Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

EchoStar Communications (DISH)

Q3 2006 Earnings Call

November 7, 2006 12:00 pm ET

Executives

Jason Kiser - Treasurer

David Moskowitz - SVP, General Counsel

Charlie Ergen - Chairman and Chief Executive Officer

Carl Vogel - President

Bernie Han- CFO

Analysts

Michael Pace - JP Morgan

Brian Kraft – Credit Suisse

Jason Bazinet - Citigroup

Doug Mitchelson – Deutsche Bank

Todd Chanko - Jupiter Research

Michael Harkins - Levy Harkins

Lale Topcuoglu - Goldman Sachs

Matthew Harrigan - Janco Partners

Jeff Wlodarczak - Wachovia

Vijay Jayant – Lehman Brothers

Doug Shapiro - Banc of America Securities

Spencer Wang - Bear Stearns

Presentation

Operator

I would like to welcome everyone to the EchoStar quarter three earnings conference call. (Operator Instructions) I'll now turn the call over to Mr. Jason Kiser, Treasurer of EchoStar Communications. Please go ahead, sir.

Jason Kiser

Thank you, operator. Thanks for joining us. My name is Jason Kiser, I'm the Treasurer here at EchoStar. I'm joined today by Charlie Ergen, our Chairman and CEO; Carl Vogel our President; David Moskowitz, our EVP and General Counsel, and for the first time, Bernie Han, our new CFO.

Let me give you a quick recap of the financial performance for the quarter before we open it up for some Q&A at the end. But before we get started, as most of you know, we do need to do our Safe Harbor disclosure. For that, I will turn it over to David.

David Moskowitz

Thanks Jason and good morning, everyone. Let me add my thanks to all of you for joining us. As you know, we do invite media to participate in listen-only mode in the call, so we ask the media not identify participants and their firms in their reports. We also don't allow audio taping of the conference call and we ask that you please respect that.

All statements we make during the call that aren’t statements of historical fact constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve known and unknown risks, uncertainties, and other factors that could cause our actual results to be materially different from historical results or from any future results expressed or implied by the forward-looking statements.

I'm not going to go through a list of all factors that could cause our actual results to differ. I'd ask that you take a look at the front of our 10-Q for a list of these factors. In addition, we may face other risks described from time to time in other reports we file with the SEC. All cautionary statements that we make during the call should be understood as being applicable to any forward-looking statements we make, wherever they appear. You should carefully consider the risks described in our reports and should not place undue reliance on any forward-looking statements we make. We assume no responsibility for updating any of our forward-looking statements.

Also note that during the call we will refer to certain non-GAAP measures, which are reconciled in our 10-Q or on our investor relations website. With that out of the way, I'll turn it back over to Jason.

Jason Kiser

Let's take a look at the quarter. Total revenue for the quarter was $2.47 billion, a slight increase over last quarter and 16% higher than the same period a year ago. Continued subscriber growth and higher average revenue per subscriber were the primary drivers of the increase.

From an EBITDA perspective, we generated $580 million during the quarter, a decrease of $34 million from last quarter but $68 million higher than the same period a year ago. Net income for the quarter came in at $140 million, a decrease of $29 million from last quarter and $69 million lower than the same period a year ago. We should note that the net income for Q3 of last year includes $73 million of a tax valuation allowance.

Basic earnings per share for the quarter were $0.31 compared to $0.38 last quarter and $0.46 for the same period last year. During the quarter, free cash flow was $181 million. This represents a $27 million increase from last quarter and $8 million lower than the same period a year ago. The decrease from last quarter resulted from an increase in purchases of property and equipment partially offset by an increase in net cash flows from operating activities.

Let's look at the DISH Network specifically. During the quarter we added 295,000 net new customers, ending the quarter with 12.755 million subscribers. Churn for the quarter was 1.76% compared to 1.70% in Q2 and 1.86% for the same period a year ago. During the quarter, our average revenue per subscriber was $62.86, an increase of $0.15 per sub over the second quarter and an increase of $4.99 for the same period a year ago.

The year-over-year increase in ARPU was driven by several items. While we had price increases in February, we also had smaller programming discounts during the quarter than we offered in our 2005 promotions. We had higher equipment rental fees resulting from increased penetration of our lease program. We continue to see increases in advanced set-top box households which show up as increased ARPU from the additional fees that we receive. The increased availability of channels in both standard and high definition helped to increase ARPU as well. Lastly, we're starting to see an impact on fees generated for our DISH home protection plan.

Subscriber-related margins decreased 51 basis points from Q2 and about 178 basis points from Q3 of last year. The decrease in sub-related margins from Q3 of last year was primarily driven by a couple of factors. First, there were lower programming margins, most of which was the result of a one-time vendor credit that had a positive impact on last year. We should point out that when looking at comps versus last year, the $35 million credit in Q3 of '05 provided for approximately 165 basis points of nonrecurring benefits margins in that period.

However, we did have higher refurbishment and repair costs for returned receivers associated with increased penetration of our lease program and higher costs from the expansion of our in-home service and call center operations to support subscriber growth and improve service levels.

As we mentioned last quarter, our SAC calculation no longer includes certain benefits from our lease program. Instead, these benefits will be separately discussed and all prior periods SAC amounts have been revised to conform to the current calculation. During the third quarter, subscriber acquisition costs plus equipment capitalized under our new subscriber lease program decreased $9 per add from the same period a year ago.

For the quarter, we averaged approximately $688 per gross addition compared to $683 for Q2 and $697 for the same period a year ago. The decrease in SAC from Q3 of last year was primarily driven by several factors. First, we experienced reduced hardware costs. We also had fewer receivers per installation due to the use of more dual receivers. We were also able to redeploy more equipment returned by disconnecting lease subscribers. Lastly, we experienced a reduction in accessory costs related to the introduction of less costly installation technology and our migration away from relatively expensive and complex Super DISH installation.

Separately, the benefit of payments we received in connection with equipment not returned to us from the disconnected lease subscribers and returned equipment that is made available for sale rather than being redeployed was $29 million for Q3 compared to $30 million in Q2 and $25 million for the same period last year.

We will take a quick look at the balance sheet. At the end of the quarter, we had approximately $7 billion in debt. We also ended the quarter with cash and marketable securities of $2.8 billion, which excludes $197 million of restricted cash and marketable securities. On a total debt per subscriber basis, we ended the quarter at $547 per subscriber. On a net debt basis, that drops to $328 per sub.

Capital expenditures in the quarter were $377 million with about $267 million of that amount going for all capitalized leased equipment and the remaining $110 million for satellite and general corporate CapEx. That's everything on the numbers. So with that, operator, we will take questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Michael Pace - JP Morgan.

Michael Pace - JP Morgan

Thanks. First question is, I'm just wondering if you can make some comments on given that the competitive environment is obviously changing, cable triple plays have been rolling out more and more over the course of 2006, I'm wondering if you can comment on any changes to the quality of the subscribers that you're getting comparing to maybe 12 months ago and maybe even 24 months ago? What internal metrics do you use to judge that?

Charlie Ergen

This is Charlie. I would say, in general, there hasn't been much change to the subscribers that we're getting. It's been fairly consistent. I think that's backed up by fairly consistent churn ratios for us in the last four or five years. We certainly, perhaps on the high end with HDTV and more advance services we do perhaps get more than our fair share, versus cable system. But I haven't seen perhaps as much impact from the triple play that we read about every day yet. Obviously that's a factor and obviously it's something we've got to keep our eye on, certainly a competitive force in the marketplace.

The many customers that decide they want high-speed broadband and they may get it from a phone company or a wireless company, they may get it from a cable company, but they want the best video with 100% digital, best quality, most high-definition television, most advanced DVRs and they tend to look at satellite. I think we get our fair share of the best customers.

Operator

Your next question comes from Brian Kraft – Credit Suisse.

Brian Kraft – Credit Suisse

Thank you. Just wanted to find out what your latest thoughts are on the potential for an investment in a broadband entity. Is this something that's still much of a priority for you? If so, should we be thinking about it as more likely a minority equity investment or could it perhaps be something more substantial, something you take a larger stake in?

Carl Vogel

I think we continue as we've said in the past number of quarters to look at all opportunities that present themselves. We have announced that we're doing more with [Wild Blue] on a satellite broadband venture, and we have announced we're doing more with reselling DSL through our connected venture.

Our threshold is that we'll look at anything that makes sense as long as the economics make sense. We don't have a preference for owning a network or not. We want to make sure that whatever we invest in makes a lot of sense and that we can get an adequate return on our investment. And as Charlie indicated, we seemingly are doing fairly well holding our own in terms of gross and net connects, revenue per sub, et cetera.

We continue to look at broadband opportunities. We will make an announcement when we find something that makes sense. It could range anything from reselling as I commented earlier, to making an investment in a fairly large scale if we find something that makes sense.

Operator

Your next question comes from Jason Bazinet - Citigroup.

Jason Bazinet - Citigroup

Thanks so much. One quick question, I guess in terms of earnings and economic return on whatever business you enter. Can you just remind us again, in terms of offering some sort of -- for lack of a better word, a Vonage type phone offering -- why that doesn't make sense from your perspective? Given that there's nothing embedded in your equity for that sort of revenue stream today and you could offer it at a deeper discount to the cable guys and potentially reaccelerate your video net ads. What doesn't make sense about that logic?

Carl Vogel

Again, I don't think we're having any problem with our gross to net video adds, we haven't been presented an economic model where we think we can get an adequate return on the net incremental profit from reselling anybody else's product. With respect to Vonage specifically, I think we're more focused on having a broadband data product. If the consumer wants to select those VoIP products, they can do whatever they want as a consumer. But we haven't seen any model that makes the resale economics particularly compelling to us at this point. And we haven't seen a tremendous amount of demand out of our subscriber base for a VoIP product. I could see why that would be very good for Vonage, but we haven't seen an economic model that makes sense to us.

Charlie Ergen

Just to follow-up on that. I think that there is a point to your question in the sense that we have the opportunity for brand extension with customers, if they like us and like the video service that we provide them there are other things we can certainly sell them in the future. Having said that, we don't want to defocus on our core business and certainly our priority has to be to our core video business, which is fairly robust. In terms of gross adds, it was certainly the most we've done in a quarter for a long time.

There's an opportunity there, it's just, when you spend a dollar there, you don't make as much return as we do on going out and getting a video subscriber today. You focus where you make the best return. I don't think we lose sight of what you're saying. I think we're looking at those kinds of things if we have the availability to have a brand extension.

One of the things you have to do if you look at that is you better be really good at your customer service to begin with. That's an area where we slipped a little bit in the last couple of years and where we've made a bigger investment in customer service and you see that a little bit in the margin this quarter. We opened up a new call center, a domestic in the United States call center in Texas. Those are never very efficient when you first open them up, but it puts us in a better position to take care of our customers. We spend a lot of money in our installation service side of our organization in terms of training and making sure we do a better job.

We've got work to do on customer service. We're not rated number one in every poll like we used to be. If you do have great customer service, then you can do the kind of things you're talking about.

Jason Bazinet - Citigroup

If I could just follow-up. I agree the near-term metrics are right, but I think what has The Street a little bit concerned is they're looking at Cablevision’s video net adds now that they're well along with their phone deployment, and they are guiding at a growth rate that is faster than the industry's category growth. If you take that and as all the other cable operators roll out phone and you augment it with your partners on the telco side becoming your competitors, there's this nagging sense that things could get pretty nasty pretty quickly in spite of your robust quarter this quarter.

Am I hearing that there's not a sense of urgency strategically to do something that's more pervasive than just a video offer as long as your near term metrics are robust?

Carl Vogel

No, we're very active. I've said this on every quarter. We look at every opportunity we can to make brand extensions to the DISH Network platform and leverage our operating overhead. It isn't any necessarily sense of urgency. I don't particularly buy into the fact that Cablevision is the benchmark for EchoStar nor the benchmark for the industry having run a cable company myself in the past. I think Cablevision has a very unique set of demographics, a very unique market footprint, and very unique elements of scale in terms of density, in terms of what they already have from a backbone standpoint and they have been very, very successful with a very aggressive model with great demographics. We don't do well in New York, we don't even carry the S-network.

But in terms of our telco partners, I believe AT&T has said that their telco opportunity, where they are going to build a UVerse product is about half the footprint. That leaves the other half of the footprint available for a combined home zone EchoStar footprint product and I believe that represents somewhere in the neighborhood of 18 million homes. So it's not that we don't have any sense of urgency and it's not that we're not looking at strategic investments that make sense. But if we're reselling a product that has a retail value of $19 and we're getting half that profit at best, the economics just don't work if there's a lot of call volume and there's no quality of service and everything else.

So we are looking at resale opportunities that make sense, as I indicated with respect to our Get Connected program. We're aggressively looking at broadband opportunities that may be on our own, where we make our own investment in the network. We went to the auction, we've been very active in looking at opportunities. It's not that we're breaking our arms, patting ourselves on the back for a good quarter and forgetting about the future. We're very aggressive in those areas and we see opportunity in those areas, but we're going to do something that makes sense economically.

Jason Bazinet - Citigroup

Okay. That's very helpful, thank you.

Operator

Your next question comes from Doug Mitchelson – Deutsche Bank.

Doug Mitchelson – Deutsche Bank

Thanks. Hello gentlemen, a variety of questions today. The Home Zone set-top box, could you tell us how it performed in the test markets? Would you expect out of the Home Zone product to increase the pace of growth initiatives from AT&T?

Carl Vogel

I think you'd have to ask AT&T that. They are just rolling out in the test markets and the current Home Zone product is an MPEG3 product, because we think the kind of customer that wants Home Zone is going to be a higher-end customer. We think that our focus at EchoStar is to make sure that product gets transitioned into the MPEG4 product that we're doing for all of our HD customers today. I think the test market is going to reveal a lot in terms of potential demand and I'm sure AT&T will give you some guidance and discussion of that.

Internally, I can just say we're very optimistic about that type of product as long as it has the feature set that we think it needs, which the one it's lacking today is MPEG4. That is part of what we're working with Home Zone folks from an engineering perspective to make sure that's the kind of product that we envision is the one that's out there long-term. In the meantime, a lot of testing is going on, a lot of lessons learned. I think it's like anything else we probably overestimate day one what it can do and probably underestimate what it will do a year or two from now.

Doug Mitchelson – Deutsche Bank

So AT&T in the press release didn't list EchoStar as contributing to the development of the Home Zone set-top box, but it sounds like you are. What's the involvement you have technology wise?

Carl Vogel

There is integration to use our operating system so it works with our satellite system, so we have been involved in the integration effort. I would say that the heavy lifting of it has been done by the Home Zone --

Charlie Ergen

Two Wire.

Carl Vogel

A company called Two Wire has done the heavy lifting of that particular development. We've been a bit more active on the MPEG4 implementation, although Two Wire and AT&T both are involved in that.

Doug Mitchelson – Deutsche Bank

I don't know if you can remind us, maybe it hasn’t been disclosed yet, but how does that work? When they issue a Home Zone box are you going to bear the burden of that cost? Do they bear the burden? Is it split somehow?

Carl Vogel

We're not disclosing any kind of split. It's not too distant from how we do it today with AT&T.

Doug Mitchelson – Deutsche Bank

On the 10-Q and Jason also mentioned implementation of a technology that is producing cost of accessories related to the lower cost of inflation. Can you tell us what technology you were referring to there?

Jason Kiser

That's the Dish Pro Plus technology whereby we don't have to penetrate the house with two wires. We only have to penetrate it with one.

Carl Vogel

We developed some technology really that's fairly complicated when you're looking at three satellites in terms of switching and in terms of wires, we come to the house and we have developed technology with the help of others that allow us to come in, at least from an installation point of view, once the dish is installed outside, everything else is relatively simple to come in.

I guess the other piece of that is that we've also simplified. We've gone to high-powered satellites with the 129 degree location and not doing as much with the medium-power satellite today which caused a larger dish. Any time you have a larger dish, you have service calls, wind loading, and added installation cost. So we’ve improved there.

Doug Mitchelson – Deutsche Bank

That leads into the dual tuner question. What percentage of installs these days are dual tuner installs?

Charlie Ergen

We don't disclose that, but one of the things that again, this is something we do different from anyone else in the industry. Again we don't get a lot of value for our engineering group. We have one of the most sophisticated digital engineering groups in the world today, that has developed some pretty amazing products.

One of thing is the dual tuner, which also allows you to watch and record, but it also allows you to go to another TV set in your house without paying an extra set-top box charge so that saves our customers $5 or $6 or $7 or $8 a month over what cable would charge you. Again, it hurts our ARPU a little bit, but when you add up the true cost of a triple play bundle and then you also look and say I want to buy video separate and I want to buy DSL separate, I want to buy voice separate, if you really do the math, many times DISH network will come out ahead of any of the promotional offers and certainly the long-term offers that are out there. I think ultimately customers are economic animals and once they do the math, you know, we're in pretty good shape.

One of the ways that we're able to save $5 to $8 over our competition is that dual tuner, for our customers.

Doug Mitchelson – Deutsche Bank

Two last questions I'll ask them at the same time at the risk of having Moskowitz have to give a laundry list of information here. Your previous press release you were working on a work around related to TiVo Pass? Is that still the case and how is that progressing?

The second question for you, Charlie, is how do you feel about the returns you're getting on your investment in new subscribers today? Do you think they're going to go up or down as you go forward?

Charlie Ergen

The second part I will answer first. The returns on new customer subscribers today is still the best place for us to invest. It's been fairly constant for the last 18 months. It's probably not what it was eight years ago. But still, by a large factor better than anything we can find to put our money today, and still a very good return compared to what most businesses get.

On the capital, I think if you look at our capital structure and look at return on capital we've done pretty well. TiVo, I guess I talked in general about TiVo, we've got certainly good news there in the sense that there's really two ways for us to make sure that TiVo is not an issue for us and of course today it is not an issue. All of the customers are using their DVRs, we are shipping DVRs, the court has mandated a stay and injunction from the district court. So our customers aren't impacted. The appeals court also said that we had a strong case --

Carl Vogel

Substantial case.

Charlie Ergen

Substantial case. They've already made one ruling that the court erred in not letting us present to the jury our non-infringement legal opinion. So we've already got that happening.

Of course, the other thing that's happened is the other part of your question is that TiVo during trial, did explain to the jury and the judge exactly how they believe their system works. You could logically look at the fact that if we have a set of world class digital engineers and we now totally understand how at least TiVo says their system works and they certainly under penalty of perjury have said how it works that certainly looking at alternative technology is something that we will and can and should look at. That obviously would have a long-term positive impact should we be able to design something that would give us an alternative technology and not impact the quality of our product. So that's one reason having an engineering organization is important.

I will point out that we are not accruing any kind of contingency for TiVo at this point. I think we stopped at the end of July.

Carl Vogel

The judge had awarded damages through July 31st. So we did accrue the full amount through July 31st. We've taken a look at it more recently and concluded that we are more likely than not that we will prevail on the appeal. Consequently, we precluded that we do not need to continue to accrue for any further damages with respect to TiVo, whether it be a per month fee per household or whether it be additional interest on the judgment. We're not accruing any additional amounts because of our conclusion.

Charlie Ergen

And I'll point out that we still have our own patent litigation against TiVo where we believe they violate the EchoStar DVR patent, the intellectual property we have. I might take this opportunity while we're talking about legal maybe talk about Distant Signal. Distant Signal litigation, where the news is not as good as on the TiVo side where we got reversed on the court of appeals. Even though we got a settlement with all of the broadcasters other than the Fox-owned and operated stations, the district court did not feel that they the ability to accept that offer. So we are under an injunction to turn off customers by December 1st, and you'll read in our disclosure that we have approximately 900,000 customers who may get at least one distant network signal from us.

So there's really two things there. One is obviously at this point the only entity that could save legal customers would be Congress. They are meeting in a special session November 13th and we certainly have been on Capitol Hill, and I believe we do have support to make sure that customers, legal customers, don’t lose network signals. Having said that, it's obviously an uphill fight in a lame duck session to pass something that would save those customers, but we certainly are going to try to do that.

Obviously the only real company that's against us on Capital Hill is Fox/DIRECTV. They have an understandable business reason why they would be against us. But we have obviously the fact that the broadcasters were willing to settle shows we had broad support there.

To put in context, I think we disclosed that we're taking in about $3 million of revenue a month in Distant Signals so it is not a huge revenue situation. The majority of those 900,000 customers do in fact already get local from us or have the ability to get local because we do it in 170 markets. I believe we're launching five more markets before December 1st. So we will be in 175 markets. So we're in about 96% of the households where people can receive their network signals from local.

Having said that, we obviously skew towards rural America and we still have 40 markets that we're not doing distant signals. There's some very complicated things in the law in terms of short markets where there's not all the broadcast stations in the local market. There's another 11 of those we do today. There's RV owners, and so it gets a bit complicated.

I think our attitude certainly, you know, on a balance it could increase churn and could increase some of our expenses to go out and offer antennas for customers that we'll put in for free for those customers and it could increase churn if customers decided to go to an alternative provider. We certainly will encourage customers to go to light line cable or an outdoor antenna.

Our attitude really is if we're not as competitive in some of those markets, then we've got to go get our customers somewhere else. Some of the energies we focused in those markets we'll focus someplace else. If somebody gets a customer from us in one of those markets, then we've got to go and get two of their customers from a different market. We're competitive and it's not acceptable for us as a management team to be talking about the fact that we have an excuse of why we might not have as good of subscriber count one month and we have to go out and be smart and focus our attention on where we do have advantages in the marketplace. There are significant advantages that we have in many parts of the market.

On the other hand, we hope Congress will look at that. These customers have done nothing wrong, they're legal customers. I think Congress has indicated they want competitive environment out there and they really want to do that. Congress has the ability to make sure those that customers are taken care of but we have to wait and see how it all turns out. Regardless of what Congress does, we're going to be out there fighting for our fair share of customers and if we lose any customers, we're going to fight to replace them.

Doug Mitchelson - Deutsche Bank

Thanks for all the time, gentlemen.

Operator

Your next question comes from Todd Chanko - Jupiter Research.

Todd Chanko - Jupiter Research

Yes, good morning. The past year has certainly been the year of portable video, dominated, of course, by Apple iPod. I was wondering if there are ways for you to capitalize on that phenomenon with your investments specifically in a pocket dish DVR and if you could talk a bit more about that.

Carl Vogel

Well, I think we certainly have an investment in Arcos, they are the dominant portable video provider in Europe. They're not as well versed here because Apple certainly is a very strong competitor. They have new products that they're bringing to the marketplace. We hoped to have them out for Christmas, but they've been delayed. We think those are formidable products.

When you talked about the earlier question about brand extension. We think there's some brand extension we can do with Arcos in terms of portable video because we think many of our customers who watch video in their house would like to take it with them. Certainly the programmers we need to work with to make sure everybody's comfortable with the security and everything else, and right now our biggest hold up there in being more aggressive there is just a better product from Arcos.

The operating system was a little bit hard to use, in our opinion. And we went in and worked with them on a new operating system and some new features that we think will be important that I guess you'll probably see at the CES show. We think that will be the product next year that has some potential.

Todd Chanko - Jupiter Research

Thank you.

Operator

Our next question comes from Michael Harkins - Levy Harkins.

Michael Harkins - Levy Harkins

Charlie, in London, BskyB for about 11 weeks has had a broadband product that seems to be satellite based or satellite download. What advantage do they have over you, and why can't EchoStar do something like that? What sort of costs would be incurred? Thanks.

Charlie Ergen

Again, I'm not all that familiar with what BskyB is doing but they did invest in a terrestrial wired network and what they may be doing is doing one way terrestrial and the second way, the return path, would be a satellite. Hughes did that years ago here and it wasn't very popular, and now it's probably even less attractive in the United States in my opinion because if you can do something via cable, you can do it two-way today. You don’t really need to -- there is a company in the United States that does it the way you describe it. They don't have a ton of subscribers.

So if you look at the engineering side of it, we think the best way to do it is probably if you had to pick a way to do it, you would probably do it terrestrial wireless, probably secondly you'd do terrestrial with a wire; and third, you would do it satellite, two way via satellite. The only reason you don't do it terrestrially wireless in the United States today is all the spectrum hasn’t really been consolidated and nobody has spent the tens of billions of CapEx to be able to do that. But you're starting to see muni WiFi and you are going to see people like Clear Wire and others that are certainly working at that.

Our focus today is, obviously, to do what we can do and that's work with people who have an infrastructure and let us piggyback on that and sell the product for them on a partnership basis and then of course with Wild Blue, we know that we have a fair number of subscribers who are outside the range of a terrestrial wireless product or outside the range of a wired product. So as Wild Blue launches a new satellite later this year and make that operational next year, they'll have more capacity to do some more there.

Again, we're not putting a big investment there. We don't get the kind of returns there that we would on our core video product. But to the extent that we can make a little bit of money there and satisfy a customer need and perhaps secure a customer from churn, possible churn, it makes some sense to us to do it.

We continue to evaluate all of the technologies in broadband and there are certainly going to be quantum leaps in broadband technology. It's unclear to me who is ultimately going to prevail there and whether billions of dollars in investments are going to get a return or whether billions of investment in satellites will get a return, or whether billions of dollars of investment in wired terrestrial will get returned. But I think we'll be as good as anybody at figuring that out.

Michael Harkins - Levy Harkins

Thanks, Charlie.

Operator

Your next question comes from Lale Topcuoglu - Goldman Sachs.

Lale Topcuoglu - Goldman Sachs

Hi, guys. Charlie, to the extent you can answer, where do you see the direction in terms of the profitability of your business? Obviously third quarter was great. And I'll be a little bit more direct about this question too. As a controlling shareholder, how would you evaluate a decision to either own 100% of this business or own it not at all? Is it just as simple as an economical calculation based on your ROI?

The second question I have is, obviously there's been a lot of news whether DIRECTV gets owned by Liberty or not. Would you expect the competition with DTV to get worse or don't expect much of a change should Liberty Media actually ends up owning DIRECTV?

Charlie Ergen

Well, I think the Liberty DIRECTV question, obviously the fact that DIRECTV at least is in play in the press is certainly on a slight margin probably positive for us because it certainly creates some anxiety in management and employees within DIRECTV. If you live in Los Angeles, are you still going to have a job? If you live in New York, are going to move it to Denver? Are you a Liberty guy or a News guy? And so forth and so on.

So I would hate to have to manage the day-to-day side of that because employees talk and gossip and worry. We're fortunate that we're able to chart a little bit steadier course as a company. Having said that, clearly there's probably nobody I respect more than the folks at News Corp and Liberty so they're equally formidable and equally smart. I would see no advantage, probably one way or the other if they decided to do something. Other than there's always a transition period where things are in flux and probably on the margin a slight advantage for us.

As far as our own company, you know, I look at it, we run the company for shareholders and that includes myself, but includes probably people on this call. We try to make sure that everybody's who's ever trusted us enough with one of their dollars, that they are going to get a return on that and that we are doing the right thing for them. We've shown in the past there's been two times where I've given up control to merge with DIRECTV because that was the right thing to do for the shareholders. If there's something that's compelling out there either to own more or to own less, and it is the right thing for shareholders, then we would always take a look at that and our board of directors would look at that and that's how we look at it. I think we're economic animals.

As a shareholder, I'm passionate about the company, I love coming to work, and love to achieve more than we've achieved today and love to take on new challenges and everything else. But I look at my job as being a CEO. I can't let that part of it come into play.

Carl Vogel

Somebody else earlier asked about the return on our invested capital and our internal rates of returns on our new customers and we still see that as a very compelling economic. I think all of you that follow this business know that if we slowed down on the growth side, we would generate tremendous amounts of free cash flow.

But we have, at least to this point, decided that there's greater opportunity in adding new technology and enhancements to our platform working to be fixed mobile and portable and making those investments to play out that revenue opportunity and hopefully leverage our operating infrastructure to do that. As we look at our plan, we still see the best return on our dollar to continue to drive the DISH Network video service brand as far as we can.

That being said, to the extent those economics change, there's tremendous cash flow opportunity that comes off of this business but we certainly haven't gotten to that point yet.

Operator

Your next question comes from Matthew Harrigan - Janco Partners.

Matthew Harrigan - Janco Partners

One very high ROI niche for you has always been the foreign programming. You're really practically the only source apart from some nice bouquets across a lot of European and Asian languages. Have you pretty much locked up a good number of the rights medium term in that, or is that an area where you see some accelerating competition from Comcast and others?

Secondly, as your business matures and you have 12.7 million customers, obviously a lot of the SAC expenses incurred is just maintaining the water that's in the sink as opposed to adding customers. If you really were running the company for cash flow apart from the plain vanilla SAC issues and the point that Carl made about expanding the venue for EchoStar, is there a lot more that you could do to increase free cash flow? In other words if you did decide to do something, do you think that The Street may actually be underestimating the steady state free cash flow generation if you weren't inclined to grow the business as much?

Carl Vogel

Let me talk about the foreign programming first. It is a segment that is becoming increasingly competitive, but the good news is that we've been a good partner to our foreign programmers for over 10 years and the good news is we provide ubiquity of footprint across the entire country. We do see some impact from both DIRECTV and cable operators to expand their international offerings, but we're very comfortable with where we're at. We continue to work hard to maintain our relationships with our programmers. It's an important segment of our business, it is profitable but that's not to say we may win some and we may lose some going forward. But it's an area where we spend a lot of time, we have focused people both on the ground in the States and in Europe and in Asia and in the Middle East. So it's an area where we continue to maintain focus on and I think we'll continue to show decent results.

In terms of the free cash flow opportunities, I think The Street can do the math. Jason went through what we generated in cash flow, what we spent in capital expenditures, where we spent it, I believe two-thirds of our Cap Ex spend was for SAC-related items and you can do the math and come to your own conclusions.

I think this quarter we ran around a 23% EBITDA margin. I think that when you look at running more of a steady state business, your marketing costs change, your CapEx costs change. We would still be aggressive in maintaining our satellite fleet. But as I think you all know, those are capital expenditures that come in somewhat peaks and valleys.

We believe there's certainly material opportunity to increase cash flow if we slow down the business, but I don't want to anybody to get the impression we're slowing down the business, because we're not. We still think there's plenty of opportunity there. The Street can come to their own conclusions as to how we spend our money, what money would be necessary to go forward, the timing of those expenditures, and I think when you do that math we're a pretty compelling investment opportunity.

Matthew Harrigan - Janco Partners

So it wouldn't just be a linear function of what percentage of the gross adds or incremental net adds? You think it would be beyond that?

Carl Vogel

Yes. I don't think it's quite that simple.

Matthew Harrigan - Janco Partners

Okay, that's what I suspected, thank you.

Operator

Your next question comes from Jeff Wlodarczak - Wachovia.

Jeff Wlodarczak – Wachovia

Hello, guys. Congratulations on a strong quarter. Charlie, thanks for participating on the call. Two questions.

Charlie Ergen

I missed you guys last time.

Jeff Wlodarczak – Wachovia

No, we missed you.

Carl Vogel

He's been preparing for weeks for this.

Charlie Ergen

I just happened to be in town today.

Jeff Wlodarczak – Wachovia

Well, hopefully you were somewhere warm. Charlie, can you provide more color, it's a bit old now, but I would certainly like to hear more or your commentary. There were $3 billion from the DISH DTV merger.

Then, can we drill down a bit on the subscriber-related expense line? It was up sequentially. Carl, last quarter you said there were some one-time items, single-dish transition, was that continuing in this quarter and then were there any network conversions in that expense item this quarter? Thanks.

Carl Vogel

I mean, there's obviously a lot of synergy. I don't know what the number of the synergy would be between DIRECTV and DISH, that is obviously a big number. We looked at it years ago when we tried to acquire DIRECTV. It was several billion dollars. I imagine it's in some ways a little better and in some ways a little worse now but it's not something we're spending time on, let's put it that way. We spend our time running our business.

The expense thing I think is a good question and something that certainly we're focused on in terms of the customer-related expenses. There's a lot of buckets in there from retention marketing to installation and service to call center. Those would be your three biggest buckets. Again, Jason mentioned that the margin is a little misleading because of the one-time gain we had last year.

We made a strategic decision as a company that our customer service level wasn’t at the level that we wanted it to be. So we really had some management out there really controlling expenses, but doing it by not answering the phone as fast or not showing up as fast to do an install and that's not the way you run a business. We gave strict direction that we are going to make sure we're meeting our metrics from a customer service perspective. We then come back in behind that and say, now your expenses went up, you've got to control your expenses, but you've got to maintain those levels of customer service. We've got a fairly young team and some new people and we have to give them a little bit more direction than perhaps I'd like to, but we nonetheless committed to that.

So we opened the new call center so we could answer our phone calls in a more timely manner. That is costly, it is new people, it's inefficient when you first do it. In the summertime you have more service calls because of lightning and those kinds of things. We want to get in and install our systems a little faster so we don't lose the sale because somebody else comes in before we get there. That requires manpower to do that. Our business has been strong so you've got over time that you are paying time-and-a-half on and so forth.

And then retention marketing, we now have our MPEG 4 product so we didn’t want to go out and put an MPEG2 DVR in and then come back and have to put an MPEG4 DVR in six months later, so we now have our full complement of product. We've had one of the only performing HD DVRs on the marketplace and we're able to go out to those customers from a retention point of view that perhaps were waiting in previous quarters. That's your biggest bucket. I don't think you turn those kinds of expenses around over night in one quarter. It will need some significant oversight.

The other thing is we brought Bernie in as our CFO and our prior CFO, Dick Reiner, is now running the service organization. Number one, he knows the business, he knows our company now and he's out in the operations with a very strong financial background to put some controls in place there and some things that maybe didn't exist but what we would like them to do. I think we're in much better shape to attack that.

It is certainly not wildly out of control by any means, but we're perfectionists and we've got room for improvement there. I hate to lose money in operations because you lose it forever. You get no benefit by being inefficient. We'll see how it goes for the next four quarters to see what kind of steady progress we make.

Operator

Your next question comes from Vijay Jayant – Lehman Brothers.

Vijay Jayant – Lehman Brothers

Thanks. I've got two questions. First on the Home Zone product Carl you mentioned it's going to be deployed in half of the territory where IPTV is not deployed. Can you envision eventually the Home Zone product to instead of the DSL from the phone company that could actually be an IPTV product and bundled with a broadcast TV signal via satellite? Is that potentially a product that could evolve given, I believe that IPTV may be constrained for multiple TV homes.

Second, on Distant Signal issues, can you tell us how many of those customers are in areas such that they can get local channels that will require a [inaudible] to enable those local channels given their multiple satellites? Thanks.

Carl Vogel

I will start with the Home Zone. We do believe there's a potential IPTV application there. We are somewhat agnostic at the moment what that broadband connection may be. As Charlie indicated, we're working on our own MPEG 4 version of a set-top box that provides additional content and additional on demand content through a broadband connection. So an IPTV certainly may be part of that.

And as I said, we're somewhat agnostic about the broadband connection and as I said earlier, we're looking at our own opportunities to provide our own broadband connection. So I think conceptually we like the potential marriage of our broadcast satellite business combined with some type of a broadband connection to enhance the viewer experience through IPTV or whatever it may be. In terms of distance, I guess Charlie or Dave.

Charlie Ergen

Again, the majority can get local, and certainly the vast majority of that majority does not need any additional equipment. Having said that, I mean, we are out there installing new equipment for the customers who need it today. It's a very tight window, we have asked the judge to give us more time, there is no guarantee that the judge will give us more time beyond December 1st. I don't know that we would, with weather and everything else, I don't know that we'd be able to accomplish all of that, all of the installations.

They have been working pretty hard at it to make sure that no customer gets disrupted where they in fact can get a local channel. Then we'll deal with those customers who can't get a local channel; again, offer an antenna, maybe life line cable, maybe they'll switch to our competitor. Those are all things that we'll have to deal with. And if they switch to our competitor, we're going to have to get new customers to replace them.

Operator

Your next question comes from Doug Shapiro - Banc of America Securities.

Doug Shapiro - Banc of America Securities

Thanks a lot. I apologize if you addressed this earlier on the call. Charlie, I think this is the strongest growth quarter you've had in the last couple of years and it doesn't look like your promotions are really that different or more aggressive than they were at this time last year. Just wondering if you could talk about what the sources of the strength is? Is it just blocking and tackling, or is there anything specific you can cite?

The second thing is if you could quantify what you mean when you say the majority of your Distant Signal customers can get local. How big is that minority?

The third thing is in the Q you cite the amount you would have to pay on a monthly basis if the TiVo litigation isn't resolved in your favor. Should we assume that's based on $1 to $1.25 per sub per month or can you tell us how that math works?

Charlie Ergen

The math really is from what looked like the judge and jury were awarding them on an ongoing basis and as an estimate, I don't think we know for sure what it would be.

David Moskowitz

We don’t know for sure what it would be and it's a little more complicated than that because there's also a calculation for interest, which would compound. We've assumed if notwithstanding our belief that we'll win on appeal, we don't, we assume it will compound at some rate. So it's not quite so simple as this many customers at this many dollars a month. There are some assumptions in there.

Charlie Ergen

But it's based on the trial and what the jury said and how they're forming it. We don't totally understand their formula, but if you can figure it out and analyze it, more power to you. We've made our best estimate of what we think it would be.

In terms of doing something different, I don't think we really did much different. Mostly blocking and tackling. We did advertise a bit more, we did spend a bit more money on that. That was one thing that drove margins down a little bit because we thought we had a strong NFL offer with the NFL Channel Network 24 hour. So we did a bit more there and I think the early odds are that was probably pretty productive for us.

I don't think anybody delivers better video than the satellite guys at the price points and the quality. I think that cable's pretty flat in terms of new subscribers for video. Where they're getting their growth is broadband connections. And clearly it's a great product and people want broadband, and they're getting phone connections, though there may not be much money in it. I just think that the satellite guys are probably –

I point out something too. Within the satellite guys, some of the satellite businesses is coming from phone companies, but as it relates to EchoStar and DISH Network, we really control our own destiny. I think AT&T reported the number was 50,000 net new subs that they got. I think the net subs that perhaps DIRECTV got from Qwest and Verizon and BellSouth were materially more than that.

I think as an independent company, we're doing pretty well. We have a product that people want and we give them good customer service and they know how to use our operating system. It's a bit hard to pry them away from us.

If I read the analyst stuff, I’d expect the sky to fall tomorrow. Every time I go to my computer and look at how we did yesterday or today, you know, we don't see that yet. So logic tells us it's going to be more competitive. Logic tells us that there may be something to all this investment that other people are making. But logic also tells us that there are a lot of people -- not everybody drives a big fancy car and lives in a big house, there's a lot of people in America that are middle class and a lot of people in America that want the best. We do pretty well with that middle class and we do pretty well with people who want the best. So I don't know. We'll have to see.

We've been pretty steady. We haven't had a lot of ups and downs and we haven't changed our credit score. We haven't changed what we're doing. We haven't gone out and looked for a weaker customer or a better customer. We've kind of just keep doing what we're doing. Sometimes it's depends on what other guys do and what their promotions are and sometimes that affects you in a particular quarter. I just think that we think that there's going to be demand for satellite for a pretty long time.

To Carl's question about the IP, I think people don't care where they get their video. I think every customer if they were on DISH, they would want a satellite dish to get HDTV and get the best video. I think they would supplement that over the next five or 10 years with IPTV. They're going to supplement that with mobile video, they can get it through a WiFi connection. They're going to supplement that with perhaps a local connection from cable or phone company. Our ARPU side of the equation might change a little bit, but I think the number of households we can get into, we still have a long way to go.

Doug Shapiro - Banc of America Securities

I don't know which number it was in the order, but the other question I had was about what's the proportion of the 900,000 that lives outside of the local and local footprint?

Charlie Ergen

We haven't disclosed that and there's a reason. It gets a bit complicated because just to give you an idea, certainly the majority, you could probably use some logic here, but 95% of households are in a local market. Of the 900,000, the majority of them live in a local-local market. Because we skew rural, obviously we've got a disproportionate number of people in that 5%, in those 40 markets that we don't do local, we have a disproportionate percentage that can’t get local. That's one factor that drives the number a little higher than you might expect.

The second thing is that in some markets the market itself doesn't have all of the networks, it only has two of the networks. So they're short of some of the networks. And if we lose our 119 license, it is unclear that we can bring in those other two channels, which effectively makes us less competitive with that particular customer.

The third factor that we don't know today is we have RV owners who are truly RV owners that would have qualified, but they didn't ever send in their RV because they already qualified as a Distant Network so they didn't send in their RV material. They may be in a local/local market, but have an RV, which means they would qualify for Distant Network when they're using their RV. We don't know how many of those customers just never sent the paperwork in. So it gets a little bit confusing.

It's a factor. It's going to affect us as we disclosed in I think logically a little bit less ARPU and a little bit less high churn. It depends on how we manage around that. Last time this year we had a hurricane. That affected us and we had to manage around that and everyone came in and said we're going to lose subs and as a management team, we said no, we're not going to lose subs, we are going to gain subs. We lost subs for a while and we went back and got the subs back because the cable company or our competition didn't get there as fast as we did, or they were building new houses and we were in there ready to go when they were building new houses. We'll certainly recover from it.

It's disappointing, I think the part I feel worst about is customers trust us and customers rely on us for their networks and we as a management team made some poor decisions in hindsight. So there's consequences, potential consequences to customers who did nothing wrong. I hate to make mistakes and I don't feel good about it. And having said that, I worked in the legislation, I know that it is not Congressional intent for these customers to lose their signal. We'll see if Congress will do something about it.

Doug Shapiro - Banc of America Securities

All right. Thank you.

Jason Kiser

Operator, I think we've got time for one more.

Operator

Sir, your final question comes from Spencer Wang - Bear Stearns.

Spencer Wang - Bear Stearns

Thanks. Two quick questions. Your ARPU growth has reaccelerated over the last two quarters or so and you said a couple different reasons in the Q. Is there one factor maybe more so than others that's causing the reacceleration?

Secondly, could you give us a sense of what proportion of your sub base was commercial? Was that segment a material driver of your net adds this quarter? Thanks.

Charlie Ergen

A very small percentage of our base is commercial and it was not a material driver of our net ads this quarter. In terms of ARPU increase, a good portion of it is rate increase driven. I think we had some successes in advanced services, principally DVR and HD. We had a little bit less discounted programming in 2006 rather than 2005. So it's really a combination of additional DVR and lease fees, HD and then to a lesser extent on a percentage basis, but rate increases, as well. We have had good growth on our DVR and HD business and hope to sustain that growth.

Appreciate the calls and appreciate your time, thanks.

Operator

This concludes today's conference call. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: EchoStar Q3 2006 Earnings Call Transcript
This Transcript
All Transcripts