DIRECTV Q3 2006 Earnings Call Transcript

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DIRECTV Group, Inc. (DTV)

Q3 2006 Earnings Call

November 8, 2006 11:00 am ET


John Rubin - Vice President, Investor Relations

Chase Carey - President, Chief Executive Officer, Director

Michael W. Palkovic - Chief Financial Officer, Executive Vice President

Bruce Churchill - President of DIRECTV Latin America


Craig Moffett - Sanford Bernstein

Doug Mitchelson - Deutsche Bank

Aryeh Bourkoff - UBS

Vijay Jayant - Lehman Brothers

Ben Swinburne - Morgan Stanley

Steve Mather - Sanders Morris Harris

Doug Shapiro - Banc of America Securities

Jessica Reif Cohen - Merrill Lynch

Tom Watts - Cowen & Company


Good day, and welcome to the DIRECTV Group third quarter 2006 financial results and outlook earnings call. Today’s conference call is being recorded. At this time, for opening remarks and introductions, I would like to turn the conference over to the Vice President of Investor Relations, Mr. John Rubin. Please go ahead.

John Rubin

Thank you, Operator, and thank you, everyone, for joining us for our third quarter 2006 financial results analysis conference call. With me today on the call are Chase Carey, our President and CEO; Mike Palkovic, CFO; Larry Hunter, our General Counsel; Bruce Churchill, President of DIRECTV Latin America; and Pat Doyle, our Treasure and Controller.

In a moment, I will hand the call over to Chase and Mike for some introductory remarks, but first I am obligated to read to you the following.

On this call, we make statements that may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve known and unknown risks, uncertainties and other factors that could cause actual results to be materially different from those expressed or implied by the relevant forward-looking statement. Factors that could cause actual results to differ materially are described in each of the DIRECTV Group’s and DIRECTV U.S.’ annual reports on Form 10-K, quarterly reports on Form 10-Q, and our other filings with the SEC, which are available at

Additionally, in accordance with the SEC’s regulation G that requires companies reporting non-GAAP financial measures to reconcile these measures to the most directly comparable GAAP measures, we provide reconciliation schedules for the non-GAAP measures. These schedules are attached to our earnings release and are posted on our website at

With that, I am pleased to introduce Chase.

Chase Carey

Good morning, everybody. Overall, I would say Q3 was a good quarter for us. We achieved most, though not all, clearly, of our targets. I also think it is important we took real strides forward to strengthen our business for the long-term.

Looking at the quarter, I would say the highlights for the quarter financially were probably led by the top-line revenue, as well as our bottom-line profits, which both continued to show strong growth.

I think we felt particularly positive about the $416 million in free cash flow before interest and taxes in the U.S., which we generated. I think that cash flow number really reaffirms the strength of our business and ultimately the value of our business.

Touching on some of the key metrics in the quarter, the gross adds, which exceeded 1 million subs, with that continued increased subscriber quality, served to reinforce the competitive strength of our offer in the marketplace.

ARPU growth, which was around 6%, was another strong number for us. We also continued to be successful in stabilizing key costs like SAC, subscriber acquisition costs, and retention marketing even as we significantly increased advanced product, essentially DVR and HD box penetration, which year on year was up around almost 10% from a year ago.

We also in the quarter did take important steps to strengthen our business beyond the financial metrics, and obviously launched our new HD DVR box, which is proving to be extremely popular. We are largely through our Sunday Ticket sales for this year and we met or slightly exceeded our expectations in that area.

Really, throughout the business, we continued to take important steps to improve execution and results in key areas, like sales and service, but we still have work to do.

The one area where we did not achieve our third quarter goal was churn. It was down from a year ago, so we made progress, but I would say we had targeted a monthly churn that would be more in the mid 7s to 1.7, instead of the 1.8% we reported. Competition in the marketplace is certainly one of the pressures on churn, but I would say we generally felt pretty good about our competitive position, and I would say the impact from competition is about what we expected.

The primary reason we did not really achieve our churn target for the quarter was really more internal execution, which ranges from execution in particular sales niches to issues like debugging new advanced set-top boxes for a particular segment of the box area.

We are making progress on getting on top of some of these issues in our execution, but we still, again, we still clearly need to do better, and that is a place we expect we will continue to make progress.

Before I hand it over to Mike, who will really take you through the financials in more detail, I do want to make note of the real strength of our Latin American business. We completed the final step in the Sky - DIRECTV merger with the closing of our Brazil merger in August.

As we look at these businesses, they are really continuing to deliver really across the board outstanding growth in subs and revenue, profits, cash. We are increasingly bullish on these businesses. One of the things we do hope to do, probably at the beginning of next year, as part of a larger session where we take a deeper look at the business, is really for the first time trying to give everybody a better and clearer sense of what we really see in the potential of that Latin America business as we go forward.

With that, I will turn it over to Mike and then come back and make a few comments.

Michael W. Palkovic

Thanks, Chase. Revenues for DIRECTV U.S. increased by 12% to $3.4 billion. Similar to recent quarters, the revenue growth was driven by our larger subscriber base along with strong ARPU growth of 6% to $72.74.

Much of the ARPU growth came from price increases and higher fees for multiple boxes, and we also generated solid growth from a 51% increase in subscribers with HD, DVR, and HD DVR services. Last year, we had 2.8 million subs with advanced services, and today, we have nearly 4.3 million subscribers.

Also contributing to the ARPU growth was the 22% increase in advertising revenue.

In terms of subscribers, there were several important trends in the quarter. First, we continued to improve the quality of new subscribers. Total gross adds of just over 1 million were down 9% from last year, but more importantly, we attained 7% more, or about 55,000 higher quality subscribers in the quarter.

From a relative perspective, higher quality subs increased 75% total gross adds last year to 85% in the current quarter.

In terms of our distribution channels, for the first time in almost a year we saw a sequential increase in sales from our independent dealers. This was an important milestone, because if you recall, the main reason we had missed our gross add targets early in the year was due to the lower sales from this channel. We believe we now have the right incentives in place for these dealers to attain higher sales and quality subscribers.

Another positive trend in the quarter was the continued strength in direct sales, which represented one-third of total gross adds, up from only 26% a year ago.

Finally, our telco partners’ bundled offers continue to be extremely popular with customers. Verizon, Bell South, and Quest had a new record for bringing in north of 250,000 gross subscribers in the quarter.

The improved credit quality of new subscribers, plus the higher HD and DVR penetration rates, is helping drive down our monthly churn rate from 1.89% last year to 1.80% with the current quarter. The improvement in churn is largely due to lower involuntary and first-year churn, related to the reduction in the higher risk gross adds. Involuntary churn declined from about 46% of total churn a year ago to 38% this past quarter.

Although we are pleased with the progress made on involuntary churn, we still have much work to do in the area of voluntary churn. The increase is not being driven as much by competitive factors as other internal issues, which Chase touched on earlier. We are seeing increased demand, which is good, but it is causing strain on our service infrastructure, from the call centers to our installation network.

Related to trends such as significant increase in sales of advanced services, the new lease program, as well as increased demand for our direct sales and telco channels, the latter of which we are working through a few certain execution issues. We have identified the areas that require improvement, and we are now executing on a plan to ensure that we maintain the high standards that our customers expect from us.

Operating profit before depreciation and amortization increased 143% to $823 million. This increase included capitalized costs for leased set-top boxes of $325 million, $203 million in SAC, and $121 million in upgrade retention market.

Excluding these capitalized costs, operating profit before depreciation and amortization would have increased 48% and the related margin would have increased from 11% to nearly 15% in the current quarter.

The biggest driver of the increased margin was the lower acquisition costs resulting from the decline in higher risk gross subscribers added in the current quarter. Even though our SAC per subscriber of $632 was relatively flat versus last year, our total cash acquisitions costs were about $55 million lower because we added about 110,000 fewer customers with lower credit scores.

In other words, you will not see us use valuable cash to attract poor quality customers.

As I mentioned, SAC was essentially flat compared to last year, and down a bit from the second quarter. The stabilization of SAC is particularly impressive when you consider that we nearly doubled the penetration rate of customers buying HD and/or DVR services from about 15% of total gross adds last year to 28% this year. The higher cost related to these advanced boxes have been mostly offset by the significant reduction in all of our set-top box costs.

One other SAC variance worth mentioning is the $10 benefit compared to the prior year from the increased subscribers attained by a segment of our telco partners, who share in a portion of the SAC expense in exchange for a higher revenue share. Offsetting this benefit was a lower benefit versus last year in the category of fees collected from the lower quality subs. That benefit is approximately $5 less than what we were getting last year in Q3.

Also contributing to the margin improvement was the decline in G&A expenses, mostly due to lower bad debt expense and ongoing scale efficiencies.

Upgrade and retention costs of $329 million were $38 million higher than last year, almost entirely because the number of existing customers upgrading to high definition programming nearly doubled over last year.

Excluding the $17 million that was spent in the quarter to swap customers to MPEG-4 HD, upgrade and retention costs were lower than last year when looked at as a percentage of revenues. This reduction relative to revenues was largely due to improved customer segmentation and highly targeted programs put in place earlier this year.

In some cases, we may accept a slightly higher churn rate for lower retention costs if, for example, we lose a lower value customer who may not want to pay us a fee to add or upgrade a receiver.

Looking quickly at our businesses in Latin America, with the Sky Brazil merger closing in the third quarter, we have now completed the consolidation of DIRECTV and Sky businesses in the region. Over the next year, we will migrate the DIRECTV subscribers to the Sky Brazil platform. With the close of the Sky Brazil merger, we now own approximately 74% of the combined businesses and consolidate Sky Brazil’s financial results. Because the merger was completed on August 23, 2006, we included about five weeks of Sky Brazil’s revenue, approximately $57 million, in the quarter.

Also related to this merger was a $61 million non-cash gain reported in operating profit before depreciation and amortization, and the addition of Sky Brazil’s 869,000 subscribers.

In total, we now have 2.6 million subscribers, or just over 4 million including the subscribers in Mexico.

Turning to our cash and balance sheet, DIRECTV U.S. generated $416 million in cash before interest and taxes in the quarter, brining year-to-date cash to about $1.1 billion, or double last year’s cash before interest and taxes for the same period.

Compared to the second quarter, total debt at the corporate level increased $210 million to $3.62 billion, due to the assumption of Sky Brazil’s debt.

Cash and short-term investments increased $220 million from the second quarter, mostly due to $320 million of free cash flow generated in the quarter, and a $97 million net payment from News Corp on the completion of the Sky Brazil merger, offset by about $250 million used for our share repurchase program.

As of the end of the third quarter, we had purchased about 183 million shares at an average price of $16.12, for a total cost of roughly $2.95 billion.

With that, I will turn the call back to Chase.

Chase Carey

Thanks, Mike. Just to wrap up, obviously the next set of months are going to be really busy for us. You will see an array of things. You will see continued progress in our plans to really establish ourselves as the market leader in HD. In 2007, we will also launch an array of new content initiatives, including VOD, Game Lounge, which is our video game service, and new features to integrate TVs and PCs, as well as other new hardware and software features.

Financially, we are pretty much on track with our previously discussed goals for 2006. Net adds for the fourth quarter, we expect to see an increase, both sequentially and compared to the prior year. Churn in the fourth quarter should be significantly lower than the third quarter, also lower than the level we had in last year’s fourth quarter. SAC in the fourth quarter should be a bit higher than we have seen so far this year, as we continue to increase sales of HD and DVRs, but comfortably in the low end of our $650 to $700 target range.

Upgrade and retention marketing, excluding the MPEG-4 HD swaps, will likely end the year around the $1.2 billion we talked about, a little below last year’s number, relative to revenues.

Overall, we think Q3 was certainly a solid quarter for us and we feel good about Q4 as we look forward.

With that, we are happy to take your questions. I will turn it back to John for a second.

John Rubin

Thank you. Before moving into Q&A, investors should note that we have members of the media on this call in a listen-only mode. I would like to remind the media that they are not authorized to quote any participants on this call, either directly or in substance other than the representatives of the DIRECTV Group.

In addition, we are webcasting this call live on the Internet and an archived copy will be kept on our website.

Finally, I would like to ask callers to limit your questions to only one or two until everyone has had a chance to ask their question.

With that, Operator, we are ready for the first one.

Question-and-Answer Session


(Operator Instructions)

Your first question is coming from Craig Moffett with Sanford Bernstein. Please go ahead.

Craig Moffett - Sanford Bernstein

Good morning, guys. A couple of questions, if I could. First, the telcos, the net gains reported by the telcos were about 226,000. That is actually higher than your net gains. Is it simply that a lot of those customers are actually pre-existing DIRECTV customers and are just opting in to the bundles?

Second, Mike, if you could just comment on where HD TV penetration is overall today as a portion of those advanced boxes you talked about. How much of that is MPEG-4 and where you see that going in terms of the portion of your retention marketing costs?

Michael W. Palkovic

Craig, the telco number, yes, their number does include opt-ins. We look at it both ways internally, but our number on the growth side, as we discussed, a little over 250. Their base is just over a million, so we would look at that business segment separately, but yes, that is a little color behind that.

As far as the HD numbers, we are currently at around a little under 10%, about 9.5% of our subscribers are taking HD today. About 9%, or a little bit below 9% of our new adds take HD.

As far as how that is going to affect retention spending, I think the number that you see in the quarter is consistent with our annual target to keep that line at about $1.2 billion. As we increase take rates on HD and DVR, we lower other categories that historically have been in that category. We also, as we commented on, manage who gets the better offers, so we are putting the better offers in front of the better quality subscribers.

It is our view that we should not have any problems staying in that range and still keeping pace with growing both HD and DVR to the level that I think the market will demand over the next couple of years.

Chase Carey

I guess the only thing I would add on the telco side is I think you have a little bit of apples and oranges. I think what comes in sort of gross versus what settles out as net, or how does churn move through, really I do not think -- first and foremost, do not have that type of connection you are making through a channel. By and large, there is sort of a growth sales initiative that ends up with so many customers. Once a customer is a customer, it’s a customer and the issues around managing churn are really pretty detached from where that customer came through. You can do that math on it, but I do not really think -- I think it is apples and oranges as a way of looking at the business.

The other thing I think you do need to look at is sort of what is -- through each channel, clearly there is a segment that is incremental and there is a segment that you get through other channels if it wasn’t there.

Again, there are a lot of moving parts in it that I think you need to take into account as you try and evaluate it.


Your next question is coming from Doug Mitchelson with Deutsche Bank. Please go ahead.

Doug Mitchelson - Deutsche Bank

Thank you. Unless I missed it, you did not give an update on your broadband strategy. An investment has seemed imminent for a while. Is your strategy evolving at all, and where are you at there?

Separately, could you just give us a sense of what growth you saw in Sunday Ticket customers year to year and what percentage of those subs took your higher-end super fan offering?

Chase Carey

Sure. In terms of broadband, there is not a lot new to say, so I probably will not dwell on it too much. It is still active. We are still engaged in looking at -- obviously, again, as I said before, DSL certainly in the short-term continues to provide, to marry with us, whether it is through our specific arrangements or just through customers buying DSL on their own in the market. Telcos have a pretty aggressive standalone DSL price out there.

I think that is the short-term response. We are certainly engaged in looking at ways for us to intelligently work with potential third entrants beyond the telcos and the cable guys into the marketplace. Those conversations are ongoing and current, but probably not a lot new to say about those.

On Sunday Ticket, I do not think we give specific numbers. Again, I would probably just assert a more subjective comment on it. We certainly felt good about it. The numbers met, probably, realistically, a touch exceeded our expectations, probably on both levels, both the Super Fan package, which is the extra package, as well as the base package. We saw a growth in it, obviously Super Fan we saw growth because really it was not there full-scale last year. You cannot measure that when it is much on growth.

I think we are very pleased with the Sunday Ticket results from both levels this year.

Doug Mitchelson - Deutsche Bank

Could I just specifically ask then, are you confident in WiMAX technology?

Chase Carey

Yes. I believe WiMAX, I think the technology -- we have spent a lot of time. We have talked about this for a year. We believe it is very competitive technology. We believe it is technology that obviously offers features that do not exist in a wire world, mobility first and foremost. It is a technology that you continue to improve and build upon. I see an [influx] of this, just as we did with the satellite.

People talk about probably the issue you wrestle first and foremost with in WiMAX is what is the capacity down it. We think we can get a capacity that is quite attractive to most customers and continue to improve it, to make it a product with increased speeds. When I am talking capacity, really speeds that continue to be a service that really serves the vast majority of the marketplace, and certainly marries with our satellite video service to be a very vibrant offer.

Again, I think if WiMAX is trying to compete without marrying it to a satellite business, that could be a whole different picture, where you would be trying to take the bulk video. If you try to take the bulk video that we are putting down there and put it down a WiMAX path into a home, you have a whole different set of challenges.

You take that video down a satellite path and leave the WiMAX capacity free to compete in a complementary way, I think it is a very vibrant, attractive alternative.


Your next question is coming from Aryeh Bourkoff of UBS. Please go ahead.

Aryeh Bourkoff - UBS

Good morning. Just to clarify the answer to the last question, it sounds like you endorse the WiMAX strategy in complement to the DIRECTV business. Could you give us a sense of what holds up any sort of announcement then for the broadband strategy? It sounds like you have a reasonably deep understanding of what the options are.

The second question I had is, Chase, if you could talk about your view of the telco entrants into video, and from a Verizon perspective, if you are seeing them come in with files, what the impacts are, and if you believe that IP TV is a viable competitor to DIRECTV or maybe even a potential partner? Thank you.

Chase Carey

Yes, I think we are pretty sanguine on WiMAX and believe it will be very much a part of the broadband mix going forward.

I think the reality is, when you say what is the hold-up, for us, it is sort of what is the most attractive and the appropriate relationship for us to establish with entrants that are building WiMAX businesses. It can range from an investment to a distribution arrangement. I think we are continuing to make sure we strike the right arrangements that maximize the value that we bring to that business.

The reality is, and I think there is sort of a misperception that somehow the WiMAX businesses are waiting for us to grow. Realistically, WiMAX today is more in a stage of technological development and infrastructure development. Our real value to it is distribution. We are not developing the WiMAX. It is the Intels and the Qualcomms and the Motorolas and the Ericssons and the Samsungs and the Ciscos. Those are the guys that are really advancing wireless broadband forward today.

It probably really becomes a market proposition. Obviously some of it is out there today with players like Clear Wire, but I think it has to continue to move to the next generation, which I think in the next 12 months, you will see the next generation of WiMAX technology coming forward, and at sort of the end of ’07 and probably more likely into ’08, real market deployment of these services.

It is moving forward. There really isn’t -- other than in some ways, the media’s desire to be able to have an answer to a question. The business is moving. We are engaged with all of them. We bring a unique proposition that really uniquely positions us to be value-added to the players there. We want to make sure we maximize the value and maximize the arrangements in ways that work for us.

Ultimately, not having a deal really is not changing the pace of what is going on, or the timetable of what is going on in the WiMAX world. I guess on the one hand, there is no hold-up. On the other hand, there is no real imminent pressure. If we had a deal tomorrow, it is really not going to change what is going to occur in the next half year in terms of developing and moving WiMAX forward.

You have big players investing major amounts to develop that business. For us, it is sort of striking the right arrangement, the right relationships with it, with those players. I think we know, and most acknowledge we are unique in terms of really the fit that we bring to any player in the WiMAX business.

I guess the one thing I would clarify is WiMAX, which actually I used in some ways as a phrase to describe wireless broadband technology. I am using it in that context as a more generic phrase for wireless broadband, not differentiating because there obviously are different vehicles there -- different technological solutions for the same thing. I do not mean to be indicating a preference for WiMAX over other technologies. I am really using it as a catch-phrase for wireless broadband.

The other question was telcos. It is still pretty small. At this point, on the AT&T front, I think it is almost non-existent on the IP TV front, so there is really nothing. You have a couple of markets that have moved with FIOS on the Verizon front, and it has increased the level of competition in the market but it has not dramatically affected where we are in subs. I’m not going to say it has no impact, but it has fairly impacted on the margin. I looked the other day at Keller and I do not think Keller -- it is a small market, so you cannot extrapolate. They have gone into a few others. It probably has a little bit of an impact, but again, it would not be a dramatic impact.

I think we have to see as they play out on a larger level. I think some of the challenges will really be what are the economics for them as they try to roll it out, and is it a sustainable business model? I think that is probably as meaningful as what -- you know, one question is what is the impact on us, and I guess the other question is the big as they go, what are they spending on it, and is that sustainable? Is that really an impact one can extrapolate? Today, it is too early, and I guess that ends up saying the impact is modest today, but it is awfully early stages.

Aryeh Bourkoff - UBS

But as the BellSouth deal gets close to closing and you have that as a robust partnership with BellSouth, have you had any conversations with AT&T about rolling that partnership, having a stake [inaudible] dish?

Chase Carey

We have had very broad -- we are always in touch with the guys we have relationships with, BellSouth, Verizon, Quest. We are always talking to people in the marketplace. I think the reality is that AT&T, I think is probably going to deal with their BellSouth deal before they determine the next step. I think they have to move forward to get that deal closed before they determine where they go from there.


Your next question is coming from Vijay Jayant of Lehman Brothers. Please go ahead.

Vijay Jayant - Lehman Brothers

Thanks. One for you, Chase. Given your key shareholders are probably contemplating offering DIRECTV as an asset to address their own ownership issues, what are your thoughts about the prospect of any potential dislocation to the business, the management structure if that so happens?

Second, on the heels of that, is the extension of a buy-back, given you only got about $50 million left, probably in limbo until there is some resolution on that ownership change?

For Mike, cash taxes in the quarter of $35 million. When do you become a full cash taxpayer? Thank you.

Chase Carey

The Liberty transaction, realistically it is predominantly today an event between News Corp and Liberty. DIRECTV I think, while the press around it always adds a level of distraction, I think we have done a pretty good job of staying focused on the businesses and the challenges we have at hand. That is what I determine we are going to continue to do, is focus on our business and operate our business. That will take that forward.

In terms of the buy-back, we are actively -- I think it has been said last time, certainly talking with the Board about the broad range of sort of the balance sheet. Your balance sheet, cash flow, and other issues, probably nothing that much new to say in terms of again, comments I made before and obviously we went on to leverage our balance sheet with increasing cash flow, as I touched on and as you have seen on the quarter.

What we use that cash for, probably again, we do not have a really different perspective. So there is not a lot new, but I would leave it that it is probably a topic that is being actively discussed from a broad perspective.

Michael W. Palkovic

Next year, we will be a full taxpayer, in 2007.


Your next question is coming from Ben Swinburne with Morgan Stanley. Please go ahead.

Ben Swinburne - Morgan Stanley

Thank you for taking the questions. I think in the fourth quarter you guys will anniversary the beginning of the credit changes from the scoring changes from last year, and in a typical DIRECTV year, I think fourth quarter gross adds are up from third quarter. Should we assume that trend for the fourth quarter on the gross add side? Along those lines in the third quarter, and Mike, you may have mentioned this, and I missed it and I apologize -- did the “quality” or good subs gross adds, did that grow year over year? Could you give us a sense of the direction of [latitude] there?

Chase Carey

I guess what I would say on gross adds, actually, I am not sure it is up. I think actually a year ago, fourth quarter was below third quarter. I am just doing that from memory, but I think that is true. I am not sure.

The fourth quarter, we expect to be a good quarter. I do not know that I am going to get into the micro is it a touch above, a touch below. We expect it to be a good quarter and we feel good about the fourth quarter. It is really on a net basis, we expect to be up sequentially and quarter on quarter. We expect a solid quarter on a growth basis.

Michael W. Palkovic

Your second question, we were up in absolute numbers, 55,000 in quality subs versus the prior year, and up from Q3, obviously, in the quality sub category.


Your next question is coming from Steve Mather with Sanders Morris Harris. Please go ahead.

Steve Mather - Sanders Morris Harris

Thank you. Just two things. First, Mike, how do you rationalize the high churn against your year’s worth of efforts to go after a higher quality sub?

Secondly, for Chase, I spent a lot of time this summer assessing, discussing the sustainability of SAT-TV in general, relative to cable, VOIP, and telco fibre. I am just wondering, to what extent do you think you need to add other brand extensions? I am thinking things you have talked about before -- portable video players, maybe DIRECTV VOIP. You have scuttled DIRECTV DSL in the past. Maybe even dramatically better pay-per-views. How do you think of that sustainability and then adding these other extensions?

Chase Carey

I will let Mike answer the first one.

Michael W. Palkovic

Steve, the first question, we look at it obviously on both sides. The involuntary, poor quality subs. We have done extremely well there. We have driven that number down quarter over quarter significantly.

The issue that we are dealing with today, and I think we have some pretty good operational plans to address them, are on the voluntary side. As we talked about, while competition is there, the increase was driven more about the things we are doing to move the business forward in terms of rolling out set-top boxes, and again, generating strong demand for DIRECTV, and dealing with that appropriately on the service side of the business.

That is the issue we are dealing with today. We have done extremely well dealing with the poor quality, and that is showing up in the churn coming down. We have to deal with this other issue. That one is on us to deal with within our own infrastructure.

Chase Carey

I guess in terms of your question, which had a lot of moving parts to it, so I will try and break it down into a couple to address the sustainability of satellite TV.

I am very bullish on the ability for us to compete long-term in this business. I think there are two levels that we have to compete at, and they are both important. I think first and foremost, we have to have a great video offering. That includes really -- obviously, we think HD is going to be a critical part. We think HD, you go down the road, it is going to be like color TV. Homes are going to have HD services. More and more homes, I think you will see it this Christmas, will be moving HD very much to the forefront of what matters to them in a television decision.

First, I think we have to be, and we are today, we are the best video. We are the video leader and any survey or research would show you that. We have to continue to build that, position VOD. I think we will be a part of that. VOD today really does not have a lot of traction in the market, but I think it will continue to grow and evolve. I think it will just take longer for consumers to understand.

We will certainly be launching and building VOD products as we go through the next year. I think in many ways, the ability, ease of use and reliability are probably features in VOD as opposed to just bulk, that are more important. Having the right things, having them there, having them there when you want them.

I think there are things between storage and broadband connections we believe we can provide consumers. I think we have to make sure we are providing to the degree the video experience transcends the traditional home, and we are competitive there. We will be moving in the first-half of next year to such that you can access DIRECTV through a PC, our video offering through a PC, not just a TV. Moving forward with handhelds. I think the question is still what type of content do people want to watch on smaller handheld devices, but I think we need to be there and make sure we are at the forefront of where those things are going. I think we are well-positioned to do it. Certainly video leadership I think has to be a cornerstone for us.

I think the second part of that you touched on is how do we compete in video. When looking at the larger universe of broadband and telephony, and you touched on a few years ago, DIRECTV having its own DSL service. I do not think -- was it Velocity, I think it was called, but I do not think that is the path one pursues.

I think what is obviously important is consumers have choice in broadband and telephony, and I think they will. I think anybody who believes you are just going to have one monolithic player in providing these services I think is just wrong. I think you will have multiple players.

I think there are questions about all of it. I think there are questions still around where the telcos ultimately end up and are they short-term partners or short- and long-term partners? What happens with the cellular telephony players as they emerge and come into the marketplace? What happens with WiMAX? I think we do not even rule out what happens with broadband, power lines and the like.

I think you will see an array of competition in this marketplace. The ones who are successful, who execute well I think will emerge, but I think you will have choices and options in the marketplace. In many ways, we are ideally positioned to marry with any of them.

Again, what we are looking to see is in certain places, is it smart, intelligent for us to both create value and help get us and our selected new entrants move forward and build their business.

I do think you will have that choice in that competition that emerges in the marketplace. I think that will be a part of how we compete. Beyond video, it is part of the broader mix of services. I actually think the consumer likes to pick and choose. I think the bundle is just about price. I think the issues in terms of a single bill or a single install -- today, installation of something like DSL, 95% of it or something is just drop-shipped to your homes.

I think those services, as they get more mobile, I think mobility will move to the forefront, but I think you have a lot of things going on in there and I think we will fit very attractively with the mix of players, with an array of options for their consumer.


Your next question is coming from Doug Shapiro with Banc of America. Please go ahead.

Doug Shapiro - Banc of America Securities

Thank you. Chase, two questions for you. The first one is that a few years ago, I think maybe one of your first or second conference calls as CEO, you talked about a long-term target for churn. I think that was somewhere near 1.4% or so. I was just wondering if you have changed your mind about what you think that floor is.

The second thing is just looking for a little more color on what you mean by dealing with the service side of the business if that means more investment in CSRs or if that is just an execution issue.

Last, just a housekeeping note. I was wondering if you could tell us year-to-date, what you have spent on swapping out those legacy, high-definition subscribers?

Chase Carey

Sure. Churn, I think that is right. I think it was actually the first call when I first came in at the beginning of ’04. I talked about an array of metrics and goals, subs, SAC, ARPU. I think I said at one of the conferences a month or two ago that actually, I think we have hit or met or exceeded all of them except for churn. Churn, we acknowledge we will not -- we had targeted churn I think for the end of this year getting it down more to the range that you talked about. We are obviously not going to get there this year.

I think what I would say is if I look back three years, the market probably is a bit more competitive than I would have thought back then. I think that is a part of the dynamic. I think there probably also was the degree to which the challenges of rolling out three new generation set-top boxes, new HD, new DVRs, new HD DVRs, and some of the wear and tear on those, probably are all part of ending up saying that clearly the churn -- are all part and parcel of a -- what would be a reason we do not hit a churn target that we had for the end of this year three years ago.

I did say earlier in churn, the competition is about what I would expect. I guess I would say by looking at this year, it is. I think obviously three years versus looking back -- three years versus looking back three, six, nine months are obviously different perspectives. Today, it is a competitive environment that is pretty much what -- I would say ’06 has rolled out about the way I would have expected ’06, but looking back longer, it is probably a touch more.

I actually still think that is the right goal for us. I think it is a place to get to. It clearly is going to take us longer. I am going to again say we are not going to get there the end of this year.

I do think it is mostly execution. In the right places where we are executing right, when you look at -- and it will drift up over time, but you look at DVR, you look at HD, you look at when you get the right mix of advanced services into a home. It clearly has the benefits and achieves the type of results we expect it to achieve.

I think what we continue to find, of whether it is a particular dealer that is bringing in the wrong type of subs, so we got on top of the dealers as a whole, but there are still two who are problematic. I am not picking on them, or it can be ourselves. That is an offer we had that we try through a particular, that we run through a particular channel of direct sales. Did not -- brought in the wrong type of customer, or again, we did not know that we had -- not in all the advanced boxes, but in some subset of an advanced box, we had a glitch. We did not get on top of that to the degree we would have liked, and that has a bit of an impact.

I think those are the areas and those are the types of things that we need to tighten up. I still think it is a goal we should strive to, but clearly it is taking us longer to get to.

In terms of service, it is purely execution. It is not investment. To sum degree, it is absorbing -- I have used the installation network, obviously, for the ability to put two big components of service, installation and call centers, or online. Again, it would be bumped in with the call centers.

If you take the installations and you look at the shift we have had in the last 12 or 18 months where we used to not have any idea who is doing our installations, or the quality of it or a handle on it.

We have moved our installation and service business from probably being -- I do not know. What would it have been? A quarter of it a couple of years ago. Management threw a network of HSDs, essentially eight dozen or so, regional providers that cover the country, that we have a much closer relationship with and a much better handle on the service and quality.

Those visits have gone from 25% to north of 90%. You put that much volume through those -- have we gone through some growing pains? It has clearly improved our ability to get a handle on it, to set the right benchmarks, to adjust costs appropriately, to capture the efficiencies we need to measure the right metrics and hold people to the right standards and the right targets. But are there some growing pains as we go through trying to execute day to day, moving those many visits, and it is millions of visits. It goes from 25% to 90%-plus of our service and installation calls into this managed network.

It is an important step to make, but clearly there are growing pains we work through and we tackle as we get the overall quality and efficiency of that where it needs to be.

When I talk about execution, it is really much more dealing with those issues, and likewise. I mean, in the call centers, probably first and foremost, it is, as you have a significantly greater level of advanced boxes, as another example, you have a more complex relationship. A customer is going to have more calls about if they get a DVR, how does it work? How do I find my way around it? Do you get HD?

You get these new devices and the reality is customers are going to have more questions or issues with it. We have to figure out -- and we pre-emptively provide the right tools up front. We are actually taking steps in the next couple of weeks where we are sending every DVR customer a cheat sheet, a glossy one-page, here’s the 20 things you have to know about your DVR.

How do we continue to learn to do thing that get us in front of that customer experience to mould to as efficiently and as effectively as possible, improve it for them and enable us to deliver the quality and the economics we want.

Michael W. Palkovic

Doug, your last question, we spent $38 million year-to-date on swaps. That is roughly 85,000 swaps that we have done.

Doug Shapiro - Banc of America Securities

And the total target was 150 or so?

Michael W. Palkovic

We were targeting getting through the entire base in a two- to three-year period. The longer we wait, obviously costs come down in both the box and the new antenna that has to go on the house. We are managing that to pick the right time to get to the customers. Obviously the end game is to reclaim capacity. We will pick up the pace on that in 2007.


Your next question is coming from Jessica Reif Cohen with Merrill Lynch. Please go ahead.

Jessica Reif Cohen - Merrill Lynch

Thank you. Chase, could you discuss the advertising sales change from why you brought it in-house? Particularly since advertising has been so strong this year. Will there be any start-up costs associated with this move?

Chase Carey

What? I am sorry. I could not -- oh. It was a pretty discreet group already, and I think for us it was really economics -- economics as well as just coordination. It was a group that, an awful lot of it was pretty discreet, dedicated to us. We run a fairly -- we are a fairly large player now. We have grown that significantly.

It was mostly just the benefits were essentially economic and coordination.

Jessica Reif Cohen - Merrill Lynch

Will there be any start-up costs associated with that?

Chase Carey


Jessica Reif Cohen - Merrill Lynch

Could I ask one other question, completely different? Latin America, could you give a little bit more color on the operations? The ARPU, potential size of the market. What economic class do you think you can go down to? A little bit about the competitive market, cable, and if there is anything in telco going on?

Chase Carey

I will let Bruce talk. I have talked to it briefly. Again, to do it really quickly on a phone call is tough, which is why I said I think we recognize we have probably not provided the level of visibility and understanding of the Latin business that we would like. It was somewhat while we were going through trying to get these mergers closed, it was somewhat difficult to really put forth a reliable long-term picture.

I guess I would say, before Bruce tries to do it, it is a pretty tough thing to do and we would hope to do it in the right setting with the right understanding in the next few months.

Bruce Churchill

I guess all I would probably do is underscore that I think when we announced the transactions that we felt in a three-year timeframe from when we got these mergers done that we would be at 5 million subscribers. I do not think we are going to back off of that.

I think the numbers, because you know them well, for the Mexico business are quite public. The kinds of operating metrics that you see there, those are probably slightly better than other markets in Latin America, but they are relatively consistent. That is probably pretty good information to go on.

As Chase said, I think we are probably better served going to more detail at some other time.


Thank you. We have time for one more question. Your final question is coming from Tom Watts with Cowen and Company. Please go ahead.

Tom Watts - Cowen & Company

Just on the HD front, you are planning on launching sats 10 and 11 next year. I think that is going to give you a local HD in 70% of the markets. Going beyond that, you mentioned you think HD is going to be everywhere, ultimately. Is there additional investment required? Is there a roll-off of standard definition capacity at some point? How should we think about that longer term issue?

Chase Carey

The satellites, we are putting up two next year. They would actually give us the capacity and capability to bring HD local to everybody. There is an investment in each market. That is, essentially you have to make an initial investment to provide the back-haul of the local signals to an uplink. As you do each market, it is about $1 million a market.

We have built it out for about 50 or so already. We are probably today close to 60% today. We will certainly be well beyond 70% when we get this up.

The satellites will give us the capacity to bring local and 150-plus channels on national HD to everybody. Again, the investment that remains would be into the markets we have not built up. It is about $1 million a market to provide the back-haul facility.

Tom Watts - Cowen & Company

Ultimately, when you go to 100% of the -- or take all of your locals and turn to HD, you will have to make that investment for HD in each of those markets?

Chase Carey

Yes. We will have an investment to build out, if you build out 200 DMAs. I mean, we are not actually in standard def at 200 DMAs. We are at about 140 or so, but if you went to 200, you would have another 140, 150 markets that we would have to build back-haul facilities for, to deliver HD to it.

It is not cannibalizing standard def investment.

Tom Watts - Cowen & Company

Could you just comment briefly on your Wild Blue rollout? I think that is slated for about now -- what you are doing there and how that might -- how WiMAX plans might fit into that.

Chase Carey

We look at Wild Blue at this point as predominantly a rural solution, and really not one that we expect is competing with existing or WiMAX options. It is not really one that we expect to be competing aggressively with cable broadband, DSL broadband, or wireless broadband as it emerges.

It would have to make some real leaps in terms of economics and capabilities to get to a place where it competes. I think it has a real role in rural America where those options do not exist, and that is predominantly the role it will play for us, to provide that to a rural customer who wants broadband with video, and probably in most cases does not have the other options.

John Rubin

Thank you, everyone, for joining us.


Thank you, ladies and gentlemen, and that concludes today’s call. Please disconnect your lines at this time and have a great day.

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