Welcome to the Time Warner Cable fourth quarter and full year 2009 earnings conference call. (Operator Instructions) Now I will turn the call over to Mr. Tom Robey, Senior Vice President of Time Warner Cable Investor Relations. You may begin.
Thank you. Good morning everyone. Welcome to Time Warner Cable's 2009 full year and fourth quarter earnings conference call. This morning we issued two press releases. One detailing our 2009 full-year and fourth quarter results. The other announcing the initiation of our regular dividend.
Before we begin, there are a couple of items I need to cover. First, we refer to certain non-GAAP measures, including operating income or loss before depreciation and amortization which we call OIBDA. In addition we refer to adjusted OIBDA and adjusted OIBDA less capital expenditures. Definitions and schedules setting out reconciliations of these historical non-GAAP financial measures to the most directly comparable GAAP financial measures are included in our earnings release and our trending schedules.
Second, today’s announcement includes certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 which are based on management’s current expectations and beliefs and are subject to uncertainty and changes in circumstances. Actual results may vary materially from those expressed or implied by the statements herein due to various factors including economic, business, competitive, technological, strategic and/or regulatory changes that could affect our business. These factors are discussed in detail in Time Warner Cable's SEC filings, including its most recent annual report on Form 10K and quarterly reports on Form 10Q. Time Warner Cable is under no obligation to, and in fact expressly disclaims any such obligation to update or alter its forward-looking statements, whether as a result of new information, future events, or otherwise.
Finally, today’s press release, trending schedules, presentation slides and related reconciliation schedules are available on our company’s website at www.timewarnercable.com/investors. A replay of today’s call will be available today beginning approximately two hours after the call has ended and will run through midnight ET February 1.
With all of that covered, I will thank you and turn the call over to Glenn.
Thanks Tom. Good morning everyone. 2009 was a very good year all things considered. We grew our revenues by 4% and adjusted OIBDA by 5% compared to 2008 and that was despite a sharp recession that caused many consumers to lose their jobs and homes and which drove the sharpest advertising downturn in a generation.
Despite these challenges we met or exceeded every element of our guidance for the year. We posted net adds of nearly 800,000 primary service units in 2009 and customer relationships were steady at 14.6 million. Our 2009 performance reinforces our belief that we are in a great business and it demonstrates that we have managed it prudently.
We again carefully balanced ARPU and subscriber growth and we controlled our costs. Despite lower growth in our subscription business and a decline in ad sales, we increased our adjusted OIBDA margin in 2009 compared to 2008. We also reached a significant qualitative milestone in 2009. Through our spinoff with Time Warner we became an independent, publicly traded company with a single class of stock.
In the year just ended we strengthened our balance sheet considerably. After paying a $10.9 billion special dividend which from perspective is equal to more than $30 per new Time Warner Cable share we reduced our leverage from 3.7 times adjusted OIBDA last March 31st to just over 3.3 times at year-end. We are comfortably on track to achieve our target leverage of 3.25 times in the first quarter of 2010.
As a result of our progress in 2009 we are now positioned to begin returning capital to our shareholders. This morning we announced the initiation of a regular dividend and established a quarterly rate of $0.40 per share or $1.60 per share annually. This starting point reflects our confidence in the strength and stability of the company’s cash flows.
We set the yield higher than our cable peers and higher than the average of S&P 500 companies that pay a dividend. In fact, the yield at initiation is in the 85th percentile of all dividend initiations by S&P 500 companies in the last 10 years. The dividend provides significant yield, yet it also provides us the flexibility to invest in organic growth as well as to consider strategic acquisitions and additional means of returning capital to shareholders over time.
Turning to the year ahead there are widespread reports of an economic turnaround. However, we have not seen a material improvement in the economic factors most relevant to our business. Things like housing vacancies, unemployment and consumer confidence. Nonetheless, we expect that our core residential business will continue to grow and that growth in our commercial business will accelerate in 2010.
In addition we are poised to see growth in our high margin advertising business for the first time in over a year due to the strengthening of the ad markets and political ad spending around the midterm elections that promise some very competitive races in parts of our footprint.
You will see both new products and product improvements from us this year. In video we will have the capability to carry as many as 200 HD channels, will enhance our network DVR based Start Over and Look Back products and we will introduce multi-room DVR. In high speed data we will make our DOCSIS 3.0 product available in more cities and we are about to launch a portal that will enable our digital phone customers to manage their accounts and features to which they subscribe.
In addition to the accelerated growth we expect in our commercial business we will invest in our Roadrunner mobile product in the year ahead. Now available in parts of Texas, the Carolinas and Hawaii, Roadrunner Mobile will become more broadly available as the year proceeds. We will have some margin dilution due to the start up costs of this business but we believe that mobile broadband could become an important part of our portfolio in the coming years.
We are continuing to focus on cost management not just due to continuing weakness in the economy but because it is part of what we do every year. In summary, we came out of 2009 strong and well positioned to face the challenges in the year ahead. Our balance sheet is strong and we are very pleased to demonstrate our confidence in our free cash flow through the initiation of a meaningful quarterly dividend. We will execute with the same discipline you have come to expect and we will continue to invest in growth in 2010.
Now over to Rob for more details.
Thanks Glenn and good morning everyone. As Glenn mentioned we delivered another quarter of solid financial results meeting or exceeding our full-year guidance in every category.
Let’s start with the 2009 highlights on slide three. Despite the weak economy and tough competition we held customer relationships essentially flat in 2009 while adding almost 800,000 primary service units and more than one million revenue generating units. We grew full year 2009 revenues by almost 4% and adjusted OIBDA by almost 5%, demonstrating the resilience of our business, our financial discipline and our focus on balancing ARPU and subscriber net adds.
We also reduced our capital intensity while still investing in our fast growing commercial services business. Full year CapEx as a percentage of revenues was down 240 basis points from last year. This decline coupled with our adjusted OIBDA growth resulted in adjusted OIBDA less CapEx growth of almost 22%, exceeding our full-year guidance. We generated record full-year free cash flow of over $1.9 billion and diluted EPS of $3.05 per share, slightly ahead of what we projected at the start of the year.
With our very healthy free cash flow we de-levered rapidly following payment of our special dividend in March and we ended the year with a leverage ratio of 3.3 times and as Glenn discussed given our reduced leverage and our ability to generate free cash flow we have started returning capital to our shareholders through the initiation of a $1.60 per share annual dividend.
Before we turn to our results let’s turn to slide four and I will spend a minute on the dividend. First, I want to say I am really excited to have reached this significant milestone and to have done so less than a year after taking on an incremental $10.9 billion in debt to finance our special dividend. In the intervening months we did a lot of research which included talking with many of you about your views on returning capital. Our dividend announcement today incorporates key elements of what we heard.
First, we heard that we should make the dividend meaningful. Our initial dividend yield is higher than our cable peers and higher than the average of S&P 500 companies that pay a dividend. I think it is significant that very few companies initiated a dividend with a yield that is 83%.
Second, we heard it is important to increase the dividend over time. While it is premature to talk about future increases it is clear that our dividend payout ratio leaves us flexibility to do just that.
Third, we heard we should retain adequate liquidity for other initiatives. Our dividend provides us with the flexibility to invest in organic growth as well as consider strategic acquisitions and additional means of returning capital to shareholders over time.
With that let’s turn to our results starting with subscriber trends on the next slide. During the fourth quarter we added 101,000 primary service units to end the year with 26.4 million PSUs. As a reminder that includes both residential and commercial PSUs. PSU connects continue to be much weaker than a year ago, offset in part by much lower disconnect as churn was down across the board.
Fourth quarter video subscriber trends improved with video subscribers declining by 105,000 compared to 119,000 lost in the fourth quarter of 2008. Fourth quarter digital video net adds of 56,000 also improved meaningfully year-over-year as did DVR net adds of 105,000. Once again, HSD was our best performing PSU category. We added 122,000 high speed data subscribers, an 8% increase over the 113,000 HSD subs we added in last year’s fourth quarter.
We finished the year with just under 9.3 million HSD subscribers. Our residential HSD subscriber mix continues to shift towards our premium tier products with Turbo accounting for almost 70% of our residential net adds in the quarter. That is the highest percentage in the last six quarters. At year-end Turbo subscribers represented about 11% of our residential HSD subscriber base.
Digital phone was the only PSU category for which net additions were down year-over-year in the fourth quarter. We did, however, add 84,000 subs as we continued to take share from the telcos. Total subscribers at year-end exceeded 4.2 million. While our customer relationships declined by 55,000 in the quarter we continued to increase the number of customers in bundles. We added 64,000 Triple Plays and 27,000 Double Plays. As a result, over 57% of our customers were in Double or Triple Play packages at year-end.
Let me briefly summarize our full-year subscriber results on slide six. I think it is important to remember that despite all of the very difficult economic news in 2009 we held our customer relationships pretty much flat and grew PSU by over 800,000 and RGUs by over one million. Digital phone subscribers increased nearly 12% and high speed data subscribers grew over 6%. Video subscribers declined by 210,000. That is more than the 104,000 we lost in 2008 despite the benefits of the DTV transition. However, we continue to grow our digital video and DVR subscriber base.
Before moving onto our financial results let me give you some color on what we are seeing early in 2010. In aggregate, year-to-date PSU net adds are well below year-ago levels. Net adds in all three residential PSU categories are off last year’s pace. This is not unexpected. While there are some signs the economy is set to recover, unemployment and vacancy rates in our footprint continue to be much higher than they were in the year-ago period. On a positive note, commercial PSU adds have actually been somewhat higher than last year.
Moving onto our financial results let’s start with revenues on the next slide. Full year revenues increased 3.9% or $668 million to $17.9 billion. Fourth quarter revenues of $4.5 billion grew 3% over the fourth quarter of 2008. During the fourth quarter subscription revenues increased just over 4%, reflecting a 3% year-over-year increase in primary service units and over a 1% improvement in subscription revenue per PSU.
Residential revenues grew over 3.5% while commercial revenues grew just over 14%. HSD subscribers growth drove a 7.5% increase in HSD revenues. Once again providing the largest contribution towards our subscription revenue growth. Voice revenues rose more than 11% also driven by subscriber growth partially offset by lower monthly ARPU and video revenues rose about 1.5% year-over-year driven by an increase in DVR revenues, price increases and an increase in digital video subscribers which were partially offset by a decline in video and premium channel subscribers and transactional video on demand revenues.
You will notice our trending schedules this quarter include a more detailed breakout of the components of video revenue which should help you better understand the drivers of our video revenue performance.
Let’s turn to our commercial operations on the next slide. We added 9,000 business class phone customers and 2,000 commercial HSD subs in the quarter. We closed deals with 67,000 commercial video phone subscribers and 184,000 voice lines. That is more than double the number of subs and lines we had at the end of 2008. At year-end we had 295,000 commercial HSD customers. Commercial revenue growth remains strong despite the weak economy growing just over 14% to $243 million in the fourth quarter and increasing nearly 15.5% to $915 million for the full year.
Our fourth quarter commercial revenue growth was driven by commercial data which grew 6.5%, business class phone revenues which doubled year-over-year and sub [backhaul] revenues which increased fivefold. During 2009 we restructured our commercial organization and staffed up our commercial sales force. As we said to you last quarter we expect these changes to reaccelerate our commercial revenue growth to north of 20% for 2010.
Flipping to the next slide, as we have been discussing all year ad revenue declines have been a drag on our overall revenue and adjusted OIBDA growth as well as our margins. Full year ad revenues were down nearly 22% versus 2008. In the fourth quarter ad revenues were once again significantly lower than the year-ago period, down about 17.5%. As you can see from the chart the trend is encouraging. Ad revenue grew 10% sequentially and the year-over-year decline in Q4 was the lowest of the year.
Moreover, more than 2/3 of the year-over-year decline in the fourth quarter was driven by lower political advertising. The remainder of the shortfall came from national sales so our local and regional sales which comprise the largest part of our business were actually relatively flat. Given the recent improvement in advertising trends and the anticipated benefit from political advertising in 2010 we expect advertising revenues to return to growth in 2010.
Turning to ARPU on slide 10. Fourth quarter subscription ARPU per customer relationship increased almost 5% to nearly $99 reflecting continued increases in bundle penetration and our pricing discipline. As I mentioned our subscription ARPU per PSU was up over 1% year-over-year in Q4 and has increased year-over-year for each of the last six quarters. Higher commercial contribution has certainly helped here as residential subscription ARPU per PSU was essentially flat in part reflecting a shift in our residential subscription revenue mix from higher ARPU video to lower ARPU HSD and voice.
Looking at product ARPUs, video ARPU increased nearly 4% from Q4 2008 driven primarily by price increases and higher penetration of digital video services including DVRs. Both residential and commercial video ARPUs improved. HSD ARPU grew over 1% versus Q4 2008 and increased year-over-year during each quarter of 2009. While the year-over-year growth in Q4 was primarily driven by increased revenues from commercial HSD, residential agency ARPU also improved. Digital phone ARPU declined just over 1% year-over-year. That is a continued improvement in the year-over-year trend.
Turning to adjusted OIBDA on the next slide. Full year adjusted OIBDA increased 4.7% to $6.5 billion as margins improved by 20 basis points. Fourth quarter adjusted OIBDA grew 3% year-over-year to $1.7 billion. Once again, the decline in our high margin advertising business was a drag on adjusted OIBDA growth and margins. Our focus on cost management yielded fourth quarter operating expenses growth of just 3% reflecting a 4.1% increase in cost of revenues and flat SG&A expenses.
Drilling down further on costs, programming expense, our largest cost category, increased just over 5% for the quarter and 6.5% for the full year as video and premium channel sub declines and lower VOD costs only partly offset contractual rate increases, incremental retrans costs and fees for new channel offerings. I know there is a great deal of interest in how our recent programming deals will affect 2010 programming expense. At this point our expectation is that 2010 programming cost growth will be modestly higher than in 2009.
Employee costs which represent almost 1/3 of our total OpEx grew almost 3% in Q4 2009 with almost all of the increase attributable to higher pension and medical expenses. Marketing expense of $155 million in the quarter increased 27% versus last year’s fourth quarter as we spread our marketing more evenly across the quarters this year. Full-year marketing spend was pretty much flat versus 2008.
Fourth quarter voice costs were up over 11.5% due to growth in digital phone subscribers. Bad debt expense for the quarter was down $40 million year-over-year. This decline was primarily due to improvements in collection efforts and the reduction in the allowance for capital accounts to reflect the quality of residential receivables at the end of the year. For the full year bad debt expense was less than 1% of revenues, down 30 basis points year-over-year.
Turning to capital spending on slide 12, our capital spending in the quarter was $944 million bringing our full-year CapEx to just over $3.2 billion, consistent with our guidance. Total CapEx as a percentage of revenues for the year was 18.1% versus 20.5% in 2008. For the full year we increased commercial capital spending about 60% year-over-year to $352 million. We increased commercial line extension CapEx which includes the capital we spent this year to grow our cell tower back haul business. We also spent more on scalable infrastructure to support some of our other commercial growth initiatives.
Residential capital spending was down approximately 13% versus 2008 with a decline in CPE CapEx, mostly lower HD DVR spending, accounting for nearly 90% of the full year reduction. Residential line extension and upgrade CapEx declined while scalable infrastructure and support capital spending increased primarily related to spending on capacity expansion initiatives to accommodate more HD channels and faster HSD speeds. Landel will talk about some of these initiatives in a moment. Looking forward to 2010 we expect that capital spending will be less than $3 billion.
Moving onto cash flow on slide 13, full year adjusted OIBDA less CapEx increased 21.7% year-over-year. In the year ahead we plan to grow adjusted OIBDA less CapEx in the mid-teen percent even as we incur on the order of $50 million in start up losses in conjunction with the continued rollout of our new wireless broadband business. We generated full-year free cash flow, a record, of $1.9 billion. Our full-year free cash flow increased 10.2% year-over-year despite significantly higher interest payments.
As you look out at your 2010 forecast remember that unless there is further economic stimulus legislation bonus depreciation will go away and in any event prior year depreciation benefits will reverse so cash taxes will be significantly higher this year.
Turning to the next slide, diluted earnings per share exceeded guidance at $3.05 for the full year 2009 compared with a diluted loss per share of $22.55 in 2008. Looking forward we expect 2010 full year diluted EPS will be in the $3.25 to $3.50 per share range.
Turning to the balance sheet on the last slide, at December 31st our net debt and preferred equity totaled $21.6 billion and our leverage ratio was 3.3 times. We remain on track to achieve our target leverage ratio of 3.25 times by the end of the first quarter even with our new dividend. During the quarter we continued to solidify our balance sheet, taking advantage of favorable market conditions to include short-term borrowings with attractive longer term [buys]. We have also continued to swap fixed interest for floating to improve our overall cost of borrowing. I am exceptionally pleased with what we have been able to accomplish this year to strengthen our balance sheet.
So, to summarize before I turn it over to Landel, we posted another quarter of revenue and adjusted OIBDA growth rounding out a year in which we generated very strong free cash flow despite the challenging environment, we strengthened our balance sheet further and we demonstrated our confidence in our long-term fundamentals by initiating a very meaningful dividend.
Thanks Rob. This morning I am going to take a couple of minutes to recap some of our key accomplishments in 2009 before turning to an overview of the important work ahead in 2010.
Operationally we made a lot of progress last year in a very difficult environment. Let me share some of the highlights. First on the product front. We rolled out our own program guides which are now deployed on more than half of our digital set tops. We expanded the deployment of Start Over, now reaching 7 million households or about 80% of our digital video subscribers. Through our successful efforts to switch digital video and all digital conversions, a lot of our cities have north of 100 HD channels and our average is now 87 compared to 57 a year ago. We have made DOCSIS 3.0 technology a reality in New York City where our WiBand product is now available.
In marketing we expanded our enhanced store deployments in Best Buy and we heavied up our fourth quarter media spending in key cities and customer segments. In commercial we brought in new, seasoned management and we hired more than 240 sales professionals towards the end of the year which positions us well for 2010.
To summarize 2009 we made a lot of operations progress in a challenging environment and we made investments that will make us even stronger as we go forward.
Turning next to the competitive environment, as we enter 2010 we believe that we are well positioned competitively. Telcos have continued to expand their fiber based deployment and we estimate that AT&T’s U-verse product is now available to approximately 20% of our homes path and Verizon’s FiOS offering is available to 9%. This availability has increased in a relatively steady, predictable manner and we expect that by the end of 2010 the two will expand their respective fiber based offerings to cover between 38-40% of our [paths]. Verizon said they will complete their FiOS build in 2010 and AT&T in 2011.
These deployments in many cities have now passed their first and in some cases their second anniversary and as a result increasing numbers of telco video customers are coming off of their initial contract. This provides a significant opportunity for us to win back customers who mistakenly thought the grass might be greener over the telco fence, that is until the telcos dug up their yard. In fact, we have seen increasing numbers of win back in recent quarters and we intend to sharpen our focus on this opportunity in 2010.
One last point on telco competition. It appears that in our service area the footprint expansion has slowed but more importantly their video share growth is also slowing. We are also competing well against the satellite providers. Recent aggressive promotional activity, particularly from Dish, have continued but we believe we were successful in slowing subscriber migration in the fourth quarter with strong but balanced promotions and increased media spend.
Turning to 2010, we have aggressive operational objectives for the year ahead. We intend to further strengthen our products, sharpen our marketing and invest in key growth initiatives even as we reduce costs by further improving the efficiency of our operations. Beginning with our residential subscription business I want to highlight some of the changes we are driving in 2010.
First, we are redoubling our focus on our video products. In a number of cities we are going to carefully realign the digital video lineups where channels of like genre are grouped. We are also putting in place capabilities to accommodate as many as 150-200 HD channels in most of our systems by the end of the year. We are able to do this in large part due to the success of our switch digital video deployment.
This year we will effectively complete our company-wide deployment by installing switches in L.A., Dallas and New York City. Our network DVR Based Start Over product has been a tremendous success with customers. Now that it is broadly available we are turning our focus to Look Back to extend the availability window to 72 hours after a program has aired. We now have look back rights at 87 networks and we are planning to launch in additional cities this year. In addition to enhancements to our network DVR products we are excited about our multi-room DVR product which we will also introduce later in 2010.
Next turning to high speed data. The early experience with our DOCSIS 3.0 enabled WiBand service has been very positive. In its first quarter of availability in New York City it generated 2,000 net additions. More than 1/3 of these were commercial customers. Not surprisingly roughly 9 of 10 new residential WiBand subscribers were existing Time Warner Cable subscribers who upgraded their service. In 2010 we plan to make our WiBand product available in additional cities. As I have mentioned in the past our deployment will be surgical, focusing on those areas which we need higher speeds than our existing Turbo product provides and to the extent that we identify broader needs we can expand our deployments.
In phone our net adds declined pretty sharply over the past year as competition from wireless continues. Despite the challenging environment we believe we have substantial opportunity in phone so this month we embarked on a plan to recharge our digital phone product. Our approach has three key elements; First, we are focusing internally on driving better performance of our sales channel through training, coaching and most importantly incentives. We launched a similar program in the Carolinas a couple of quarters ago with strong results.
Second, we will adjust the positioning of digital phone to customers and we will introduce more differentiation. You will hear more about this as the year progresses.
Third, we are focused on segmentation. Our analysis indicates that certain of our large and profitable customer segments continue to hold substantial untapped opportunity. We also plan to launch our new phone manager product beginning in the second quarter of 2010. In addition to enabling our customers to manage their accounts and features to which they subscribe, our new portal will provide viewable voice mail and caller ID on the PC. This is really cool stuff.
We are off to a good start with our new wireless broadband product, Roadrunner Mobile. As our product launched in Dallas and parts of the Carolinas in December we have added more than 1,000 subs and in recent weeks we have launched the service in San Antonio and Hawaii. As you would expect most of our Roadrunner Mobile subs were existing Time Warner Cable customers. So far around 2/3 have taken the unlimited 4G service and most of the rest have taken the nationwide 4G/3G plan. We are encouraged that almost 20% of new wireless customers also added one or more additional Time Warner Cable products.
We expect to launch Roadrunner Mobile in a sizeable fraction of our footprint in 2010. As a result we expect a pretty substantial expenses especially related to marketing and device activation. We are willing to make a significant investment at the start of the year because we believe that wireless broadband could become a meaningful part of our business down the road.
In commercial, we hit the ground running in 2010 after spending much of 2009 hiring and training new members of the team. We ended 2009 with approximately 2,500 employees, an increase of more than 500 during the year and we expect to drive commercial revenue growth above 20% in 2010.
In advertising we are seeing positive signs as Rob mentioned. During last year’s downturn we focused on metrics and more importantly share gain. We think the investment in May to enable us to come back even stronger this year. Another component of the opportunity here is advanced advertising. We expect o continue to make steady progress in 2010 with a focus on interactivity.
The first set is implementation of [EBID] which is a set of standards underlying interactive applications. We currently have around 900,000 [EBID] enabled set tops in New York City alone and we expect to have approximately 7 million deployed in our system by the end of 2010. In addition to our own use, [EBID] enabled set tops are also critical to Canoe’s success. Canoe’s first ITV advertising product will be a request for information application which will allow viewers a 30 second spot to use their remote control to request advertiser special offers like coupons or product sample via mail.
Canoe is currently testing this product with several network partners and they are on track for commercial launch this spring.
Turning now to marketing. We upgraded media spending in the fourth quarter using a marketing resource allocation model and now govern how and where we place media. We will use these models in 2010 to better allocate our media on a consolidated, enterprise wide basis. We will also continue our successful competitive advertising campaign in 2010. We believe our message continues to keep the competitors at bay as we go directly to the competitor’s weaknesses.
We went to school on pricing in late 2009 and we think the rate increases we have undertaken are a more strategic, smart review of management. In addition, we have created a longer term enterprise live pricing architecture and by the end of the year all areas will have standardized pricing and promotional approaches. We think this more centralized approach combined with increased use of segmentation and targeting of high volume customers will also improve yield management.
One last point on marketing, all of our continuing improvements are in the context of balancing share, ARPU and profitability. We are always focused on improving the efficiency of our operation and in 2010 we will continue to put a lot of energy into cost management. It is a little early but we think restructuring expense in 2010 may be anywhere from $25-50 million. We will update you on this later in the year as we have further estimates.
Let’s give you three examples of our cost management initiatives this year. First, we are planning to further consolidate some sub-scale calls. While our satisfaction scores have been climbing and we feel our service levels are good we think there is a significant opportunity to find a more optimal spread inside of the call centers. In 2010 , we will work to consolidate centers where it makes sense and virtualize calls across more markets to load balance and reduce cost of service.
Second, we have embarked on a concentrated effort to streamline our procurement processes by leveraging our nationwide scale. Third, we have launched an initiative we call Go it Alone in which we will transition certain digital phone support functions away from Sprint. The transition will improve our economics but it will take several years to complete.
In summary, we made great progress on the operational front in 2009 even while making some investments that we expect will benefit us in the years ahead. In 2010 we have an aggressive agenda to further improve our products and marketing and we plan to expand our investments in commercial and wireless broadband. All of this is targeted at making Time Warner Cable more competitive so we can drive more growth and more profitability.
Thank you. With that I will turn it over to Tom for the Q&A portion of the call.
Operator we are ready for the Q&A portion of the conference call. As we are a little bit short on time, we would ask each caller to ask please just a single question so that we can accommodate as many callers as possible. First question please?
Question and Answer Session
(Operator Instructions) The first question comes from the line of Craig Moffett - Sanford C. Bernstein.
Craig Moffett - Sanford C. Bernstein
I wonder if I can just ask a question about the dividend and the cash return for a minute. You have been fairly clear Rob in talking about a targeted net debt ratio of 3.25. That would obviously imply the cash payout would have to be in excess of what you just announced for the dividend. Can you talk about how you square that circle? I know Glenn mentioned strategic acquisitions but I wonder if you could just comment a bit more on that?
Let me jump in. I think that you actually made most of the points. We have been pretty consistent. As you know we have an ongoing dialogue with all of our owners, at least certainly our largest ones. What they have been expressing is very consistent with what we are doing. First they are saying they like the capital structure with the 3.25 times target, things like an appropriate kind of leverage that keeps us investment grade and recognize that is just a target so we are probably not going to be exactly that. We could be a little more or a little less over time. It is hard to hit it exactly.
Second we are hearing make sure you are investing enough in the business where you get a good return and keep the business healthy. Third, to the extent there is excess capital return it. We have had a lot of dialogue about the preferred form of the returning money because there is obviously different techniques. Although we hear different things from different people I think there was a strong consensus that starting with a meaningful dividend was a good idea. That is what we have done and we think we have made quite a statement with the size of the dividend. As I said in my prepared remarks the yield is significant compared to what others have done in the S&P 500. So that gets to your question which is really if nothing were to change and we weren’t to make any more investments over time we would further de-lever.
I would say it is our intent to stick to what I just said. So 3.25 is kind of our North Star target. We do want to make sure we have invested the right amount of money in the business and the business environment remains uncertain, particularly tax laws and policies. Rob talked about the meaning of the deprecation on the free cash flow. We want to start with this big dividend and then we want to explore organic growth, perhaps some small investments in and around our business and over time if we keep de-levering then we will look at additional ways to return capital.
Craig Moffett - Sanford C. Bernstein
Is there some parameter you would have around how much you would de-lever? Not to be dense but obviously the math would say that as long as EBITDA is growing that means you have to be paying out essentially all of your cash flow to keep from de-levering, right?
I understand. I think it would be not a good idea for me to put out the particular set or parameters around that. Rest assured the 3.25 is our long-term target.
The next question comes from the line of Jessica Reif-Cohen - Merrill Lynch.
Jessica Reif-Cohen - Merrill Lynch
You have your Get Tough or Rollover campaign and I just want to know you have had these recent negotiations. How would you rate yourselves? Did you get tough and did anybody roll over and could you just talk about the outlook? I think we all have a handle on 2010. Can you talk about 2011 and 2012? With more cable network negotiations [for] retrans coming up with some of the networks?
Let me deal with the overall and then have Rob jump in. The Get Tough or Rollover campaign really had two purposes. One was to better educate consumers about how all this works. Secondly to start a dialogue with consumers to hear back from them about what they thought. I think that one thing we have learned which maybe we all should have known but we are so close to the business, consumers really don’t understand how this business works. They don’t understand that the fees they pay us go in part for us to buy programming. In fact as recently as yesterday I had somebody sort of down on the street tell me he thought we just owned all the channels.
So I think that education effort was well worthwhile. I think in a broader sense we said this at conferences, we heard from consumers’ frustration about the size of the package and perhaps desire for more choice. Everybody on this call knows that going to full ala carte is completely impractical. It is impractical for the program economics. Just think about doing an installation call, trying to take a customer through hundreds of channels, describe each one, do you want it or do you not want it, clearly that doesn’t make any sense. But I think if this industry and the programmers work towards an environment where we offer more variety of packages, some of which might be slightly smaller, I think that might be consumer friendly and I think we would be in better shape as an industry including programmers.
Beyond that I think the retrans process is clearly broken. We are hearing that from public officials. The rules around this date largely back to 1992, the Telecom Act, when the world was a lot different than it is now. 18 years is a long time. I think the idea that consumers are being held hostage, there is a threat signals are going to be pulled off and these things happen at 3 a.m. on New Year’s eve, that is not a good consumer thing for anybody. It is not a great mechanism. I think we need to reform how negotiations work. That is not to say there shouldn’t be payments. I am just saying the way you arrive at the payment. This isn’t working for consumers which means it is not really working for the broader industry. So having said that, Rob can you talk about specifics?
I am not going to go into too much detail on the recent programming deals we did and whether we got tough or rolled over is somewhat in the eye of the beholder I guess. What I will say is that I mentioned in my prepared remarks is that our expectation that programming cost growth in 2010 will be largely higher than what it was in 2009 and certainly the results of the most recent deals are baked into that estimate. As for 2011 and 2012, you know how many moving parts and meaningful deals there are that remain to get done over that time horizon it is very hard for us to make any real meaningful projections at this point.
The next question comes from the line of Ben Swinburne - Morgan Stanley.
Ben Swinburne - Morgan Stanley
If I could just quickly go back to some of the guidance numbers and then I have sort of a bigger picture for Glenn, the EBITDA less CapEx guidance suggests I think something around mid single digit EBITDA growth, maybe even a little less. The earnings number was a little bit lower than I thought. Is there any comments you can make on D&A or tax rate we should know or think about versus 2009 that would help. Glenn, as you think about the data business and what is going on in Washington with net neutrality and the bid for Comcast case, how do you see all that playing out? How would you like it to play out? What is the upside case for Time Warner Cable sometime in the next six months or so if we can be back to usage based billing, or caps and charging for overage, etc. How do you think about that at this point?
No meaningful changes on tax rate for 2010. D&A is in fact up somewhat.
On the net neutrality question, I think I won’t comment on the Comcast case because an awful lot has been written about that and I don’t really know anything more than what everybody else knows looking at the trial.
On net neutrality I think everyone knows the FCC has a proceeding on net neutrality. Net neutrality was part of the administrations platform during the last election. Having said that I think net neutrality has become a grab bag for a large number of issues that maybe don’t relate to whatever net neutrality originally started out to be. Having said that, I think the FCC has promised to [welcome] a process in which they are open and seeking different ideas and seeking construction input and will make a rational set of decisions.
So far that is what we are seeing and we are actively participating in that process. We think we have a really good dialogue going not only at our company but the industry. So there has been a normal process of filing comments as we and many others have done. There will be reply comments. This will play out over many months but I think the process is very healthy at this point.
Ben Swinburne - Morgan Stanley
Do you think you can get to a point where you are potentially charging application providers, YouTube or other folks who are looking for priority access as a way to monetize the network which is in contrast to the current motto where effectively the consumer is paying that bill?
I don’t know. That really is the issue that originally net neutrality was about. There are a bunch of people who would be against that.
The next question comes from the line of Vijay Jayant – Barclay’s Capital.
Vijay Jayant – Barclay’s Capital
Keeping the same theme, there has obviously been a lot of discussion about Apple attempting to secure content from cable network operators and potentially taking a much smaller gross margin on regular programming than you probably get. They don’t really need to support a network given their platform. Do you have deals with your content providers that provide any protection from anything like that happening? Is there a risk? Obviously this is pretty topical right now on letting this new franchise in from that [kind] of a thing.
Without getting into too much detail on any particular contract it obviously varies from programmer to programmer but we are always very focused on trying to maximize the value to our customers what it is we are paying fees for and that includes imposing limitations on the programmer’s ability to exploit the content in ways that undercut that business model.
The next question comes from the line of Mike McCormick – JP Morgan.
Mike McCormick – JP Morgan
Could you give us a sense for, I know you talked about some of the initiatives for 2010, but what you are seeing in commercial services revenue. It has slowed growth in the last couple of quarters. Obviously the economy continues to weigh. What do you think from a demand standpoint and was there any seasonality?
First of all I am really happy with the growth roughly of 14% in the fourth quarter and 15.5% for the year particularly in the face of what you mentioned; a tough economic environment out there. Remember our sweet spot is the small businesses, actually very small businesses, who have been particularly hard hit by the economy. We have seen some increase in churn on that front. Having said that, as we indicated in our prepared remarks we are going to increase the growth rate to north of 20% next year and I am happy to say as I look at the tail end of the fourth quarter moving into the first I am seeing my revenue growth improve. So actually when I look at this business I pay attention to sub but I pay more attention to my revenue growth month in and month out, quarter-over-quarter and I am seeing positive trends there.
Mike McCormick – JP Morgan
Is that demand driven or something on your part?
I think right now it is probably more stuff on our part. Again, as we indicated, the economic factors out there are really mixed right now. We are not seeing a lot of improvement on Main Street. Our improvement right now is what we are doing. Focusing on the sales channel which we indicated before hiring of sales professionals was up. In the fourth quarter they were primarily trained to be honest with you. As I move into the first they are on the ground selling product. So a lot of that is coming out of what we are doing.
Mike McCormick – JP Morgan
From a competitive standpoint who do you run into most often?
We compete with everybody out there. My primary competition though is the [items].
The next question comes from the line of Tuna Amobi – Standard and Poor’s Equity Group.
Tuna Amobi – Standard and Poor’s Equity Group
First on your web online connect is it still true the website and online partners is still a growing portion of your growth connect and if you can quantify that it would be helpful. Secondly, Glenn I thought your recent comments on vertical integration in the context of the Comcast deal I think you couched that in terms of risk avoidance which was quite interesting. So guess the question there is do you feel laws and regulations are conducive for a lot of kinds of mergers and if so would you consider going after a target like Charter partially or in whole?
On the online I am not going to give you an exact breakdown but let me tell you what we are doing and our strategy around this. It is becoming a bigger portion of our sales channel activity. If you look forward, during 2009 and late 2008 our focus was primarily on using retailers. So outsourcing some of that to drive growth through selling online. As we moved through the year especially towards the end of the year and moving into 2010 a big focus on Timewarnercable.com. So investment in that product to move more and more of the sales back to our online environment which is cheaper, but not totally turning down retailers.
We think there is a good mix there. We actually want both. We don’t see cannibalization. We actually think putting emphasis on both drives the sales across the channel. So what you are seeing us do strategically is move more of the activity to our online environment, Timewarnercable.com, but still using outside retailers.
Tuna Amobi – Standard and Poor’s Equity Group
So it is safe to say the economics are comparable right?
Actually I think the economics are a little bit better in our favor when we move inside.
Actually I think your question to me really had two parts. First was my comment on vertical integration. Obviously I am not going to talk about the Comcast deal. They need to talk about that and their motivation. I think I have made in the past some comments about what happened when we put Time and Warner together which was many, many years ago. Back I think in 1990 and the deal was made obviously the year or so leading up to that. So different era. 20 years ago. At that time we had a theory that by being vertically integrated by having a studio, by having networks and by having cable distribution that as the world changed and it continues to change the relative profitability in those segments might change and we would have everything and we would be fine. That indeed turned out to be the case even though there were no particular operating synergies between the pieces.
We also discovered over time that not only couldn’t we lose in a sense but we could also never win because Time Warner had other businesses to but there was also some part of the company that was not doing well and some parts that were doing quite well and investors tended to focus on the part that wasn’t doing well. So I think Time Warner can speak for itself but I think in part that is what has led to the various spinoffs that you have seen and what is obviously a different company today than it was.
I don’t know that any of that necessarily by looking at Comcast/NBC. They have to talk for themselves. More broadly on M&A, I think that we have been pretty consistent on this. We will consider looking at acquisitions in our space, nothing that is too far from our space. We are going to do it in a disciplined way meaning we are here to earn returns for our shareholders. If there are things we think we can bring value to where we think we can make money for our shareholders we will pursue that but we don’t feel we have to acquire things just to do it.
The next question comes from the line of Spencer Wang - Credit Suisse.
Spencer Wang - Credit Suisse
This question is probably for Rob. You had good margin expansion in 2009 and it seems like your 2010 guidance or the inference is the margins could continue to expand with programming cost increases offset by some of the efficiency stuff that Landel referenced and maybe an improvement in advertising. I just wanted to confirm that is kind of how you are seeing directionally margins go in 2010?
I am thinking margins are flattish. I think that is the same thing I said to you last year at this time when you asked the question. Maybe even slightly down a bit. Let me just give you the drivers so you can get a flavor for what is going on here. Our residential subscription revenue mix continues to shift in the direction of higher margin businesses meaning more HSD and phone relative to video. That is actually a benefit to margins. Our overall subscription revenue mix continues to shift towards commercial which is higher margin, that is another good guy. Then we have got the return to growth of our high margin ad business. All of those things should help and when you layer on top of that some of the initiatives Landel discussed. Those are all helpers.
On the other side, we have this continual issue we talked about a lot which is margin compression on the video side and the new piece to the puzzle is we are going to invest a bunch of money this year and what I suggest is that something on the order of $50 million that shows up as operating expense in the rollout of Roadrunner Mobile, our wireless broadband offering. When you roll all those things together I think they more or less offset one another and we are probably in the flat to maybe a slight bit down realm.
The next question comes from the line of Doug Mitchelson – Deutsche Bank.
Doug Mitchelson – Deutsche Bank
A question and a clarification. On the clarification side you said D&A was up and if I remember from last year’s 10-K amortization would be down. Why would depreciation and D&A combined be up with amortization down? Why would tax rate be flat because amortization is down that would suggest tax rate could come down a little bit. So that is a clarification. Then for either Landel or Glenn, just interested more in the wireless side. Obviously you have the big change this year. I know it is early days but can you size the opportunity for broadband wireless or where you expect you want to be in a few years? What would you define as success in wireless and in conjunction with that do you need to offer wireless voice service to be successful and what does that technology path look like?
You have got it pretty much right. Amortization will be down. Depreciation will be up. The net of the two will be up. As for your question on tax rate we are talking about rounding. The tax rate will be essentially the same. The move you are talking about doesn’t move the dial.
On wireless I think there is really two points to make. You have probably heard me say this before. The first is that I don’t believe networks of the future are going to be either wireless or wire line. I think the networks of the future are hybrid networks where similar products are going to be offered to a whole variety of different devices before are talked about publicly. So wireless delivery has certain features for certain devices and wire line for other ones. In particular because spectrum is ultimately limited I think that needs to be brought through carefully and the traffic dumped into wires probably as quickly as possible.
If you look at some of the problems people are having with iPhones I think that speaks to that. Within that context I think what we are doing with Clearwire is really just the beginning. The network is being built. We are selling a relatively simple product. It is just air cards for PCs. I think within the context of the [ease] this will develop in exciting ways we really can’t imagine today but I think there is going to be a whole array of products using these hybrid networks in the future. So this is the very early beginning and I don’t know how to size the opportunity because I don’t think any of us really and fully imagine what the products are going to be but it is an exciting opportunity.
As to voice, we have the capability of creating a voice product. We are working with both Clearwire and Sprint on that. Having said that I think there are plenty of voice providers out there today in the cellular business and there doesn’t appear to be a crying demand for another one nor does it appear that we really need that in our product portfolio. We have the capability if we actually need it. Right now I don’t think we do.
Thank you operator. Thanks everyone for joining us. Have a great day.
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