Comcast Corporation (NASDAQ:CMCSA)
Q2 2009 Earnings Call
August 6, 2009 8:30 am ET
Marlene Dooner – Senior Vice President, Investor Relations
Brian Roberts – Chairman and Chief Executive Officer
Michael Angelakis - Chief Financial Officer
Steve Burke – Chief Operating Officer
Spencer Wang - Credit Suisse
Ingrid Chung - Goldman Sachs
Jason Bazinet - Citigroup
Craig Moffett - Sanford Bernstein
Jessica Reif-Cohen - BAS-ML
Vijay Jayant - Barclays Capital
Benjamin Swinburne - Morgan Stanley
Thomas Egan – Collins Stewart
Douglas Mitchelson - Deutsche Bank Securities
John Hodulik - UBS
Welcome to Comcast's second quarter 2009 earnings conference call. (Operator Instructions) I will now turn the call over to Senior Vice President, Investor Relations, Marlene Dooner. Please go ahead, Ms. Dooner.
Thank you and welcome everyone to our second quarter 2009 earnings call. Joining me on the call are Brian Roberts, Steve Burke and Michael Angelakis. As always, let me first refer you to Slide 2, which contains our safe harbor disclaimer and remind you that this conference call may include forward-looking statements subject to certain risks and uncertainties.
In addition, in this call we will refer to certain non-GAAP financial measures. Please refer to our 8-K for the reconciliation of non-GAAP financial measures to GAAP.
With that let me now turn the call to Brian Roberts for his comments. Brian?
Thank you, Marlene, and good morning everyone. Today we are pleased to report solid results for the second quarter really highlighting the strength of our subscription businesses and our continued focus on expense and capital management.
In the second quarter we generated $1.2 billion of free cash flow and for the first six months of the year $2.5 billion which is a 36% increase. Our ability to continue to deliver consistent and significant free cash flow was once again the result of healthy growth in revenues of 4.5% and operating cash flow growth of 5.5% as well as lower cable capital expenditures.
The combination of a weak economy and increasing competition does continue to translate into slower growth in new customer additions. In the second quarter units are also seasonally soft. Our high speed internet adds in particular were disappointing. We believe we understand what happened and have already made some corrections and are pretty optimistic the second quarter high speed internet unit growth will not represent a new trend. Steve will take you through this in more detail.
All in all we are working to strike the right balance between revenue, cash flow and unit growth and the diversity of our revenue streams and the subscription nature of many of our products are helping us to deliver healthy financial results. At the same time, we are focused on providing a superior customer experience offering the best products, delivered reliably and serviced well.
In June the American Customer Satisfaction Index (ACSI) noted a 9% improvement in our customer satisfaction scores highlighting some of our efforts to monitor customer feedback, to address customer issues and internally we continue to see improvement as well in network reliability as well as lower contact rates, trouble calls and repeat trouble calls. We know we have a lot of work still to do but have a real commitment to this effort and we are making steady progress.
We are also innovating, investing in our products and services and executing on strategic initiatives that strengthen our competitive position now and in the future. Just this quarter we launched a number of new features and applications that provide more choices and more ways for customers to access the Comcast services they already enjoy in the home.
First, we announced the launch of our trial of On-Demand online or TV everywhere which now includes programming from more than 20 programmers including broadcasters, premium channels and cable networks.
We also launched a new app for the iPhone, iPod touch community giving customers mobile access to a number of Comcast video, voice and internet services. Similarly, with the launch of Comcast High-Speed 2go in Portland and Atlanta we are beginning the rollout of 4G high speed wireless data services. We are clearly now in the execution phase of our wireless strategy as Portland and Atlanta will be followed by other major markets like Chicago, Philadelphia and others.
We continue to make progress on our key strategic initiatives deploying DOCSIS 3.0 or Wi-Band and All-Digital and expanding our on-demand capabilities with Project Infinity, which are all very important to our long-term success. We have already installed Wi-Band in nearly 50% of our footprint and we hope to reach close to 80% by year-end. As we deploy this Wi-Band capability we are doubling speed to our existing customers and introducing new, higher speed services in these markets.
We are also on track executing All-Digital and we will dramatically increase our product capabilities and help enhance the experience we offer customers particularly in high definition choices, channels and ethnic television. Steve will give you an update on both of these projects including the results from the rollout of All-Digital in Portland where we are now effectively complete.
All of our operating efforts are based on a disciplined and balanced financial approach and over the last few months we completed a number of transactions to reinforce our strong credit profile. Michael will provide more details on that and some of the new financings we have completed in a few minutes.
I am pleased with our results this quarter. When compared to almost any other business Comcast is proving to be robust even in this tough economic environment. We are delivering growth in revenues, growth in operating cash flow, great growth in free cash flow and at the same time we are positioning the company for future success.
Let me now pass it on to Michael to cover the second quarter results in more detail.
Thank you Brian. Let me begin by reviewing our consolidated results on slide four. Overall the company continues to execute well in a challenging economic and competitive environment reflecting our continued focus on profitable growth and proactive expense and capital management.
For the second quarter consolidated revenue increased 4.5% to $8.9 billion and operating cash flow grew 5.5% to $3.5 billion resulting in a consolidated operating cash flow margin of 39.6% versus 39.2% in the second quarter of 2008.
In addition to growing our revenue and operating cash flow we are also very focused on free cash flow, free cash flow per share and adjusted earnings per share as important metrics in evaluating the strength of our company. In each of these key metrics our performance in the second quarter and on a year-to-date basis are very strong and reflect meaningful progress and growth.
During the second quarter we generated consolidated free cash flow of $1.2 billion. Year-to-date free cash flow has increased 36% to $2.5 billion from $1.9 billion in 2008. To be clear, we are providing a consistent comparison for prior year results and therefore free cash flow for 2009 and 2008 specifically exclude any impact from the 2009 or 2008 economic stimulus packages.
In addition, free cash flow per share increased 3% in the quarter to $0.40 per share and our year-to-date free cash flow per share has increased 42% to $0.88 per share compared to the same period in 2008.
We generated EPS of $0.33 per share, an increase of 67% compared to the second quarter of 2008. On a year-to-date basis our adjusted EPS has increased 46% to $0.50 per share. The reason for this adjustment is to exclude a one-time gain in 2008 related to the dissolution of the Insight/Midwest partnership.
We remain very focused on executing our strategic, operational and financial plans. There are several areas that should be highlighted. Consistent with the ongoing recession and its consumer impact, we are continuing to experience a slowdown in gross connect activity across all of our service categories. The weak economy continues to negatively impact the consumer, providing us with fewer opportunities to sell new services.
Connect activity was exceptionally challenging in April and May although we saw some improvement in June as connects benefited from the broadcast digital transition and additional marketing efforts. We expect connects to remain challenging due to the difficult economic environment and competition as [R-Box] continues to increase their footprint and they and satellite remain promotional.
In addition, in the second quarter churn in both video and high speed internet modestly increased driven by higher voluntary disconnects that were concentrated in a handful of markets which are experiencing particularly high unemployment rates or levels of foreclosures. However, we are managing appropriately our bad debt and it continues to trend at similar levels to prior year.
The overall advertising market continues to be challenging. Our local cable advertising revenue declined 20% this quarter and we are not seeing any signs of recovery. Advertising weakness also impacted our national programming network. Our programming division reported a 5% increase in revenue. However, it includes a 7% decline in advertising revenue in the second quarter.
Even with these headwinds I think it is important to recognize we are growing the business and we are confident that we will continue to execute through this recession. We will remain diligent with our expense controls and are focused on delivering growth in revenues, operating cash flow and free cash flow as well as improving capital efficiency.
Let’s review our cable division’s second quarter results in more detail. Please refer to slide five. In the second quarter of 2009 cable revenue increased 5% to $8.5 billion reflecting growth in each of our businesses including video, high speed internet, voice and business services. This revenue growth was relatively stable despite lower than expected customer additions and weak advertising sales.
Total video, high speed internet and voice customers grew 84,000 for the second quarter totaling 46 million, an increase of 4% of 1.6 million new customer additions over the last 12 months. Even as we experience pressure on unit growth and advertising, total revenue per video customer remained solid during the second quarter increasing 7% to $118. Total subscription revenue per customer, which excludes advertising, grew 9% to $113 reflecting the following components; Total video revenue increased 2% reflecting a 4% increase in video ARPU and a decline in basic video customers.
Our second quarter 2009 video customer loss was 214,000 which does include some benefit from the digital transition. This quarter’s increase in video ARPU reflects rate increases and a continued growth in digital and advanced services offset by additional bundling and promotions. In the second quarter our video mix included a higher proportion of limited basic customers as a result of the digital transition and more customers subscribing to lower levels of digital service.
High speed internet revenue increased 8% during the quarter and as Brian mentioned second quarter high speed internet customer additions were unusually low at 65,000. Despite that we had stable average revenue per customer of approximately $42 and penetration is approximately 30%.
Voice revenue increased 25% for the second quarter reflecting continued growth in our customer base and a modest decline in ARPU for approximately $39. We added 233,000 voice customers this customer and now have over 7 million customers. Penetration for our voice service is approximately 15% and we believe there is meaningful growth remaining in this business. At the end of the second quarter 2009 25% of our video customers took all three services compared to 20% in the second quarter of 2008.
Revenue from our business services segment increased 51% in the quarter to $198 million. Business services continues to gain momentum and we expect business services to be a meaningful contributor to our growth.
Please refer to slide six. As you can see from this slide, cable results over the last 2.5 years has grown consistently and reflects a stable and diversified profit mix. In the second quarter of 2009 cable operating cash flow increased 4% to $3.5 billion and our cable operating cash flow margin decreased slightly to 41.3% from 41.5% in the second quarter of 2008.
On a year-to-date basis, operating cash flow grew 6% to $6.9 billion resulting in a higher OCF margin of 41.1% compared to 40.6% during the same period in 2008. In the second quarter total expenses in our cable segment increased 5% and as we expected programming expenses increased 9% reflecting higher rates and additional digital programming costs as we have increased our digital customer base and continue to add new programming.
In addition we absorbed additional operating expenses to support the digital transition and our key strategic initiatives such as All-Digital and improving the customer experience which is reflected in the 11% increase in technical labor and the 6% increase in customer service expense.
While we continue to evaluate our cost structure to extract further efficiencies, we will continue to make these types of investments to support profitable growth, enhance product superiority and improve our customer experience. Partially offsetting these higher expenses, we continue to extract sale benefits and efficiencies in our high speed internet and digital voice businesses. Compared to the second quarter of 2008 our direct costs for high speed internet declined 14% and digital voice direct costs decreased 18%.
These expense reductions were achieved while we added almost one million high speed internet customers and 1.4 million voice customers over the last 12 months. Also, marketing expense decreased 2% year-over-year reflecting timing and favorable advertising pricing. We expect marketing expense to trend higher in the second half of the year but full year marketing expenses should be fairly consistent with full year 2008.
Please refer to slide seven. In the second quarter of 2009 capital expenditures decreased 14% to $1.1 billion representing 12.5% of revenue. The decline in CapEx was the result of improved efficiencies, lower unit growth, more favorable CPE pricing and reduced construction spend. This result was achieved even as we invested in our All-Digital and DOCSIS 3.0 strategic initiatives. We expanded Project Infinity, supported significant growth areas such as business services.
Consistent with historical trends, CapEx continued to be predominately growth oriented with growth CapEx accounting for 69% of cable CapEx for the quarter and 73% year-to-date. We remain very focused on return on incremental capital and are confident our growth investments will continue to yield attractive financial and strategic returns.
During the second quarter we deployed 1.9 million digital set top boxes and adapters, bringing our total deployed to over 30 million. Included in this number are boxes and adapters deployed to 250,000 digital customers added in the quarter. In addition, we deployed approximately 340,000 advanced high definition, indoor DVR set box as we added or upgraded 171,000 advanced service customers.
We now have 8.3 million High Def and/or DVR customers and our advanced service penetration is approximately 48% of total digital video customers. We also deployed 1.4 million digital adapters in the second quarter to support our roll out of our All-Digital initiative. Steve will give an update on our progress on All-Digital in a few minutes.
We also continue to purchase equipment for DOCSIS 3.0 or Wi-Band initiative. As Brian mentioned we have already deployed this service to nearly 50% of our footprint with a new goal to complete 80% of our footprint by year-end. We do expect CapEx will modestly increase during the second half of the year as we invest to sustain our momentum in business services and continue to expand our deployment of Wi-Band and All-Digital.
Nevertheless, even as we accelerate our DOCSIS 3.0 deployment we are pleased with our capital management and expect our full-year CapEx will be both lower in absolute dollars and as a percentage of our revenue when compared to 2008.
Now please refer to slide eight. As we announced at the half-year mark, our financial strategy for 2009 hasn’t changed as we are executing on a disciplined and return oriented approach to allocating capital as well as growing free cash flow and free cash flow per share.
In the second quarter of 2009, as I mentioned we generated $1.2 billion of free cash flow, consistent with prior year. Year-to-date free cash flow has increased 36% to $2.5 billion and free cash flow per share has increased 42% to $0.88 per share compared to the same period in 2008. Given the macroeconomic events, one of our goals in 2009 was to strength the company’s financial profile and during the second quarter we completed a number of transactions to achieve that.
First, we had previously indicated we planned to use our free cash flow to pay down maturities this year. In the second quarter and over the last two weeks we have repaid $2 billion of maturing debt. We have also accessed the capital markets, raising $1.5 billion through attractive priced 10 and 30 year notes and immediately used these proceeds to tender for $1.3 billion in debt due in 2013 which was a year of unsized maturities for the company.
As we go forward in the third and fourth quarters it is our intention to repay approximately $1.4 billion of short-term debt with our internally generated cash. Given the recession and difficult economic climate, these transactions accomplished our 2009 goals as they modestly de-lever the balance sheet, reduce our cost of debt, improve our long-term liquidity and enhance the risk profile of the company. We believe our strong balance sheet is an asset to our shareholders and that modest debt reduction is accretive to our equity value.
At the same time, we are committed to returning capital directly to shareholders. During the first seven months of 2009 we have paid cash dividends totaling $568 million. Also during the second quarter of 2009 we used excess liquidity to repurchase 15.5 million of our shares for $215 million. As of June 30, 3009 we have approximately $3.9 billion of availability remaining under our share repurchase authorization so we may continue to purchase stock from time to time.
Now let me pass the call to Steve.
Thanks Mike and good morning everybody. During the second quarter we posted solid financial results and continued to grow our cable business despite a tough economy. We also made significant progress in our All-Digital initiative, launching DOCSIS 3.0, introducing 4G wireless data and completing the country’s digital transition.
With half of 2009 remaining we are really focused on the four following things; one, striking the right balance between cash flow and unit growth. Two, driving consumer additions in a challenging environment. Three, realizing operating and capital efficiencies while investing in growth areas such as business services. Four, improving our competitive position by developing new products and customer service.
Now let me move on to each of our major lines of business starting with video. Total video revenue came in about as planned but basic subscribers were weaker than expected. The [R-Box] now have over built 28% of our footprint and they and satellite were very aggressive during the quarter. We have recently launched a number of high impact marketing campaigns and are seeing better trends in July than we did in the second quarter.
As discussed previously we have started to convert systems to all digital. Please refer to slide nine for information on this. Portland became the first large system to go All-Digital in June. Today 10% of the company has made the conversion and somewhere over 1/3 of all of our systems are actively engaged in the process of converting. By the end of this year 1/3 of our systems will have completed the conversion process.
Results to date have been better than planned. Costs are a drag on cash flow growth but costs are coming in below what we planned for them to be. We are also seeing operational savings post transition in Portland and believe this effort will have an attractive ROI in addition to paving the way to over 100 High Def channels, ethnic programming and other product enhancements.
Moving on to data, ARPU was strong but high speed data net adds were disappointing at 65,000. We expected to see some deceleration in the second quarter but not at this level. There are a variety of factors that contributed to this performance. Seasonality and economy clearly played a part in our net add softness but so did our marketing emphasis. Much of our marketing during the second quarter was for the digital transition and other initiatives that had nothing to do with high speed data.
When we started marketing the Triple Play and high speed data more aggressively in July, our data sales improved markedly. In fact, we have already gained more subscribers third quarter to date than we did in all of the second quarter. We expect August and September to build on July’s momentum as we head into our strongest time of the year for data, the back-to-school season.
Longer-term, DOCSIS 3.0 will give us a speed advantage across the country. These efforts are about half complete but they have yet to contribute to our net add performance in a significant way. During the quarter we introduced our 4G wireless product which we call Comcast 2Go. Please refer to slide ten. We launched July 1 in Portland, Oregon and July 28th in Atlanta. We will be moving this product into Chicago, Philadelphia, the Washington state area and other markets this fall. While it is early, we have gotten off to a strong start and are ahead of plan.
For new customers we are offering a compelling combination of in-home and mobile data for $49.99 a month for the first 12 months. This is a great product and the good news is, it is bringing a lot of customers into the high speed data pool that are new to that segment of our business.
As reported, we also recently announced a new web service that allows authenticated cable customers to get more programming via the Internet. Please refer to slide 11. We are beta testing this to 5,000 customers today. The site is terrific and it is continuing to perform well with over 20 programmers and over 4,000 titles available and we plan to expand this launch nationally this fall. We think this effort is very important strategically for the cable industry and we are pleased to see it starting off so well.
Moving on to voice, we added 233,000 voice customers in the quarter. Penetration is now up to 15%. Close to a quarter of all our customers now subscribe to all three of our products. Similar to high speed data we are seeing an improvement as we exit the second quarter and look at July results. We continue to enhance and differentiate our voice offerings. For example, we are testing and will soon launch an enhanced cordless telephone that allows you to check your Comcast.net email without turning on your computer, synchronize your address book, search local business listings and read the latest news, weather and sports, all from your home phone.
As Brian mentioned, we recently launched a Comcast mobile app for Apple iPhone. This app allows you to check your email, synch your address book and this fall will allow you to program your DVR. In just a couple of weeks we have had over 200,000 downloads and were one of the top 12 apps for the Apple iPhone.
In the near future we will be launching converged wireless apps on Blackberry and other devices. Between our 4G launch and the Comcast mobile apps you are starting to see us flesh out our wireless strategy.
Our cable advertising business was down 19.6% for the second quarter. This is obviously real weakness and material enough that our cash flow growth rate would have been over 2 percentage points higher without ad sales. Our ad sales business was down 25% in the first quarter and 20% in the second quarter so you could say this is a sign of some improvement but the market is very opaque at this point. We have had some weeks that are better than the second quarter but it is too soon to say that the advertising market is recovering.
Moving on to business services, our commercial business continues to show very strong growth. Please look at slide 13 for a sense of how this business is ramping. Revenue was up over 50% in the quarter and year-to-date. This business is firing on all cylinders even as our base gets bigger. Our growth rate is accelerating from the mid 30’s 18 months ago to over 50% this quarter. We look forward to continued high growth rates in the quarters ahead.
We are continuing to focus on the small business sector with eight-line phone, high speed data and Microsoft communications services. We are sharpening our marketing message and building real skill in this business. At the same time we are branching off into new businesses beyond just small business customers. For example, we are expanding our Sell Back Call operations and now have agreements with wireless carriers contracted for over 2,000 towers. Our goal is to keep this business growing rapidly and this is an area where we would like to invest as much capital to get as good a return as possible. Our plan is to do that in the second half of 2009.
In summary, while the environment is challenging we are continuing to grow our cable business. As importantly, with All-Digital, DOCSIS 3.0, 4G and business services we are making the investments today that will power our growth in the future.
Thanks Steve. Operator, let’s open up the call to Q&A please.
(Operator Instructions) The first question comes from the line of Spencer Wang - Credit Suisse.
Spencer Wang - Credit Suisse
If we could just go back to the broadband net adds again you talked about seasonality and marketing playing a role in the weak results. Can you talk a little bit about anything you are seeing in the competitive environment impacting results? Do you have any plans to be more promotional with data pricing? Then one quick question for Mike. In the past Comcast has given us a sense of timing in terms of completing the buy back. Can you give us any clarity there on the buy back?
Let me go first, in terms of high speed data net adds, I think in the first quarter we gained about 300,000 high speed data subs so 365 is a big drop. It really in looking at it, it was a whole bunch of different factors but the good news is once we adjusted and really started doing more single product high speed data promotions and Triple Play promotions and shifted away from the country’s digital transition we have seen the business pick up significantly and I think the third quarter is going to look a lot more like the first quarter than the second. As I mentioned in my opening remarks, already in the third quarter we have added more subs than we did in the second. I think the primary driver that we can control is concentrating on getting those marketing campaigns out there which is what we are doing.
Why don’t I take the question on buybacks. We continue to believe the stock is undervalued. We have articulated I think a pretty balanced financial strategy for the year. We are really pleased that we resumed purchasing the shares. The way we view purchasing the shares is really based on excess liquidity. When you look at what our thoughts were with regard to the strategy this year in how we de-lever and how we generate free cash flow we are generating some excess liquidity and we though the best use for that was to repurchase some shares. We will continue to resume repurchasing and we are pleased to do it.
The next question comes from the line of Ingrid Chung - Goldman Sachs.
Ingrid Chung - Goldman Sachs
Just to follow-up on Spencer’s question regarding free cash flow and the uses of free cash flow, my first question is why wouldn’t you refinance the short-term debt that you have coming due this year? Then, what is your outlook for returning more capital to shareholders in 2010 when you are hopefully growing free cash flow again?
I think that we were very clear at the beginning of the year that we wanted to modestly de-lever. When we think about leverage we think about leverage clearly as debt to operating cash flow. We also think about debt to un-leverage free cash flow as well as debt to free cash flow. I think the goal this year was to really create an independent company from a financing standpoint. We don’t want to get into a situation where what occurred last fall with the financial crisis. I think a number of things we have done this year in terms of modestly de-levering, in terms of growing free cash flow, in terms of pushing out some of the maturities at attractive rates all represent what we think is a pretty balanced strategy as well as increasing the dividend now resuming the purchase of the shares. We are looking at that as a very balanced, maybe a touch conservative but a very balanced strategy of how we are using free cash flow.
Ingrid Chung - Goldman Sachs
And the outlook for 2010?
I think we will talk about it later in the year.
The next question comes from the line of Jason Bazinet – Citigroup.
Jason Bazinet - Citigroup
I just had a question for Mr. Angelakis on the OCF margins. I guess over a long period of time we have always been able to think about 40%-ish margins over the last decade. If we look under the hood I think you would agree that the gross profit margins on video have come down and it has sort of been helped by high gross profit margins on data and phone. If those revenues begin to slow on data and phone do you think there is enough cost cutting in the system over the next 2-3 years that will allow you to maintain these margins or do you think it is more apt to drift a touch lower?
I think our margins number one are the highest in the industry so I think that is important to note. Secondly if you look at slide six which really goes through 2.5 years of margin we have steadily increased the margins by 150 odd basis points. I think we are very focused on where the margin goes. I think we have appropriate costs in the company both on high speed and on voice that we are going to manage well and as we articulated in the call I think it is very difficult to look at the next few years but I think we are pretty confident with where our margins are.
The next question comes from the line of Craig Moffett - Sanford Bernstein.
Craig Moffett - Sanford Bernstein
I wonder if you could elaborate more on your strategy as it relates to Clear Wire. Your pricing strategy or at least your promotional pricing strategy in Portland was quite aggressive. I presume that reflects a low transfer price. I am just wondering if you can talk at all about what kinds of margins you expect to make on the Clear Wire business. Second, if you can talk about what your voice strategy may be as it relates to Clear Wire and the wireless business in general. Would you expect to start offering voice services that ride on top of the Clear Wire service? Do you think of those as effectively another free add on or do you think of those as another potential profit pool?
Just so everybody understands exactly what we are doing with this product which we call Comcast 2Go. It is powered by the Clear Wire network in the markets where they have launched their network. To the consumer it is branded as Comcast 2Go. It is primarily sold in conjunction with our high speed data products. We think of them as sold in a bundle that makes a lot of sense for the consumer and it is quite straight forward transactionally for us to process. We charge $49.95 for the first year. Most of the time when we sell high speed data alone we have some form of promotional price so one way to look at it is you are getting high speed data subs that you would have other promoted for. Plus you are getting the Comcast 2Go subs. The end of the year resets to $69.95. The combination product of the two has very healthy margins. We were just talking about 40% margins. The margin is in excess of 40% for the combination once it resets to $69.96.
We think the product is very sticky. The mobile component always comes with a contract. We think that is very sticky. Really importantly, 40% of the customers we are getting in Portland are brand new to Comcast. They are lapsed DSL customers or customers who otherwise potentially would be getting DSL and for us this is a way for us to grow our high speed data business in the home and add a new business line. I understand your point. We are using someone else’s network. There is a transfer price. How does that all work economically. But we are very comfortable that this is a product that is an enhancement to our high speed data business and can grow the overall pie.
As it relates to voice and some of the other things we are doing in wireless, I think at this point it really doesn’t make sense for us to tip our hand. We have been talking about wireless a long time and I think you are starting to see us execute our wireless strategy. Obviously 4G is a big part of it but there are other parts. Multiple other parts you will be seeing in the months ahead.
Craig Moffett - Sanford Bernstein
The growth rate you had in that 40% in Portland that you are taking from competitors, does that translate to a meaningfully faster growth rate overall in Portland or can’t you tell?
For high speed data net adds?
Craig Moffett - Sanford Bernstein
Yes, it is definitely faster.
The next question comes from the line of Jessica Reif-Cohen - BAS-ML.
Jessica Reif-Cohen - BAS-ML
Can you give us an update on Canoe?
We just had a Canoe board meeting a couple of days ago. I think we are making very good progress. You are not seeing it in the numbers right now and you really won’t see it in the numbers in a material fashion for awhile. The industry has really come together well. One of the products we are working on now relates to the roll out of [EBIS] which those of you who follow the industry well understand that [EBIS] is going to allow us to do a lot of interactivity, RFI, voting and polling. Depending on how that roll out goes, the partner MSO’s could have as many as 25 million [EBIS] enabled homes by the fourth quarter. Those homes are going to be Canoe enabled homes and then there is going to be an entire business built on that. That project is going quite well as are other things that Canoe is doing. The board meeting was 3 hours long. I spent another 3-4 hours with the Canoe team. Obviously this is a really important initiative for the company. We have got to get interactive advertising moving. I think we are making real progress.
Jessica Reif-Cohen - BAS-ML
So is this like a 2011 revenue business?
I think you will see some revenue in 2010 and it will become more material in the future.
Jessica Reif-Cohen - BAS-ML
Switching gears, what exactly caused you to step up the roll out of DOCSIS to other areas of the country? What are you seeing and what do you expect to get?
I think we have always been real believers and one of the earliest sort of advocates of DOCSIS 3.0. It was always our intention to roll it out to a majority of the country. A lot of it is operational; how you get it into the markets and is it working well, etc. I think part of the estimate is that we are getting it implemented and we are a little further along the line and continue to be big believers in it. I think everybody in the industry eventually is going to put DOCSIS 3.0 pretty much everywhere it is just a question of how fast you do it.
I just want to add I think it is part of our sort of technical repositioning of the company. We are getting the plumbing work done and getting all the operational, capital and every other issue kind of behind us. All-Digital, as Steve talked about earlier, and DOCSIS 3.0 are two big initiatives that we have to get through the whole company. Have true 2-way completely up and running on all the various devices. You come out of that period and you have a totally different product. You have faster internet. You have more hi-def channels. More ethnic channels. You have a whole other way to begin to think about bandwidth allocation. So it is going well. It is a lot of work. We are a big company. I think if the goal is to come out and be able to credibly position our products as the best whether it is video, data or cross-platform, having the DOCSIS 3.0 platform is an essential ingredient in our strategy. We are pretty happy to be getting it throughout the machine a lot faster.
Brian mentioned All-Digital. We would like to be in a position to report that we are speeding up All-Digital as well. Right now we have about 10% of the country done but about 1/3 of all the systems are in process. It is a lot of work. Both DOCSIS 3.0 and All-Digital are a lot of work. Strategically we think it is important to get those projects done. If we can speed up All-Digital as well we will.
Basically it is going well.
The next question comes from the line of Vijay Jayant - Barclays Capital.
Vijay Jayant - Barclays Capital
We hear that Motorola has finally got a switching solution that can scale. Will that change your All-Digital strategy? Is that something you would consider? Following on that, given the recent ruling on network DVR how do you think about that? Have you done any cost benefit analysis to sort of do that at this time?
I think our vision of the future is you want to be all digital and you want to switch. You want to be able to offer as many possible choices to consumers as you can. I don’t think they are mutually exclusive so we are going to continue moving and taking 100% of the company or functionally 100% of the company All-Digital while continuing to work on switching. We do think we have made real progress on the Motorola side of the house in terms of switching.
Regarding network DVR we have always believed that the network DVR is a great application that satellite can’t replicate. There are a lot of different nuances in terms of how you manage the storage, what the actual product is, etc. With all of those different choices come different costs and cost benefits. We are working our way through those now. I think there is no question some form of network DVR type service is going to be in our future. It is just a matter of determining which form it is and getting that implemented.
The next question comes from the line of Benjamin Swinburne - Morgan Stanley.
Benjamin Swinburne - Morgan Stanley
Mike on the all digital roll out I believe you are expensing, and correct me if I’m wrong, the labor on those DTA deployments which I think is probably creating some drag on your margins. As we think about next year some of those expenses should roll off as you complete this project. I wonder if you could help us think about or quantify that trend this year and as you look forward.
For Steve on the competitive front you have a 20% overlap for T and Verizon. Which of those two might be meaningfully more competitive or more promotional if there is a big difference in the two from a product perspective? Where do you think that 28% goes, sort of best guess from here over time?
Let me take a stab at both of them. First on the competitive, it is 28% now. I think by the end of the year it will go to around 30%. AT&T has much more footprint. It is easier for AT&T to expand their footprint more quickly because they are not doing as intense investment or fiber work as Verizon. AT&T and Verizon go back and forth in terms of who is most compatible to our business. They are about the same. In any one quarter one might be slightly ahead of the other. It is not as it one is taking more than the other. It varies by quarter. It varies by region obviously depending upon where they are.
In terms of the all digital drag if you look at what is happening when a market goes all digital first of all it affects almost everyone in the market. It affects almost every tech. It affects almost every person in the call center. The marketing. Everyone else. It does have a drag on the business. We think in the first and second quarter All-Digital and the country’s digital transition and the combination of those two efforts was probably a drag of about a point of cash flow.
You sort of implied that in 2010 it would be a positive for us. The reality is I think for all of 2010, every quarter in 2010, we are going to still be taking systems All-Digital. So I don’t think that one percentage point necessarily comes back until 2011. The drag is more than just financial. There is only a certain amount of intellectual bandwidth a system can have and when you are going through one of these conversions it is quite intense. What is great is when you come out and the Oregon system has now come out the other side, you have clear savings and efficiencies and you can then offer your customers 100 high def channels, lots of ethnic channels, really a better video product than any of our competition. Plus of course high speed data and everything else. So when a system is going through it and it might take 9-12 months for a particular system to get through the All-Digital conversion. It is clearly a drag in a lot of different ways but when they come out it is a real benefit.
Let me just add one minor point. The reason we are taking 9-12 months in a system is we want to be the minimal dislocation. You can do it faster but then it as more people clog up phone calls we are really sensitive to try and make this as least disruptive to the consumer as possible and just have it be a benefit when we are finally done. That seems to be working.
I think we have talked about this before, in 2009 and 2010 we are allocating capital for both the All-Digital as well as the DOCSIS 3.0 roll outs. Obviously we are accelerating DOCSIS 3.0 a bit. It is not going to be meaningful in terms of how we manage capital. That will be a bit of a benefit to us in 2010 but we will have the All-Digital CapEx in 2010. In 2011 our hope is obviously the capital goes away and some of the expense drag goes away as well.
The next question comes from the line of Thomas Egan – Collins Stewart.
Thomas Egan – Collins Stewart
A question on basic. Who do you see as being more competitive right now, i.e. who are you losing more of your basic customers to? Is it more of the [R-Box] or is it satellite? Then I have a follow-up on the All-Digital.
I think at this point it is more of the [R-Box] than satellite.
Thomas Egan – Collins Stewart
Regarding All-Digital, we saw with Cablevision as they took off about 14 analog channels off of the channel lineup they added digital but lost analog. So can you talk a little bit about as you proceed with the All-Digital transition what is the impact going to be with analog versus digital subs?
Well the way our all digital works the only people who stay analog are lifeline or B1 customers which is a small minority. They continue to get ABC, NBC, CBS, CSPAN, whatever else is on that lifeline tier. Everyone else goes to digital so there really is no analog base. We don’t lose subs when we go through the transition. We may lose some but we also gain some because of that production, etc. Everyone who then gets converted to a digital customer who was analog gets something. Typically it adds a dozen new channels. We add music channels. They get digital picture quality. So no one goes backwards. There is an inconvenience. You need to put a digital converter or set top box in someone’s house. 80% of a the time we do that with a self-install kit.
It is a fairly easy thing. We drop ship. You don’t need to take a half a day off of work and wait for someone to come in and do it. Whether it is a regular functioning digital set top box or a D to A converter, no matter what happens everybody goes forward in the market. No one goes backward.
The next question comes from the line of Douglas Mitchelson - Deutsche Bank Securities
Douglas Mitchelson - Deutsche Bank Securities
Just to further the conversation on wireless looking out a couple of years one question I get a lot from investors is regarding 4G wireless rollouts and the impact it will have. You have already discussed your wireless efforts and you are the first market where your solution helps you take share for now. Is there a risk that reverses when 4G gets out there for the [R-Box] given their scale and their ability to essentially compete on price? That is the first one.
Second, I am wondering about the 2010 programming cost outlook. This is a tough year for programming cost renewals but based on the contracts coming up for renewal I would think that 2010 might be a little bit better year. Just curious on any comments you might make there.
On wireless, our working assumption is the wireless companies are going to do what they are going to do anyway. So 4G is the next evolution in their technology. I’m not sure how quickly it really does get here. They are barely deployed to 3G and what the return on capital would be to completely go to the next generation this quickly. We are just going to have to see their behavior. There is not much we can do. Our view is how best to enter the market and when Clear Wire came to us and said we could start from scratch with over 100 MHz per market and have version spectrum deployed to innovation with 4G right out of the box. That was very appealing to us. We have only launched two markets in just a few weeks or few months but it is very exciting to begin to have the bundle that Steve talked about.
We are assuming that obviously the wireless companies will have their own bundle. The question we never got back to that was asked in this space as well was what about voice with wireless. A lot of us believe that in wireless in the long run voice is going to run on top of data as an application and that is not here today but there are a lot of people who see that day coming. So it is a real good beginning. We also have done some nice work with the iPhone with our wireless team and the data team. It is just the beginning of having a complement of products. I think it is important strategically and hopefully will be a good investment in addition to that as well.
On the programming side, we don’t want to get too far ahead of ourselves with regard to 2010. If we look at programming costs from two perspectives; one is as we add more digital customers our programming costs go up. That we acknowledge and actually are happy to have more digital customers. What we are obviously very focused on is what is the increase in our costs on a run rate basis. I know we are somewhere around 9% or a little bit higher. We are working really hard to be sure that number comes down.
The next question comes from the line of John Hodulik – UBS.
John Hodulik - UBS
You mentioned you saw improving trends in July on the basic subs front. I think versus what you were seeing in June. Can you talk a little about what is driving that? Are you seeing some bottoming in the economy? I would imagine you had gotten some benefit from the digital transition in June and for July to be better I’m just wondering if you guys are doing something different or if you are seeing something different in the market?
I think really what is happening in terms of our business picking up relative to our plan is really jus the focus of the marketing efforts. When 1/3 of your company is going through the All-Digital transition they are really thinking about that. When 100% of the country is doing the country’s DTV transition they are thinking about that. What we found is day in and day out we need to have a strong Triple Play promotion which we do with the $99.00 one-year Triple Play promotion and you need to have a strong high speed data message in the market frequently and a basic sub message and a phone message in the market frequently. It is interesting, once we started doing that and really getting back to that during the month of June and July the business really responded.
As it relates to high speed data what happens in the third quarter it is traditionally a good high speed data quarter as you have back to school. So whatever momentum you start in July and August typically increases in September. It is very hard to predict what could happen with competitors. I don’t think the change in the economy is having a material impact. I think it is more what we are doing in terms of our marketing and we hope the trends continue.
I just want to conclude by saying that the important question we are studying all the time but I think what this quarter demonstrated, what the first half demonstrated, is it is about a balance between our financial focus and discipline and rigor and unit in a world where 28% has now been over built. We are realistic about that. We have planned for it. We are constantly balancing. So it is a combination of execution as Steve just talked about. How do we adjust that execution? Every week, every month and every quarter.
We are keeping our focus on the big picture which is a very solid business in tough economic times with some unusual things going on and I think we are going to come out of it and be the strongest we have ever been. So we are pleased with the quarter.
Thank you John and thank you all for joining us this morning. Operator please provide instructions for the replay.
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