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Executives

Bruce Churchill - Executive Vice President, Chief Executive Officer of Directv Latin America LLC, President of Directv Latin America LLC and President of New Enterprises

Jonathan Rubin - Investor Relations

Michael White - Chief Executive Officer, President and Director

Patrick Doyle - Chief Financial Officer, Executive Vice President of Finance and Member of Proxy Committee

Analysts

Jeff Wlodarczak - Wachovia

John Hodulik - UBS Investment Bank

Thomas Eagan - Collins Stewart LLC

Jason Bazinet - Citigroup Inc

Michael McCormack - JP Morgan Chase & Co

Richard Greenfield

Todd Chanko - Jupiter Research

James Ratcliffe - Barclays Capital

Todd Rethemeier - Soleil Securities

Marci Ryvicker - Wells Fargo Securities, LLC

Bryan Kraft - Credit Suisse

Matthew Harrigan - Wunderlich Securities Inc.

Ben Swinburne - Morgan Stanley

DIRECTV (DTV) Q1 2010 Earnings Call May 6, 2010 2:00 PM ET

Operator

Good day, ladies and gentlemen. My name is Melissa, and I will be your conference operator today. At this time, I'd like to welcome everyone to the DIRECTV First Quarter 2010 Earnings Conference Call. [Operator Instructions] It is now my pleasure to turn the call over to your host, Jonathan Rubin, Senior Vice President of Investor Relations and Financial Planning. Sir, you may begin.

Jonathan Rubin

Thanks, operator, and thanks, everyone, for joining us for our first quarter 2010 financial results and outlook conference call. And with me today on the call are Mike White, our President and CEO; Larry Hunter, General Counsel; Pat Doyle, CFO; and Bruce Churchill, President of DIRECTV Latin America. In a moment, I'll hand the call over to Mike, Pat and Bruce for some introductory remarks. But first, I'll 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 statements. Factors that could cause actual results to differ materially are described in each of DIRECTV's and DIRECTV U.S.'s annual reports on Form 10-K, quarterly reports on Form 10-Q and our other filings with the SEC, which are available at www.sec.gov.

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 measure, we provide reconciliation schedules for the non-GAAP measures, which are attached to our earnings release and posted on our website at directv.com.

With that, I'm pleased to introduce Mike.

Michael White

Thanks, John, and thanks, everyone, for joining us today. Let me start with just a couple of opening remarks and then I'm going to turn the call over to Pat Doyle and Bruce Churchill for any additional color on both our U.S. and Latin America businesses.

Overall, I think we got off to a terrific start in 2010 as our businesses in both Latin America and the United States turned in extremely strong first quarter results, leading as you saw this morning to more than doubling our free cash flow to a record $1 billion while our earnings per share nearly tripled to $0.59. Now with that said, I certainly would not suggest you just take our first quarter results and multiply them by four to predict our full year outlook. Sooner or later, we will have to pay some taxes. However, it's clear that our businesses are demonstrating tremendous operating strength, and I think that positions us nicely to meet or exceed the full year guidance we provided on our last earnings call.

Let me first turn to the United States where I believe there are three key takeaways from the quarter. First, our top line results were strong and appear to have been modestly supported by the slowly improving consumer economy. Second, the significant increase in margins reflects the benefits we're capturing from DIRECTV's operating scale and efficiencies, as well as ongoing efforts to focus on more disciplined cost containment. And finally, fueled by strong topline growth and expanding margins, DIRECTV is demonstrating the very substantial cash flow-generating capability of our company.

Let me touch on each of those three items. First, in terms of revenues. I was very pleased with our 11% growth. We did see some very encouraging trends in the quarter, particularly related to sales of premium movie channels, pay per view movies and events, as well as higher advertising revenues. Now I'd attribute much of that improvement to better execution. But as the economy also continues to improve, customers do appear more willing to purchase additional content and premium services.

Net subscriber additions of 100,000 were generally in line with our internal expectations. It's certainly still very competitive out there, but I would say no more so than the trends we saw in the fourth quarter.

At DIRECTV, we all believe there's still plenty of growth left in the pay TV market, particularly when you consider both our differentiated advantages and our planned innovations. Looking ahead to the second half of the year and in the next year, we're cautiously optimistic that we'll see favorable growth trends, particularly if the housing market expands and the competitive landscape remains stable. In addition, we're expecting to benefit from some more targeted marketing tactics that we're in the process of developing and implementing.

I'm also particularly excited about several upcoming product launches that will once again demonstrate our leadership and innovation in the industry. I believe they will further strengthen both our brand and our reputation for delivering the best video experience in America. For instance, just a couple of weeks ago, we became the first video provider to offer national high-definition distribution of Univision and TeleFutura. This is particularly important when you think about the World Cup, which begins next month. And it also marked the beginning of DIRECTV's expansion to more than 160 high-definition channels over the coming weeks. Next week, we officially roll out Multi-Room Viewing services and then in June, we begin broadcasting in 3D.

Now much like with high definition a few years ago, we at DIRECTV intend to take a leadership position in 3D. Initially, we'll offer three dedicated 3D channels including ESPN 3D, and our own channel named N3D. DIRECTV customers who have 3D televisions and equipment will be able to watch top-rated 3D movies as well as exciting sporting event such as the World Cup and Major League Baseball All-Star Game.

In fact, just yesterday, you saw that we announced that DIRECTV will present the first-ever major league baseball telecast in 3D on July 10 and 11 when the New York Yankees take on the Seattle Mariners. And later in the summer, we'll introduce our enhanced DIRECTV Cinema service, which will greatly expand the number of on-demand and Pay Per View movies we offer our customers. So as you can see, we'll be introducing a host of new products and services that we believe could potentially bolster both subscriber and ARPU growth as well as reduced churn.

Now I would point out that we don't expect the rate of growth that we experienced in the first quarter necessarily to continue for the balance of the year due in part to a couple of one-time items that Pat will cover later on.

Turning now to the cost side of the ledger. I think we've really done an excellent job managing our cost as you saw in the nearly five percentage point increase in our OPBDA margin. You could look at practically every line on our income statement and see the specific actions that our teams have taken across DIRECTV to contain costs, and in most cases, grow margins. Upgrade and retention costs, which were down about 20% on a cash basis from prior year, is a good example where we struck a favorable economic balance between lower cost and slightly higher churn.

The reduction in upgrade costs for existing customers is also related to the increased equipment investment that we're making in all of our new customers. About 70% of new subscribers in the first quarter signed up for HD and/or DVR services, which compares to only about 60% a year ago. We believe that this strategy will not only help reduce churn in the long run, but will reduce the likelihood of a customer calling us to upgrade one or two years down the road.

Another area that's operating more efficiently are our call centers, where we've attained the highest service levels in years. Yet when viewed on a per square subscriber basis, our call center costs in the first quarter were down about 5%. Subscriber acquisition cost, SAC, was the one area that was slightly higher than we would've liked due to a conscious decision we made to respond to the challenging competitive conditions in the quarter, but also due to the aforementioned strategy of increasing our upfront investment in advanced equipment for new subscribers.

Turning to DIRECTV Latin America, we had another great quarter across the board, and most notably, I would say in the area of subscriber growth. As many of you will recall, unlike the United States, pay TV penetration in Latin America is quite low. I was just down to Brazil with Bruce Churchill and the team last week and I was very excited with what I saw. I like to remind people that in Brazil, which is our fastest growing market, less than 15% of households have pay television. Add to that a relatively stable macroeconomic environment plus the region's best TV experience and you can understand why were you seeing unprecedented subscriber growth in Latin America. The growth is diversified from both an economic and geographic perspective. Economically, we're getting the best subscribers at the higher income levels through our superior HD and DVR offerings. And we're also doing well attacking the middle market segments with our popular prepaid and lower priced postpaid packages we launched earlier this year.

DIRECTV Latin America's growth is also geographically diversified through our pan-regional presence and from the fact that we're growing in both young and more mature markets. For instance, it might surprise you to hear that some of our best performing countries in the quarter were Ecuador and Colombia, which is quite a turnaround from a year ago where we were uncompetitive in those markets. And as good as our results were in the first quarter, I'm looking for even better numbers in the second quarter when we begin our unparalleled coverage of the World Cup.

In a few minutes, Bruce will provide you with more details about Latin America, so let me just wrap up my update on a couple of important other items. First, as we mentioned on our last earnings call, one of our top priorities is developing a strategy for returning capital to shareholders. We've made a lot of good progress with that strategy, and Pat's going to provide you with some more details in a few minutes. Also on the last call, I said that we begin a company-wide strategic review in the spring. We're making great progress in that area.

We plan to present our recommendations to our Board of Directors in the summer, and after that, we'll host an investor day in the fall to provide you with a much more detailed view of both our businesses and our outlook.

Earlier, I also shared with you some of the products we'll be launching over the coming months. Discussions with our board have been more long-term focused with a particular emphasis on the steps we're taking to achieve our goal of delivering DIRECTV whenever and wherever our customers want it. And we'll have more to say about that this fall as well.

In summary, now that we've completed the first full quarter since becoming DIRECTV CEO, I can honestly say that our assets, our balance sheet and most importantly the talented people all across DIRECTV are even better and stronger than I had anticipated. More importantly, I think, so are our opportunities for continued future growth. I look forward to meeting many of you over the coming months as we continue to share our strategies for increasing shareholder value. So with that, let me turn it over to Bruce Churchill to review our DIRECTV Latin America first quarter results.

Bruce Churchill

Thanks, Mike. In the last earnings call, I talked a lot about our record-setting subscriber growth throughout the regions. I'm happy to say that I may also reuse much of the speech I gave last quarter as our subscriber results in Q1 were even better. I spoke with all of you about Q4, spoke about an all-time record of $460,000 gross additions. Well, in Q1 of this year, gross additions were up 34% versus last year. [indiscernible] (22:56) And the reasons behind this success are very similar to those I shared with you a few months ago.

Higher into the market, growth continued to be driven by increasing sales of our industry-leading HD and DVR services. 30% of our new customers signed up for advanced services in the quarter at about three times the level of a year ago and up five percentage points of the same rates in the fourth quarter. The year-over-year growth is split fairly evenly between HD and DVR services.

HD growth remained strong in Brazil where we offered 3x as many HD channels as anybody else and HD has picked up steam in PanAmericana as well, where we have been expanding our offerings. Increase in DVR sales has been particularly strong in countries such as Argentina and Colombia. And as I discussed in my response to your question as quarter, we just like to reiterate that the success we're having in both HD and DVRs is a testament to the competitive advantage we've created in Latin America by leveraging the set-top box technology developed by DIRECTV U.S., enabled us to get to market with better products sooner at a lower cost.

We're also seeing strong growth from our strategy to aggressively go after the Middle Market segment as much lower penetration rates for pay TV services in Latin America [indiscernible] (24:22). Core of this strategy focuses on three main marketing tactics: Prepaid packages, Lower-priced postpaid packages and the bundling of our service where possible with the local telco.

In terms of prepaid services, we've had the greatest success in countries such as Venezuela and more recently, in Colombia, Chile and Ecuador. Venezuela represents a country where we've offered prepaid services for the longest period of time. And as such, prepaid penetration has reached over 30% of total subscribers in that country. From a DTVLA consolidated perspective, prepaid subscribers as a percent of total gross adds have been running in the 20 plus percent range. We expect that level to continue for the balance of the year. In addition, lower-priced postpaid packages have been extremely popular in Brazil and we've got some early success bundling DIRECTV with local telcos in Colombia and Argentina.

Turning now to churn. Our monthly rate obviously higher than a year ago. But then it increases almost entirely due to the initial instability surrounding the currency devaluation in Venezuela. In particular, the instability impacted prepaid churn the most. However, we remain cautiously optimistic amid a sea of uncertainty created by the devaluation in Venezuela will diminish with the passage of time and that more normal market conditions will prevail for the rest of the year.

Excluding prepaid churn, our consolidated postpaid churn in the region was extremely strong, declined about 10 basis points in the prior year, 1.56%. I attribute most of this improvement to the increased sales of HD and DVR services, as well as our more focused upgrade and retention packages. Even with the challenges in Venezuela, our financial results were quite strong. 30% increase at the top line was mostly due to subscriber growth, but we also saw some favorable pricing trends in the quarter.

Our three quarters of our 9.5% ARPU growth is related to price increases, higher sales of advanced services. The remaining portion of ARPU growth was foreign exchange related but benefits gained in Brazil were only partially offset by the devaluation in Venezuela. OPBDA was also very solid and more than doubled over last year's results. Majority of the growth was due to the gross profit and the incremental revenues, as well as lower charges related to timing of repatriating cash from Venezuela.

In terms of our full year outlook, it's too early in the year to revise or financial guidance. However, we feel that our first quarter performance is a good piece of evidence to support our bullish outlook for the balance of the year. As Mike mentioned, certainly the second quarter should be another strong quarter. As many of you know, FIFA World Cup kicks off in South Africa in June 11. We expect to take advantage of the excitement around this event to deliver a record number of gross and net adds for the quarter, which should be in the high water mark for the year.

The challenge will be to hold on to these subscribers during the balance of the year particularly in the Prepaid segment. However, this issue is already on our radar screen and we've been through this before. So I'm confident the vast majority of those subscribers would chose to stay with DIRECTV even after the excitement of the World Cup subsides.

Finally, I would like to bring your attention to two additional points. Those of you who are on the call with Televisa last week will know that our affiliate, Sky Mexico, had a ten-fold increase in net addition to about 240,000 subscribers in the first quarter. Probably [ph] (28:16) on the back of their recently launched prepaid product, VTV. Including these results, our Latin America platform now exceeds 7 million subscribers. I would just like to add that we crossed the 1 million-subscriber mark in both Argentina and Venezuela this quarter. So it's quite clear that growth remained strong throughout the entire region.

Secondly, I would just like to note that our company, Sky Brazil, was just awarded the Brazilian equivalent of the J.D. Power Award for best service provider in the communications industry. This is the eighth year in a row that Sky Brazil has won this award. I highlight this award to make a point that even with our growth, we still remain very much focused on providing the best customer experience in the business. And with that I'll conclude my remarks and I'll turn the call over to Pat.

Patrick Doyle

Thanks, Bruce. From a financial perspective, I thought that our Q1 results were as good as any quarter in our history. Our revenue growth was solid, but I thought our management of cost and margins were even stronger. And the free cash flow growth speaks for itself.

Looking first at the top line for DIRECTV U.S., industry-leading revenue growth of 11% was solid and was mostly driven by ARPU, which at 85.47 was a touch higher than our internal target.

As Mike mentioned, we're seeing much better results at premiums, pay-per-view and video-on-demand movies as well as in pay-per-view events. As we've shared with you in the past, the buy rates for many of these revenue categories had been declining for years and our goal has been to reverse this trend or to at least slow the rate of decline. I believe we are doing just that, and our team has on a terrific job getting these important revenue categories back on the right track.

Also contributing to ARPU growth was our annual price increase, which we accelerated by one month this year, higher NFL Sunday Ticket revenues due to the January game, increased revenues from HD and DVR services as well as greater advertising revenue. Net subscriber additions of 100,000 were generally in line with our expectations as both gross additions and churn were consistent with internal projection. On our last earnings call, we mentioned that gross additions this year will probably be lower than last year. We expect this year-over-year decline to be most pronounced in the first quarter due mainly to the one-time benefit gained last year from the digital transition.

Many of the stricter credit measures we've implemented over the past several quarters continue to yield positive results. The overall credit quality of new subscribers remains high and our customers continue to purchase advanced services at an industry-leading rate. As a point of reference, our penetration of HD and DVR services is now North of 60% of total subscribers or about 50% higher than the largest cable company's penetration of about 40%.

Another trend worth noting is the lower contribution from our telco partners. Last year, the telcos reached as high as 25% of total gross additions, and during this past quarter, their share dipped below 20%. This decline is related to several factors, including the continued rollout of FIOS and U-verse as well as the rapid decline in their land lines which results in fewer incoming calls and sales opportunities at their call centers.

Looking briefly at churn, the year-over-year increase in the first quarter was a bit higher than the previous two quarters. However, we're quite pleased with this level for a couple of reasons. First, although the competitive environment last quarter was comparable to the fourth quarter, it was much more challenging than a year ago. Second, we've done a good job managing the trade-off between modestly higher churn and lower upgrade and retention cost. We continue to prioritize our best offer to our best customers and as a result, we believe that most of the increase in churn is related to lower quality subscribers who have a greater propensity to shop around for the best deal. The bottom line is that this level of churn is consistent with our target range for the full year of between 1.5% and 1.6% per month.

Turning now to costs. As I mentioned, this was clearly one of our greatest strengths in the quarter as the nearly five-point increase in OPBDA margin was the largest year-over-year improvement since we implemented the lease model for set-top boxes in early 2006. A portion of the margin growth was due to the decline in gross additions. However, with the exception of SAC, every other line item on our income statement came in better than our internal targets. The largest contributor to our increase in Pre-SAC margin was upgrade in retention marketing, which from a cash perspective, declined 79 million or 20% to the lowest level in two years. This rather significant reduction, particularly considering our larger subscriber base, is primarily due to the increased investment in SAC for new customers increased usage off refurbished boxes and lower manufacturing cost for new equipment.

We're also seeing solid results in subscriber services. The performance in our call centers and installation network is particularly rewarding because of the compounding benefit. That is, we're achieving higher service levels and a relatively lower cost. But more importantly, the customer experience is greatly enhanced, which should drive lower churn in the future. In addition, we did a good job managing programming cost as our first quarter margin was relatively flat versus a year ago despite the increase in premium and pay-per-view revenues, which generally have lower margins.

Also in the quarter, we saw a decline in capital expenditures related to set-top boxes, which combined with double-digit revenue growth and expanding margins, drove substantial free cash flow growth in the quarter. The nearly $1 billion of free cash flow was not only a record for DIRECTV U.S. but was almost double last year's result.

I'd like to wrap up my opening remarks with a few comments about our outlook and strategy for returning capital to shareholders. Our strong first quarter results provide us with greater confidence that we will meet or exceed the full year guidance provided on our last earnings call. It's worth noting, however, that the revenue and OPBDA growth profile this year is in many ways, the opposite of last year's results. In other words, DIRECTV's first quarter 2009 revenue and OPBDA growth were the lowest of the year and generally improved throughout the year. Obviously, that profile impacts our growth rates this year. Also keep in mind that we be benefited from a few one-time items in the first quarter including revenues for the additional NFL game, lower charges for repatriating cash out of Venezuela and the gain related to the unwinding of the Bank of America collar.

In terms of cash flow, as you saw in our release, tax payments in the first quarter were quite modest. Beginning in the second quarter, we expect free cash flow growth to be impacted by higher tax payments compared to both the prior quarter and prior year, primarily due to the increase in our pretax earnings. Our goal, however, is to manage DIRECTV's cash tax rate of roughly the same level as last year despite the unfavorable impact due to the reversal of benefits gained from the previous two economic stimulus packages.

In terms of DIRECTV strategy for returning capital, I'd like to first point out that our top priority for creating shareholder value remains to reinvest in our core businesses. Our second priority is to return excess free cash flow and liquidity to shareholders in a timely manner. In that regard, our board approved our plan to reach a leverage target of the 2.5x total debt to DIRECTV U.S. OPBDA by the end of next year. Reaching those leverage target within the next year and a half will obviously be impacted by market conditions and our ability to tap the debt markets at reasonable rates.

In addition to executing on our plan to reach 2.5x leverage, we'll also evaluate ways to further increase liquidity by utilizing DIRECTV Latin America's rapidly growing OPBDA. In terms of returning capital, at this time, we prefer repurchasing shares over other means based on a variety of factors including our current stock price, the favorable spread between our after-tax cost of debt and free cash flow yield and other tax considerations.

Through yesterday, we had repurchased just over $1 billion of stock so far this year, leaving about $2.5 billion on our current $3.5 billion authorization. We have not ruled out other options for returning capital and we will continue to assess and review the merits of these with our board on an ongoing basis. So at this time, I'm going to turn the call back to John so that we can begin our Q&A.

Jonathan Rubin

Thanks, Pat. And before moving on to Q&A, investors should note that we have members of the media on this call in a listen-only mode. I'd 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 DIRECTV. In addition, we're webcasting this call live on the Internet and an archived copy will be kept on our website. With that, operator, we're ready for the first question.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from Doug Mitchelson from Deutsche Bank.

Todd Chanko - Jupiter Research

This is Todd Chanko who's getting in for Doug. In terms of interactive advertising, you recently announced an agreement with Dish to launch an interactive advertising platform. Some questions about that, how is it going, what are your expectations and also could you tell us a bit more about subscriber use and uptake of the direct active platform?

Michael White

Let me first touch on the -- you know, we're real pleased with this interactive advertising venture. The cable guys have had something with Canoe that they've been working. It's very early days so I probably would say it's a bit premature to comment on how it's going. Suffice it to say, we are looking at a number of different strategies at which that's only one to strengthen our advertising platform. Clearly, I think we're looking at addressable ads, we're looking at other ways to get adds through the setup box and the satellite, as well as the interactive ad venture that we've got the Dish. We're excited about being able to bring to advertisers over 30 million subscribers between the two of us. We think it'll be a terrific opportunity for advertisers. And in a strengthening advertising market, which we've seen across the board, I think it's going to be a terrific addition for us this year. But I would say it's a bit premature and frankly, I don't think -- one way or the other, it wouldn't impact our guidance.

Operator

Our next question comes from Jason Bazinet from Citi.

Jason Bazinet - Citigroup Inc

Regarding your leverage, the 2.5x, is that a net target or is that on gross debt?

Michael White

Yes, Jason, that's on gross debt.

Jason Bazinet - Citigroup Inc

And then just from a practical standpoint, if you guys do decide to buy back stock with the lion's share of the capital that you're going to raise, what's the practical limit in terms of how many shares you think you can buy back based on sort of prevailing trading volumes and all of that?

Michael White

I don't think -- if you kind of look at our expected profile both cash generation and liquidity from the issuance of debt, we don't feel like there's any issue. I mean our restrictions are probably somewhere around 2 million shares a day that we could repurchase. I mean we haven't been anywhere up that range but at half of that at 1 million shares a day, you can kind of see it equates into a very substantial dollar amount of repurchases over that period.

Operator

Our next question will come from Barclays Capital, James Ratfield (sic) [Ratcliffe].

James Ratcliffe - Barclays Capital

When you talked about return of capital, clearly, buybacks are your focus. But could also talk through both the peel and feasibility of tenders and onetime or regular dividends? And secondly, if you could talk a little bit about how the, if at all, the mix of both disconnects and acquisitions have shifted the last two quarters among cable, dish and telco?

Michael White

Sure, James, it's Mike. Let me start on the first one, and then Pat can chime in as well. As we've worked at it, again, this is a bit of a work in process in terms of our strategy we review with our Board of Directors. What became very clear to us though, in the work that we were doing, is that our very first priority should be to get our balance sheet to the appropriate leverage level, if you will, for being an investment-grade company. And hence, that is the focus of what we were talking about today, and we felt that it would be helpful to communicate a clear date by which we plan to be there. Now as we look at that, and as Pat said, first of all, frankly, given just the tax constraints we're under, we've got plenty of room to accomplish that on share buyback, kind of just open market purchases. We are clearly and will continue to look at a number of other ways that we could get there and evaluate what's in the company and the shareholders' best interest in terms of whether you do tenders or that kind of thing. It's not really needed to get to where we want to get to. But we're looking at any kind of financial instruments that would make sense. We'll obviously be assessing, but we can get there with open market purchases. As it relates to the question of dividends, frankly, first and foremost, I think our priority should be to get our balance sheet set properly. We can then have a conversation about whether we are 100% share buyback or some mix of dividends and buyback at that time. I'm sure we've all looked at dividend practices before. And in my view, at least, it's going to be heavily influenced by what the federal government does with tax rates on dividends, as at least one important consideration for some of our shareholders. But we haven't made a decision on that one way or the other. I think it's a little premature. But certainly, as we work through our strategy this summer, we'll probably have more to say on it, either later this year or early next year. Certainly, we'll talk about more specifics about our share repurchase. But for right now, I would say, our focus is on continuing our open market purchase program. Pat, anything you want to add to that?

Patrick Doyle

Yes, and I think, James, when we look at this and analyze internally, we feel very comfortable that there's a lot of value to be returned to the shareholders by continuing an aggressive share repurchase program. We got a lot of bandwidth left on, before we would even run into a question of, is there a better way to return capital to the shareholders. But like Mike said, we're going to continue to look at all of the facts as we move along, kind of how are we going to raise that? How much and what position does that put us in? And does our share repurchase strategy still makes sense under changing circumstances? But right now, we feel very, very comfortable that there's a lot of value to be returned to shareholders through share repurchases.

Michael White

The second question, James, that you touched on, which is kind of the mix of our subscriber acquisition disconnect and what trends in the marketplace, clearly, it continues to be very competitive out there. I don't think I would single-out one competitor or another. As Pat highlighted, we have seen a bit elevated churn levels in territories where files and U-Verse are being rolled out. I would say, our churn levels were pretty close to in line, maybe a tad higher than what we would have liked in the first quarter. But frankly, the trends we've seen since the end of the first quarter are very encouraging. And I have to hasten that, that some of the strategies that we've put in place to manage churn, which is to encourage more loyalty, really weren't getting fully put into place until the end of the first quarter. So some of the benefits of that should kick in, in the balance of the year. I would say, the key thing for us -- there's no Nielsen out there, like I'm used to looking at from my consumer products stays to look at share trends in that level of detail. But we're very pleased. We're right in line with our expectations on both gross and net adds. And as I look at the balance of the year, also the quality of the adds, as Pat said, 70% are taking advanced services. So we're continuing to see very, very positive trends in terms of the quality of the subscribers we're bringing on. And I think as we roll out our World Cup in Latin America, and some of our new products like our relaunch on Cinema, our Multi-Room Viewing and Connected Home initiatives in the balance of the year, we're going to have a lot of good innovation to talk to customers about.

Operator

And next, we'll go to Marci Ryvicker from Wells Fargo.

Marci Ryvicker - Wells Fargo Securities, LLC

Since you're using the Internet for your VOD product, how does reclassification, if it happens, entitled to impact you? I assume you're not immune to this. That's the first question. And secondly, with ARPU up 6.4%, how do we think about this going forward?

Michael White

Sure, Marci. Let me take the first one. Pat, you might want to comment on the ARPU for the balance of the year, because there's some onetime items there in the first quarter. But Marci, this whole announcement of the FCC's new approach was really kind of just yesterday. And frankly, the devil will be in the details. I haven't seen the specifics of the proposal yet. I think what's clear to us is I don't think it would impact our DIRECTV strategy. We're continuing to focus on making sure that we can enable all of our customers to connect their television to the Internet, which does enable us to offer more variety for our Video on Demand, as well as some exciting TV apps that we'll be talking about later on this year. So from our standpoint, I think we probably don't have a dog in that hunt. But on the ARPU thing, I'll turn that to you, Pat.

Patrick Doyle

Yes, I think if you look at the first quarter ARPU, the one additional January NFL game was probably, it's about a full percentage point of ARPU growth. And then I think as we mentioned, we moved up our annual price increase with about a month, which was kind of another point. But having said that, we were very pleased with our ARPU growth in the first quarter. As we mentioned, there were a lot of categories that were kind of dragging us down last year that are now positive. The guidance that we gave for the year, as we clearly expected ARPU to be up in 2010 versus about 2% ARPU growth we had last year, we now feel obviously even more confident about a year-over-year growth in that. But I wouldn't want to get in to any other specific percentages.

Marci Ryvicker - Wells Fargo Securities, LLC

Because we just wouldn't take that 6.4% and just move it forward and kind of decelerate from there?

Michael White

No, I wouldn't do that.

Operator

And next, we'll go to Richard Greenfield from BTIG.

Richard Greenfield

Just a couple of questions, one related to satellite replacement. Could you just update us on what we should be thinking about over the course of the next few years in terms of satellite that you plan to launch for business and any replacements that are going to be needed? And kind of how much of an issue that could be? And then two, just a follow up on the net versus the gross question that was asked earlier. You're obviously going to generate a ton of cash over the course of the next few years. You're talking about a gross debt leverage, but it seems like 50% to 60% of the debt that you would layer on to get to that target, you're actually going to net down with cash generated. And just curious why you're focusing on the gross debt versus the net debt as you think about -- is it kind of a target?

Patrick Doyle

Yes, on the satellite replacement, in our board meeting recently, they did approve us moving forward to procure another satellite DIRECTV 14. I mean, we view that as kind of, we're very happy with our fleet. And if you look at the average life of our fleet, but because the procurement period and build period is so long for a satellite, we felt it was prudent to start to begin thinking about replacements/back-up. Having said that, just because the payments on satellites are spread over the construction period, we still feel comfortable that, that fits into the kind of $500 million to $600 million kind of non-set-top box CapEx that we've talked about before. I've said I think we'll probably -- once the D14 gets done or close to done, we may be thinking about another one. So we may be on a cycle where we've kind of got a satellite being built all the time. But again, the payments would not be material in the big scheme of things of our CapEx. On the net and gross, Rich, the way we look at it, I mean, when we get to kind of the equilibrium that we're looking for, ideally, we would like to be at some minimum cash balance for our business. And we characterize that, probably somewhere between $500 million and $1 billion of cash on hand. So we don't really -- when you talk about gross and net, from our standpoint, they will squeeze down to a very small number over time, because our goal would be to redistribute or return all of the excess cash, which would include cash generated from the business, cash generated from these financings, down to kind of a minimum cash on hand that we would keep on the balance sheet. We really look at it at gross, because again, our goal is to work ourselves down to an appropriate minimum cash balance.

Michael White

And I think, as Pat pointed out in his remarks, look, this is a work in process, and our cash flow is a work in process. Obviously, as cash flows grow, that'll -- that's one area that we'd look at. And second, as Pat said, Latin America has cash that's not included, but we need to look at our tax strategies there. So we're looking at all these things, but we simply felt it was prudent at this time to be clear that our intent was to get to that leverage target by the end of next year through share buyback. What we do beyond that, I'm just saying it's premature for us to come forward with what we continue to look at that, and discuss that with our board this summer.

Operator

Our next question comes from John Hodulik from UBS.

John Hodulik - UBS Investment Bank

I guess my question is, I guess it's less and less relevant. But with the Frontier-Verizon deal and the CenturyTel-Qwest deals pending, potentially, you could lose a portion of your wholesale distribution with the sellers. First of all, I guess, the two-part question, are there any protections in your current contracts that can sort of extend your relationships with the sellers beyond the date of a transaction? And then two, do you get a chance to potentially form a new relationship with the buyers? Are there any discussions going on that could potentially allow you to actually extend the relationships in your wholesale distribution?

Michael White

Sure, John. First of all, in those two cases, Frontier, we've already been in discussions, and frankly, we're done. We have re-upped with them for the existing -- the business that we have with Verizon, that contract will continue now. We kind of changed the contract, but that deal is done. So there's no issue of our losing the Frontier business.

John Hodulik - UBS Investment Bank

So your contract with those lines that are moving to Frontier is extended for a number of years? Have you guys...

Michael White

Several years, yes. And then in terms of the Qwest business, which we have, we've been very good partners with Qwest. We really are pleased with the relationship. We've reached out to speak to both the Qwest and the Century folks about continuing that relationship. And I think we'll see how things evolve in those discussions, but we have a substantially long-standing relationship with Qwest. And I think they're pleased with how we performed, and we certainly look forward to continuing to build on that relationship in the future.

Operator

Our next question will come from Morgan Stanley's Ben Swinburne.

Ben Swinburne - Morgan Stanley

I wanted to ask Mike, last quarter, we talked about balancing growth and profitability, and how you sort of thought about those two. And at least this quarter, if I look at your numbers, it seems to me, you're skewed maybe a little bit more towards profitability. You clearly showed the pricing power of DIRECTV's product, but you also managed the cost aggressively, as you acknowledged earlier churn maybe a little bit higher than expected. Could you just sort of update us on how you think about those trade-offs, now that you're a few more months into the game?

Michael White

Yes, I mean, it's a realtime kind of thing you look at. And actually, we look at it on a weekly basis in terms of how we get the right balance. And I think that, as I said earlier, there are a number of initiatives that we've put in place to improve our retention, some of which didn't hit until either the end of the first quarter or even the beginning of the second quarter. But I think it's a balancing act. We're quite comfortable that we've done the prudent thing financially in terms of our pricing decision that we still have a great value for consumers. And again, we still have 925,000 gross adds in the first quarter. That's a lot of gross adds, even if it's a little bit below prior year in an absolute sense. So to be honest with you, I actually was quite happy with the gross adds. I think we're continuing to work on the churn. And as I said, the good news on the churn is, some of those initiatives that we put in late in the quarter are already taking effect, and we have seen some improvement in the second quarter already on our churn number. So I think I feel pretty good about the balance. I still feel that our most important priority is to continue to retain our great subscribers that have been loyal over the years and then continue to bring the service to others as we go forward.

John Hodulik - UBS Investment Bank

Pat, going back to the balance sheet, I have one question about the $3.5 billion buyback plans you announced last quarter. Is that the limit you can do this year? Are you still planning to do that this year? Any update there? And then you had mentioned in your prepared remarks that you might be able to extract more cash or put some leverage at DLA. I just wanted to know if you could sort of size that up or help us think about how you're looking at that opportunity?

Patrick Doyle

Sure. So on the $3.5 billion, I think we've talked before about just trying to make sure we condemn the middle of the fairway on some of the tax rules. I think we clearly are. But we also think if we finish the $3.5 billion before the end of the year that we could add on to it and continue to do a little bit more share repurchase before the end of the year in addition to the $3.5 billion. And thinking about Latin America, we've talked to the rating agencies. Again, we've got kind of a lot of work ahead of us on just getting the U.S. leveraged up to 2.5x. But we're just kind of looking at, as Latin America, again, continues to grow, continues to grow EBITDA, free cash flow. Today, they're not generating that much, because they're in a heavy growth mode. But we think by kind of the time we get to the end of '11, the DIRECTV Latin America would be another asset that would allow us to either put it into our combined credit or look at other options to also leverage that EBITDA at 2.5x, to kind of continue to be able to return cash to the shareholders. So a lot of work left on that, but we certainly have done a fair amount of exploring and talking to the rating agencies as well about our options.

Operator

Our next question will come from Bryan Kraft from Cross Research.

Bryan Kraft - Credit Suisse

I guess as you look at second quarter, if my math is correct, it appears we could see negative net adds in the second quarter, and that's assuming a smaller year-over-year increase in churn as compared to the first quarter and kind of a similar sequential change in gross adds as we've seen historically in the second quarter. I guess what I want to ask is, is that the right way to think about at that or do you think that the improvement that you're seeing in churn in the second quarter so far is going to be enough to keep net adds positive into the second quarter.

Michael White

Well, certainly, I'll start, and then Pat, you can chime in. Let me be clear, Bryan, we're not expecting a negative quarter in the second quarter on net adds. You can always have something happen in the economy or the competitive environment or even the market, I guess, as it's happening as we speak, that could change that, but that is certainly not our expectation, first of all. And second of all, as I mentioned, one of the key elements, which is churn, is already appears to be improving over the first quarter a bit. So certainly from my standpoint, that is not my expectation. I still expect we'll see a positive quarter.

Operator

We'll go on next to Jeff Wlodarczak from Pivotal Research Group.

Jeff Wlodarczak - Wachovia

Since the exit of Dr. Malone, have the credit agencies changed their tone on what's the reasonable target leverage for you guys? And is there any realistic reason why your target leverage level shouldn't be as close as something, say, like a Time Warner Cable?

Michael White

Jeff, first of all, we haven't had a discussion with the credit agencies since then. I'm sure they'll continue to evolve their assessment of us. But I think that's a judgment for the credit agencies to make, but it isn't lost us that one could look at it at a slightly higher EBITDA leverage target down the road. Again, first things first, let's get our balance sheet at least to where we've been approved by the credit agencies at 2.5x. I think we'll then take a look at the entire external environment and decide where we ought to go from there. But we're certainly aware of where TWC is. And for right now, I would say, our focus is just get our balance sheet appropriately leveraged, so then we can kind of proceed.

Jeff Wlodarczak - Wachovia

And then one on DISH. One of the reasons they've been doing better is they've got great success among the independent dealers. What are you guys doing to try to reverse that trend?

Michael White

Well, we had a terrific convention, or what I'll call, revolution with our dealers in Dallas that I spoke at a couple of weeks ago. We showed them a lot of new products, a lot of innovation and a lot of new programs that we're quite excited about. And so I mean, the dealers are a very important part of our network and ecosystem here. We value what they do. I had a chance to meet with a number of them, both individually and collectively in Dallas. And they all seem very enthusiastic about the new services that we were talking about, the Multi-Room Viewing, the DVR Scheduler app that we have on the iPhone, as well as the training materials that we were providing them and kind of the deals that we have with them. So I'm actually quite optimistic about how our dealer network will perform, balance of the year.

Jeff Wlodarczak - Wachovia

Is part of the reason why you have that targeted marketing programs, is that specifically focused on the dealer network, or is that something beyond that?

Michael White

Well, we're looking at each of our channels, and I'll leave it at that for right now.

Operator

Our next question comes from Todd Rethemeier from Hudson Square Research.

Todd Rethemeier - Soleil Securities

I noticed the G&A cost dropped almost 20% sequentially on a consolidated basis. Just wondering what was going on there and what's a good run rate to use for the rest of the year?

Michael White

We didn't pay any of the management. No, sorry, Pat?

Patrick Doyle

No, I think if you're looking at a consolidated basis, we have the effects of Venezuela, of the transaction losses of repatriating cash out of Venezuela. I think kind of from an overall perspective, as we look at G&A outside of onetime items, we certainly are -- our goal is that G&A grows at a rate that's slower than the revenue growth, that ideally, we would like it to be a lot slower than the revenue growth.

Operator

And we'll now go back to Tom Eagan from Collins Stewart.

Thomas Eagan - Collins Stewart LLC

Just to revisit the question on competition, where do you see your voluntary churn subscribers going? Are they going again to dish? Are they going to cable? Or is it telco? I noticed that DISH has rolled out a pretty aggressive promotion over the past month, and if you've seen any impact on that.

Michael White

No, we haven't seen any impact from that promotion, Tom. And frankly, when you look at where they're going, it's pretty equal across-the-board. It's not one versus another. As I said, you see somewhat higher churn rates in areas where there's a kind of a major rollout going on, from either files or from U-Verse, although the files territories are kind of now settling down. So I don't think I could kind of point to one specific competitor or another. I think it's very clear, there's lots of competitors in our video space. We all compete hard for the customer. And the best way we can compete is to continue to innovate with new products and services and provide a great value for our subscribers.

Thomas Eagan - Collins Stewart LLC

And then just lastly. If you could talk about where you are in your discussions with TiVo about rolling out any new service.

Michael White

Sure. I mean, we've had an ongoing series of meetings with Tom Rogers and the TiVo team earlier this year. We're in the process of working with them. We've provided them specs for our box. And I think we expect them to have a box for us, an updated box, maybe the end of this year, maybe early next year. And probably don't know the specific date that Tom's got targeted, but we're working closely with them, and certainly expecting to see a new box out of them that would work on DIRECTV, sometime in the not-too-distant future.

Thomas Eagan - Collins Stewart LLC

Any thoughts on how the service or the futures would differ from what TiVo is rolling out now with RCN?

Michael White

To be honest with you, we're all working on a lot of the same things. I mean, we've got demos that we've looked at internally that include television apps that would enable you to look at YouTube on the television, that would enable you to do things with movies and photos, that do Video on Demand. So a lot of the same, what I'll call, the connected experience across your screens, we believe is quite strategic, and it's something we'll talk about as we kind of compete our strategy later this year. But the good news is we've been working on this area over the last year or two, both with our Home Media Center and our Multi-Room Viewing, and you'll see more of that later this year. But to be honest with you, I didn't see anything in the functions and features, and we did see a demo of it, that was materially different in functions and features than the kinds of functions and features we've been looking to build into our Home Media Center in our Connected Lifestyle.

Operator

Our next question will come from Matt Harrigan from Wunderlich Securities.

Matthew Harrigan - Wunderlich Securities Inc.

You made a passing comment, I think, being a little bit coy about some targeted marketing initiatives fairly shortly. Would that be relating to the MDU side as you crafted more of a marketing and a tech strategy for that? And then secondly, I think Mike alluded to taking a disciplined approach, perhaps to looking at some new international markets even beyond Latin America if the opportunity really presented itself as part of your strategic review. With everything going on right now, and you being on such firm footing relative to some other players, would you selectively look at some international markets or do you think it's just too crazy in this world we're in right now?

Michael White

Matt, on your first question, and I think I just said, generally, that we're looking at channels for some targeted holistic strategies. And certainly, areas like commercial and MDU are certainly among those areas that we're working on for those kinds of things. So I wouldn't say it's only that. But suffice it to say, we think it's really important that we retain our good subscribers first and foremost. So retention strategy is first in the priority list, and then second, are looking for selected channels and strategies where we might grow our business, and MDU is a good example of that. But I think it's a bit premature for me to go into any more specifics on that at this time. On the international question, we did do some work. Bruce Churchill and his team did a kind of a bit of a scan around the world, and we've done some preliminary thinking and discussing about what the findings of that were. To be honest with you, one of the first observations, I guess, after we got done with the review that I had was, boy, Latin America is even better than I thought. I mean, both because of the opportunities that we have to invest down there. And second, because in so many other countries, there are significant restrictions on foreign ownership. In a number of cases, you can't have any. And so I think, frankly, our conclusion was after a looksee, that there may be opportunities down the road in emerging markets that will pop up and we will continue to look at them outside of Latin America. But I didn't see anything eminent or of a focus that we would chase immediately. As I said, if anything, I think both Bruce's and my conclusion was, boy, let's double down in Latin America. We got a great opportunity there, and we have a reasonably favorable regulatory environment for pay TV, and still tremendous penetration growth potential, and also new products and services potential: bundling, Internet, content, all kinds of ways that we can play.

Operator

And we have time for one more question today, and that will come from Mike McCormack from JPMorgan.

Michael McCormack - JP Morgan Chase & Co

Just a quick question on your thoughts on gross adds. Obviously, second quarter, potentially, at least on a year-over-year basis, pressured by the DTV last year. But what should we be thinking about in the third and fourth quarter of the year of gross add basis when compared to last year?

Patrick Doyle

Yes, I mean, again, I think that we haven't given out any specific gross add targets for the year. I mean, like I said, I think that we expect gross adds to be down year-over-year as we go through the year. I think as I said in my notes, I think the first quarter was kind of the toughest year-over-year comparison with, not only digital transition, but we had kind of a blowout first quarter Q1 of '09 when the competition was a little bit on their backs and we took advantage of that. So we haven't given out any specific guidance, but down year-over-year, but again, not on a percentage basis as much as the first.

Michael White

That's the U.S. business, Mike. I mean, the Latin America business is going to have a terrific quarter. In fact, Bruce is already trying to get Pat change the fiscal year-end to June 30.

Operator

This does conclude today's DIRECTV First Quarter Earnings Conference Call. You may now disconnect your lines, and have a pleasant afternoon.

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