bear Stearns

What's holding the company back since you're so close to finishing the first buyback from announcing another one, or is there an intention that that was it?

Neil Johnston

Victor at this point I'm unable to comment on any future buybacks. All I can say is that currently we have, you know, we still have $20 million remaining on the existing one. Does that answer your question?

Victor Miller - Bear Stearns

Absolutely.

Neil Johnston

Great, thanks.

Operator

I would like to hand the floor back to management for any further or closing comments.

Robert Neil

As always, thanks for participating in the call, and taking the time to ask some good questions this morning. As always, Neil and I are available if you have follow-ups later. Thanks again.

Operator

Thank you. This concludes today's Cox Radio conference call. You may now disconnect.

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Source: Cox Radio Q2 2006 Earnings Conference Call Transcript (CXR)
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