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

DIRECTV (NASDAQ:DTV)

Q2 2010 Earnings Call

August 05, 2010 11:00 am ET

Executives

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

Michael White - Chairman, Chief Executive Officer and President

Jonathan Rubin - Investor Relations

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

Analysts

John Hodulik - UBS Investment Bank

Spencer Wang - Crédit Suisse AG

Richard Greenfield - BTIG, LLC

James Ratcliffe - Barclays Capital

Jason Bazinet - Citigroup Inc

Timothy Schlock - Wells Fargo Securities, LLC

Ben Swinburne - Morgan Stanley

Douglas Mitchelson - Deutsche Bank AG

Matthew Harrigan - Wunderlich Securities Inc.

Thomas Eagan - Collins Stewart LLC

Jason Armstrong - Goldman Sachs Group Inc.

Operator

Good day, ladies and gentlemen. My name is David, and I will be your conference operator today. At this time, I would like to welcome everyone to the DIRECT Group's (sic) [DIRECTV's] Second Quarter 2010 Earnings Conference Call. [Operator Instructions] It is now my pleasure to turn the call over to your host, Mr. 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 Second Quarter 2010 Financial Results and Outlook Conference Call. 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, Bruce and Pat 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 SEC's Regulation G that requires companies reporting non-GAAP financial measures to reconcile those 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, Jon, and thanks, everyone, for joining us on the call this morning. Overall, I thought our second quarter results in both the United States and Latin America were very strong and reflects solid execution of our key three core strategies for creating shareholder value.

First, we're generating very solid topline growth, driven by the strength of our brand, as well as an unrivaled suite of compelling products and services. In that regard, DIRECTV's consolidated revenue growth of 12% leads the industry and is due in large part to our company's portfolio of businesses all across the Americas, reflecting diverse geographies, demographics and growth profiles.

Second, of course, our traditional focus on operating excellence, which is driving strong margins and cash flow growth. There, both of our U.S. and Latin American businesses grew their margins in the second quarter. Our earnings per share increased 50% excluding the impact from the Malone transaction, and our year-to-date free cash flow was up 40% to $1.4 billion.

And third, as we spoke to you on our last call, we're continuing to execute our strategy of aggressively returning capital to shareholders. As you saw in the earnings release, we repurchased over $1.7 billion of stock in the second quarter, representing one of the largest quarterly share buybacks in our history.

Now before turning the call over to Pat and Bruce for a more detailed review of our U.S. and Latin America businesses, let me just offer a few observations. First, starting with Latin America. While, clearly, we expected a strong quarter, I think it's fair to say that net additions of 415,000 exceeded all of our expectations. And to put that number into perspective, it was more than 3x the net additions of a year ago and over 60% higher than our previous record set just two quarters ago. The FIFA World Cup, coupled with a relatively strong macroeconomic landscape, propelled a lot of that growth. But we're also continuing to see very solid momentum across the entire region driven by our industry-leading HD and DVR services, as well as popular postpaid and prepaid packages.

I was also extremely pleased to see that even with that rapid subscriber growth, Bruce and his team were able to significantly increase their operating profit before depreciation and amortization, and the margins by over seven percentage points to almost 31%.

Now I think we also had a very solid results with our U.S. business. Furthermore, we saw some key trends develop in the quarter, particularly in the areas of both subscriber and ARPU growth that, I believe, position us well for the second half of the year.

Our net additions of 100,000 were a touch better than our expectations. But importantly, gross adds and churns strengthened throughout the quarter. We're becoming much more targeted in our marketing strategies as well as our new promotions, which is enabling us to drive higher gross additions with much greater penetration of both HD and DVR services. Due in part to our free HD offer, which was introduced at the end of the quarter, we reached a record high penetration level of over 70% in the quarter for new subscribers activating with advanced services. So they're very high-quality subscribers.

We're also very excited about the additional demand that will be generated through our new partnership with CenturyLink, which was officially launched just this past Sunday, and we're off to a terrific start already taking orders. I might also add that we have exclusive distribution in 12 out of the 13 states that Frontier operates in, and we have an excellent partnership with them as well.

In addition to growing demand for new subscribers, I think we're also doing a better job of retaining existing subscribers. Our monthly churn rate of 1.51% was equal to prior-year's second quarter, breaking a five-quarter trend of higher year-over-year churn rates.

Much like our strategy with gross additions, we're taking a much more targeted approach to managing churn through improved segmentation. And as a result, we saw a reduction in voluntary churn for the first time in nine quarters. I believe this decline is also due to our improved customer service and boxed reliability efforts.

ARPU growth was an equally strong story in the quarter. The favorable trends that we talked about on our last earnings call, particularly regarding premiums, Pay Per View and advertising continued in the second quarter, and in some cases, strengthened even further. Premium movie revenues generated the largest favorability to our expectations in prior year. But we're also seeing very solid results in Pay Per View, movies and events. In addition, advertising revenues were very strong as we posted the best second quarter in our history.

Moving now to the bottom line, I was pleased with the nearly one percentage point increase in our DIRECTV U.S. operating profit before depreciation, amortization margin to over 28%, representing our highest margin in two years. We're continuing to execute well in areas such as programming, subscriber services and upgrade and retention marketing.

Our SAC was a bit higher than we would've liked. However, I must point out that most of that increase is related to business decisions that we consciously made to provide our customers with advanced equipment, which improves both long-term customer loyalty, as well as topline growth.

For instance, roughly 2/3 of the year-over-year increase in SACs for the quarter was due to the higher penetration of advanced services that I mentioned earlier, as well as additional investment that we announced late last year related to new services such as our Whole-Home DVR. As a point of reference, we saw our HD penetration rate increase almost 50% after we launched our free HD offer to new consumers.

We'll continue to make these investments in a financially prudent fashion to ensure that we capture the appropriate returns. It's no coincidence that many of the favorable ARPU and churn trends discussed earlier relate to the increased SAC investment we've made in previous quarters.

Now before turning the call over to Bruce for some remarks about Latin America, let me just wrap up with an update on a couple of other important items and an overview of our key priorities for the second half of the year. First, we're making terrific progress in our company-wide strategic review. Earlier this week, we had a chance to have a very constructive two-day strategic retreat with our Board of Directors, and we look forward to sharing some of our thoughts with you in the fall at our Investor Day.

We're also making very good progress on adding new Board members. Last month, I was delighted to be able to add Sam DiPiazza to our Board. I've known Sam a long time. He brings a wealth of experience and expertise, and most recently served as the Global CEO of PricewaterhouseCoopers International from 2002 to 2009. We're working hard to continue to fill the remaining Board seats, and we hope to land a couple more Directors before year end.

In terms of my top priorities for the second half, I guess I'd go back to the opening comments I made about our core strategies for creating growth and shareholder value. First, we either continue to reinvigorate growth at the top line by delivering on our goal of making DIRECTV the best video experience in the world. Specifically in the second half, that includes building on and extending our industry-leading position in HD, 3D and mobile sports. As you may have noticed, last quarter, we launched three dedicated 3D channels and added 30 new HD channels for the extra capacity provided by our new satellite. We've also just launched our popular NFL SUNDAY TICKET promotion with more value and features than ever before and a terrific ad campaign, and I'm very excited about that.

We are now including all of the services that used to be part of our SuperFan package including games in HD and the Game Mix and RED ZONE CHANNELS at no extra charge to our customers. And we're also introducing an NFL SUNDAY TICKET TO-Go service for about $50, which will provide live-streaming video of the games on mobile devices like the iPad or via a computer through directv.com.

Also in the second half, we intend to increase penetration of newer services such as our Whole-Home DVR, as well as services requiring an Internet connection to our receivers. And later this year, we'll introduce a greatly enhanced DIRECTV Cinema service that's designed to not only take share from other movie services, but most importantly, to significantly improve the overall movie experience for all of our DIRECTV customers.

Finally, and perhaps most importantly, we'll continue refining and improving our segmentation strategies for how we acquire and retain customers so that we optimize our subscriber growth opportunities. In addition, we'll continue to have a heightened focus on increasing productivity, operational excellence and driving operation efficiencies. Whether these come in G&A, our call centers, our installation network or anywhere else across our enterprise, it's critical that we strive for operating excellence to counter out some of the cost pressures that we've seen in areas such as SAC and overall programming expense.

And finally, we'll continue to repurchase stock in an aggressive fashion while pursuing our goal that we announced last quarter of attaining the leverage ratio of 2.5x total debt to EBITDA by the end of next year. That goal will be facilitated by the recent approval from our Board of Directors to authorize an additional stock repurchase program of $2 billion.

In summary, as you can see from our updated guidance, we remain bullish on our growth prospects for both the U.S. and our Latin American businesses. Although the economy and competitive landscapes continue to be challenging, we're building on strong operating momentum. We're just now frankly starting to capture some of the benefits related to a few of the key initiatives that we implemented earlier this year. Or perhaps even more exciting, I think, are the many great ideas that are coming out of our strategic reviews that I believe position us well and provide the potential to further boost our growth in both the U.S. and Latin America for many years to come.

With that, let me turn the call over to Bruce Churchill for some comments about our Latin American businesses.

Bruce Churchill

Thanks, Mike. As you saw from the release this morning, the World Cup impact on our business was everything we expected it to be and then some. The 660,000 growth additions and the 415,000 net additions easily broke previous records and our average monthly churn rate of 1.63% was the lowest second quarter rate in three years.

The results are strong across the entire region, particularly in Brazil, Colombia and Venezuela, where all three countries experienced a roughly fourfold increase in net additions compared to last year. Argentina's net additions were more than doubled. Our prepaid services continued to gain traction across the region, but the vast majority of our growth came in postpaid. Approximately 80% of total gross adds in the quarter were for postpaid packages, similar to the second quarter of 2009, as well as the first quarter of this year. The point of reference, prepaid subscribers currently make up approximately 10% of our 5.2 million consolidated subscribers. Much of the growth we're seeing in postpaid packages is being driven by the sale of advanced services. About 30% of our gross adds signed up for HD and/or DVR services in the quarter or roughly double the penetration level of the year ago. And from an absolute perspective, the number of gross adds taking advanced products with nearly 4x that of the second quarter of 2009.

HD continues to fuel much of the growth in advanced services as well. Brazil continues to have the greatest HD penetration in the region due to the fact that we offer 3x as many HD channels than anyone else in the market. However, we're now seeing very strong HD demand in PanAmericana as well, particularly in Argentina. When you combine HD and standard definition DVR sales together, we're now seeing over 40% of our new subscribers in PanAmericana signing up for one or the other of these advanced products.

Our monthly churn rate also greatly benefited from the World Cup as postpaid churn fell 14 basis points than a year ago to 1.45%. In addition to the strong subscriber results in the quarter, our financial results were also very solid. The 26% increase in revenues was mostly due to subscriber growth, and we also saw some favorable pricing trends in the quarter.

Excluding the impact of foreign exchange, ARPU growth would have been around 6% driven by price increases, higher sales of advanced services and lower promotional discounting, thanks to the World Cup. OPBDA was also very solid as it increased 66% over last year's results. Majority of the growth was due to the gross profit on the incremental revenue as well as lower charges related to the repatriation of cash from Venezuela. These improvements were partially offset by higher subscription acquisition costs related to the record gross additions. Subscriber-related CapEx on the new additions increased by over $15 million compared to the second quarter of 2009.

Regarding Venezuela, as many of you know, beginning in May, the government implemented a series of regulations that included banning the use of the so-called parallel market for converting bolivar to U.S. dollars. This move restricted our ability to repatriate dollars, which partially explains the lower foreign currency exchange losses this year compared to last. However, the amount of cash on hand in Venezuela is quite modest, reflecting the fact that we had been very aggressive in pulling cash out prior to the change in regulation. The currency-control situation in Venezuela remains fluid, and obviously, one we will continue to monitor. It remains our policy to repatriate as much excess cash as we legally can.

To wrap up my discussion on the quarter, I would like to touch briefly about the results on Mexico, which we do not consolidate. Those of you in the call with Televisa last month, you know that Sky Mexico also benefited significantly from the World Cup, adding 251,000 subscribers in the quarter compared with only 9,000 a year ago. Including these results, our Latin American platforms now exceed 7.6 million subscribers. Revenue and OPBDA growth of 26% and 21%, respectively, were also very strong in Sky Mexico.

In summary then, it was a very strong and balanced quarter. We had good operating results from all three platforms, a good mix of product sales and strong financials across the board.

Moving on to our full year outlook. With the strong first-half behind us, it's now a good time to update our full year guidance. In terms of subscribers, we now expect to add approximately 1 million subscribers this year or roughly the same as the entire U.S. pay-TV industry expects to add this year as well. I expect the fourth quarter will be stronger than the third given normal seasonality, and the fact that the timing of the World Cup, no doubt, accelerated some sales into the second quarter from the third. And as we've talked about on the last call, we remain very focused on keeping churn under control after such tremendous growth over the last several quarters particularly in the prepaid service.

Moving on to revenue, growth is up nearly 30% year-to-date, but we will be facing tougher comparisons over the remainder of the year. In the first half of this year, the favorable year-on-year comparison for the Brazilian KI helped mask the negative effect of the devaluation in Venezuela. This will not be the case for the second half of the year. However, combining our strong first half revenues with what is likely to be a slower growing second half, yields a full year revenue growth target of between 15% and 20%, which is substantially higher than our original revenue growth guidance of about 10%.

OPBDA also faces more difficult comparisons in the second half, but we'll benefit from the solid revenue growth and lower transaction charges in Venezuela. Therefore, consolidated OPBDA should grow approximately 45% for the year to about USD $1 billion.

And finally, many of you are aware that our partner, Globo, has exercised its right under our shareholder's agreement to sell 19% of its 26% interest in Sky Brazil to us. We are currently working through the process that was agreed to in 2004 to determine the fair value of Sky Brazil, and we expect to close this transaction in the next few months. And with that, I'll turn the call over to Pat.

Patrick Doyle

Thanks, Bruce. Much like Latin America, I thought our U.S. business also had an extremely strong quarter, highlighted by solid revenue, earning and cash flow growth.

Looking first at the top line, revenue growth of 9% was solid and was driven mostly by ARPU growth of 5.7%, which at $87.90 was a bit higher than our internal target. Premiums, Pay Per View and advertising sales were particularly strong in the quarter. For the first time in several years, our year-over-year buy rates increased for premium movie channels. Although some of this improvement reflects the low buy rates from a year ago, a significant portion of the growth relates to superior execution by our marketing and call center teams.

In addition to premiums, we also saw a solid year-over-year growth in Pay Per View movies, as well as higher Pay Per View event revenue, boosted by the Mayweather-Mosley fight in May. Finally, advertising sales were up almost 20% as we posted our best second quarter ever.

Much like ARPU, net subscriber additions of 100,000 were also a touch better than our internal projections due to solid execution, but also from some of the promotions we've introduced such as Free HD.

Our direct sales and retail sales channels have been performing better, which is offsetting the continued decline from our telco partners. Last year, telcos reached as high as 25% of gross additions while their contributions now are running five to 10 percentage points lower than those rate. As we've discussed on the last earnings call, this decline is related to several factors including the continued rollout of FiOS and U-verse, as well as the decline in their landlines, which result in fewer incoming calls and sales opportunities at their call centers.

Looking forward, we certainly expect that our new partnership with CenturyLink will boost sales in the telco channel. For those of you who may not be familiar with CenturyLink, they are currently the fourth largest telco, and upon completing their pending transaction with Qwest, they will become the third largest. They currently cover around 5 million homes in 33 states, so this is a very exciting opportunity for us.

We're also pleased with our monthly churn rate of 1.51%, which for first time in five quarters, did not increase on a year-over-year basis. We're now managing churn in a much more segmented and targeted fashion, with a particularly sharp eye on those higher-valued subscribers who have the greater chance of voluntarily leaving DIRECTV. A good example would include customers rolling off of their two-year commitments in U-verse or FiOS territory. One could also argue that we're now much closer to the so-called sweet spot of balancing churn with retention spending.

You've heard us say several times last year that we may have been spending a bit too much to save subscribers, particularly lower valued subscribers. As a result, over the past year, you've seen our retention spending declined modestly while churn increased modestly. Keep in mind, however, that this balance is highly sensitive to the competitive and economic landscape, so it's imperative that we continue to refine our policies accordingly.

Turning now to the bottom line, we continue to grow both our Pre-SAC and OPBDA margins in the quarter. Similar to recent quarters, we did a good job managing our programming, subscriber services and upgrade and retention costs. However, G&A and SAC costs were higher both sequentially and compared to last year. The year-over-year and sequential increase in G&A was almost entirely due to one-time items and a slightly higher bad debt rate. The one-time items included higher legal expenses in the current quarter and lower expense a year ago related to the forfeiture of Chase's compensation benefits when he left the company.

In terms of the year-over-year increase in SAC, roughly 2/3 of that increase was driven by the penetration growth in advanced products. We already lead the industry in sales of HD and DVR services. However, we're seeing our advanced penetration increase even further due to some of our new services and promotions. For example, our new Whole-Home DVR service requires customers to leave HD DVR equipment, which by the way, also requires our newer SWiM dish, both of which are more expensive than standard equipment. In addition, our free HD offer has been driving higher HD activation. We are comfortable making these investments in SAC because many of our new services, including Whole-Home DVR, generate incremental revenue streams for us. In many cases, these investments also improve efficiencies or lower costs.

Our SWiM dish investment illustrates this point well as it reduces labor costs by simplifying the installation, while at the same time improving the installation experience for the customer. It also reduces future upgrade costs by making it easier to drop ship receivers, if a customer chooses to upgrade equipment after activation. And it improves diagnostics of the equipment and avoid unnecessary truck rolls in the future.

It's also important to point out that customers with HD and DVR services continue to have substantially higher ARPU and lower churn than customers with only basic equipment. Separately, we had a modest increase in capital expenditures in the quarter due to mostly satellite payments for our newest satellite DIRECTV 14.

Adding it all up, DIRECTV U.S. grew cash flow before interest and taxes by 27% in the quarter, bringing the year-to-date growth rate to 40%.

I'd like to wrap up with a few comments about our outlook. You just heard Bruce's update on DIRECTV Latin America's outlook. So these comments apply to our U.S. business.

Our strong first-half results provide us with greater confidence that we will meet or exceed all of DIRECTV U.S.'s full year guidance provided earlier in the year. When comparing the second half of the year to the first half, we're looking for better year-over-year comparisons for both gross additions and churn. We continue to expect that the quarterly revenue and OPBDA growth profile this year will be, in many ways, the opposite of last year's results. You may recall that last year's revenue and OPBDA growth in the U.S. improved as the year progressed. Obviously, that profile impacts our growth rates this year.

In terms of consolidated free cash flow at DIRECTV, we are currently holding to our free cash flow growth target. Although we are well ahead of our goal on a year-to-date basis, much like with revenue and OPBDA, we will be dealing with tougher comparisons in the second half. Furthermore, we must be mindful of the impact that higher-than-planned gross additions may have on our near-term free cash flow.

Regarding our strategy for returning capital to shareholders, through yesterday, we had repurchased approximately 2.8 billion out of our 3.5 billion authorization. As you saw in the earnings release, our Board approved an additional 2 billion increase to that authorization, leaving us with about 2.7 billion for future buybacks, which should cover us for the next several months. We look forward to tapping into what is currently a relatively strong debt market as we continue on our goal of achieving a 2.5x leverage ratio by the end of next year. So at this time, I'm going to turn the call back to Jon so that we can begin the Q&A session

Jonathan Rubin

Thanks, Pat. Before moving on to Q&A, investors should note that we have members of 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 DIRECTV. In addition, we're webcasting this call live on the Internet and an archived copy will be kept on our website. Operator, we're ready to start the Q&A session.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is John Hodulik with UBS.

John Hodulik - UBS Investment Bank

First of all, on the buyback, the comment that you've -- $2.7 billion over the net that you may compete over the next several months, I guess just to confirm that, that sort of suggests you're going to complete by year end? If you could confirm that, that would be great. And then if you look out to other opportunities, obviously, the Latin American business is doing well, could you balance the -- maybe this is question for Michael, the benefits of returning cash to shareholders with other international expansion opportunities you see out there?

Michael White

Pat, you want to take the first one...

Patrick Doyle

On the buyback, I don't think we're setting any targets as far as when we would complete that. If you look at the pace that we've been running so far, we've been repurchasing a little bit more than $100 million of stock per week. That's certainly a pace we're comfortable with. But obviously, also, we'll look at the market, look at the share price and, as normal, be more aggressive when opportunity presents itself and then scale back in other time. So again, we don't have a set target. But I think if you kind of look at our past run rate, it should be fairly indicative of how you would see us going forward.

Michael White

The question on other international opportunities, we've completed a complete kind of scan of really the world and kind of looking at pay TV all across the world. And I would say, while we'll opportunistically continue to be open to ideas in emerging markets, our focus is Latin America. I think if there was one takeaway from the work we did, where we looked extensively at markets from China to India to Russia to Middle East, is that ours is a highly-regulated industry. We actually don't have that many regions of the world where you can own 100% of your business, where you actually have quality programming that consumers are willing to pay for, particularly sports. And where you got enough economies of scale over two languages, Spanish and Portuguese, that you can build. And lastly, that you've got a very, very talented and streetsmart operating team. So I would say we'll continue to opportunistically look outside of Latin America, but I don't see any imminent significant investments that we'd be making at this time. I think our focus is on Latin America, and Bruce has pulled together a very, very exciting strategic plan for that region and frankly, we continue to see strong growth potential primarily because of the low penetration rates that you still see for pay TV in Latin America.

Operator

Our next question comes from Spencer Wang with Credit Suisse.

Spencer Wang - Crédit Suisse AG

I just wanted to delve into the programming in cost growth topic a little bit. DIRECTV's programming cost per sub is in pretty moderate although it did re-accelerate. Is that mostly because of the premium buy rate improvement and Pay Per View improvement? That's question one. And second, I was just wondering if you could update us on where DIRECTV is with respect to TV Everywhere in terms of both technical feasibility as well as negotiations with the cable programmers?

Michael White

Spencer, on the programming thing, I think you're right. I mean, in the quarter, the uptick that you might have seen there would've been driven by premium channels, stuff like that. As we look at programming costs overall, we continue to manage them effectively. But they continue to create pressure overall on the P&L. I think as I look into the future, I still believe we can manage through things like retrans and other things. But I have to point out that we've got kind of a catch-up accounting on our NFL SUNDAY TICKET contract this year that is kind of creating some profits with a different kind of contract next year. So let's put how we deal with the NFL new contract as a separate item. We haven't yet made any decisions on how we're looking at next year in that regard, but certainly, that's going to create some significant one-time pressure on programming costs for 2011. That's, in my judgment, a separate issue from the rest. And on the rest, I think it continues to be a challenge, I think, for the industry as a whole, but we continue to work to manage through it. And frankly, we'd have to pass pricing to our customers to cover those programming costs increases in future. I think in terms of TV Everywhere, we have got, in laying out our strategy with our board, we've got a whole group of folks working on DIRECTV ideas. From a programming standpoint. We discussed digital rights and authentication in every one of our kind of programming contract renewals. It's a first topic for discussion in many ways. We've got our DVR schedule, that's doing very well. Probably our most imminent next opportunity is the NFL SUNDAY TICKET To-Go for $50. You got a fantastic experience on an iPad, I can tell you that, I'd seen it. I think beyond that, in my own view on TV Everywhere, when you look at it outside the home, it's going to be a journey. I mean each of the media companies has a slightly different take on it as to what content they would make available and when. We just want to make sure we're positioned well to provide our DIRECTV customers with a fantastic experience. So we're working on a number of things that will talk about at our Investor Day from a strategies standpoint to kind of bring our content to a mobile device for our consumers next year and in the years ahead. So it's one of the five priorities that we've got in addition to kind of the connected-home experience and some other areas that we'll talk about at the Investor Day.

Operator

We'll go to our next question from Ben Swinburne with Morgan Stanley.

Ben Swinburne - Morgan Stanley

I guess starting -- going back to Pat, to your comments about the second half of the year. I just want to clarify, were you expecting to see net adds up year-on-year versus the back half of '09? Or are you just being more so qualified about sort of a more bullish outlook for a subscriber growth for the back half?

Patrick Doyle

Ben, I guess what I was saying there -- I mean obviously, last year, we had kind of a blowout first quarter and a relatively strong second quarter. My comment was more like we're seeing good momentum on gross adds, seeing that continue into July. The back half of our year was more modest in our net adds. My comment has more of as we get into the second half of the year, I think you'll just see a better year-over-year comparison on gross and net.

Ben Swinburne - Morgan Stanley

And I have a follow-up for Mike, since you've come on, you had to navigate a number of sort of new promotions from Dish, and you've made some decisions around FREE HD and I think also your SUNDAY TICKET SuperFan pricing. Clearly, the numbers, first half of this year, speak for themselves. Maybe you could just talk about what went into your thought process on those two items, and generally how you approach the market from a pricing perspective. And if I could sneak one more in, there's been a lot of question about DIRECTV acquiring content or more content exposure, and I know you're on Undercover Boss later this year. But I was wondering if there's anything more to some of the rumors flying around out there, maybe you could just address that.

Michael White

I don't know. Our board was wondering whether I was going to ask for content rights to appear on future television shows, I don't think there's any danger of that. On the first question on pricing, look, ours is a very competitive industry. And as I said, I don't think we ought to focus on one individual competitor. Because frankly, we've seen a ramp-up in competitive activity over the last year, pretty much across the board, with the aggressiveness of the telcos as well as the other satellite companies. So I can't say whether -- I mean I wouldn't try and characterize the quarter as more or less of that. I just say it continues to be very, very competitive out there. I think consumers are still very price sensitive or value sensitive, I should say, and so our thinking here is we need to continue to be competitive in the services we provide customers. Now we're trying to do it in a very segmented and targeted way. So that we tackle these issues and try and figure out how do we continue to earn the loyalty of our existing subscribers, most importantly, and second, what do we need to do in tailoring our offers to ensure that it's competitive going forward. Our focus on Q3 is all around NFL SUNDAY TICKET. We've got a terrific program. Frankly, as we look on SUNDAY TICKET at the SuperFan thing that we had last year, I just didn't think that given what we asked consumers to pay for, it just didn't seem to me that there was enough value add to not provide HD as a part of that package. So that was probably more driven by just kind of a view of what's right for the customer than it was necessarily a competitive consideration. Certainly, the FREE HD was a competitive consideration, and we'll continue to look at that. Frankly, we'll monitor the competitive situation by quarter and make our decisions accordingly, but we're prepared to stay competitive and ensure that we continue to gain high-quality subs. And as you saw, I think one of the most important things was that we're so far able to manage through this in terms of generating good financial performance, while at the same time being very competitive in gaining net additions of 100,000, and by the way, very high quality adds. I mean we had record numbers of -- and HD DVR was 38% in the quarter, which is above -- it was 25% a year ago. So I mean very, very good trajectory for where we're trying to take our customers. In terms of content, look, I've said this before, and I think I'd probably continue to feel that we'll always be open and opportunistic if we look at tuck-under-content ideas. We just signed damages for the 101 channel. We'll continue to look at sports for opportunities, but it certainly don't see a big content acquisition in our future at this time.

Operator

Our next question is Jason Bazinet with Citi.

Jason Bazinet - Citigroup Inc

I think it's like five or six years ago, there was a lot of trepidation among investors that DIRECTV didn't have any sort of facilities-based assets to compete in the broadband space either terrestrial or wireless. I'm just wondering as you think about the competitive dynamics in Latin America and the regulatory differences in Latin America, do you think you'll be able to succeed as well as you have in the U.S., or the dynamic sort of different down there that would require a different strategy?

Michael White

I'll let Bruce talk about Latin America and kind of how we've been thinking about that. Frankly, in the U.S., we've had a significant focus on strengthening our bundles. And we've partnered up -- I think, we've probably got 90% of the U.S. covered now with bundles that we can provide our customers. But frankly, we're not really yet where we want to be on that, and we continue to look for opportunities to find other ways to create synthetic bundles with broadband services to our customers. I think in Latin America, it's at a different stage of evolution. Bruce, you want to?

Bruce Churchill

I think that's the probably the most important thing to remember is that Latin America lags the United States by several years. Having said that, we have been taking a very similar approach to the one that we've taken in the U.S., which is that we do have some bundles with some telcos in certain territories where appropriate. I mean, I think in general, therefore, we will continue to ride it out the way we have in the United States and see where it goes. Having said that, I would probably say that the opportunity in Latin America is much more wide open. I don't believe that in Latin America, we will see similar competitive pressure from something like a big fibre build out to the home that you've seen here in the U.S. As challenging as those economics are in United States, they're even more challenging in Latin America. So the opportunity is more wide open. It evolves differently. My guess is it will be more mobile and wirelessly based as opposed to landline based, and I think we're well positioned to fight in that arena.

Operator

The next question is Jason Armstrong with Goldman Sachs.

Jason Armstrong - Goldman Sachs Group Inc.

First, on the comment around gross adds and churns strengthening for the quarter. I'm wondering if you can talk us through that a bit more, and what caused the improvement? Was it kind of a step function around the FREE HD offering or more gradual through the quarter? And then second question, just on, obviously, very strong progress on the buyback. There's lots of talk about companies putting in a special dividend before potential 2011 tax change. If you guys, obviously, have plenty of firepower, is that something you would consider?

Patrick Doyle

On the churn and so taking churn first, I think we've mentioned that we really implemented, I think, some technology in the January-February time frame that allowed us to better target the customers that were high value and had the highest propensity to churn. And without getting into the details, it allows us to treat those customers differently when they call in to the call center, and it's been very effective. As I said in my notes, it's something that we're continuing to monitor and tweak effectiveness, but we're really gaining a lot of traction on that. And it's really -- the churn has really been more voluntary than anything else. On subs, yes, I think that we had a lot of good momentum in the quarter. As Mike said, I think when we responded in part on the HD for FREE, we put in some filters, but it resonated really well. And then we've launched our Whole-Home DVR early in June, and that was well received. So we saw very nice pick up in people interested in multi-room viewing, and we've seen that trend continue in July. It's being very well received by the new customers, as well as our current base upgrading to that product.

Bruce Churchill

Just to add on that before we get to the second question on the special dividend. Just a reminder, look, I was asked the question earlier about it. We felt the need to respond in a timely fashion to ensure that we continue to be competitive. Having said that, look, as we look at 2011, there are levers we haven't pulled yet, including box prices. And so there are a number of ways to try and create a compelling offer and respond to the competitive environment where we've got other levers that we can pull from a pricing standpoint as long as we got enough time to plan for it, which we certainly do for February. So we're taking a pretty comprehensive look at how we think about pricing and packaging for 2011 in line with our strategy that we're developing, and I still feel good about how we navigate those waters.

Patrick Doyle

And then I think on the return of capital, I think we're very comfortable with the path we're on now of share repurchase. We still think that there's very good value looking at where the price of the stock is today, and so we don't have a special dividend on the radar screen.

Operator

The next question comes from James Ratcliffe with Morgan.

James Ratcliffe - Barclays Capital

I'm wondering regarding -- you talked a little about SAC and the impact of higher-end customers. I noticed that most of the increase in SAC was on the expense side. So I wonder if you can break that down and how much of that was somewhat smaller gross add base and hence, more advertising the like? And how much was actually related to higher cost installations and higher per-customer expenses? And secondly, if you could talk a little bit about as you rollout DIRECTV Cinema and the like, how you see net neutrality and figuring into that? And if you've been having discussions within any of the broadband ISPs regarding guaranteed service quality.

Patrick Doyle

James, the first one, I guess, particularly if you look at the increase in SAC year-over-year, probably about 2/3 of that increase is about more on what we would call the hardware side, the advanced product side. But you also have to remember even in that light, we don't capitalize the Dish or the SWiM Dish as well, which is an expensive product which is used in all of the HD installs, including the Multi-Room Viewing product. So even though you see some stuff that, like we said, may show more on the expense side, a lot of that is still being driven by customers, with us investing more in the customers home and advanced products. We see little bit too of just a mix, with the telcos were generally of lower overall SAC and has their volume declines and is replaced by retail and other channels, you get a little upward pressure there. But again, the vast majority of that increase is coming from investment in the home, which we mentioned before we're very comfortable in.

Michael White

On the second question, James, one of the key strategies that we're kind of flushing out right now is the connected-home strategy, i.e. connecting the television set to the Internet. And frankly, we're having terrific success. We've almost got 800,000 of our customers connected, and in the quarter, we had 70,000 connections to the Internet that we added in the quarter. So I mean there's no doubt that as we look at our future vision for the home, that we want to connect the box to the Internet. And we want the consumer to have an HD DVR, so they can get the full DIRECTV experience. The net neutrality debate, it's all tied up in what are you really talking about. Are you talking about discriminating on specific content? Or are you talking about not allowing pricing for heavy users? And frankly, on the latter point, I think, if 5% of the users are using 50% of the iPhone bandwidth, you got to find a way to price appropriately or you won't have -- I mean, capital won't invest. I mean that's kind of 101. On the other hand, I don't know enough about where they'll end up in the decisions they make with the FCC. So we're really not a player in that, but we're certainly eager to partner in providing Internet services to the homes of our customers with compelling and simple broadband bundles. And frankly, I think you'll see us looking to connect more of our homes to the Internet as we work forward on that.

Operator

We'll take our next question from Marci Ryvicker with Wells Fargo.

Timothy Schlock - Wells Fargo Securities, LLC

This is actually Tim Schlock for Marci. The first one, can you kind of discuss what you're seeing in the ad environment during Q3? And then the second one is, I noticed that your ARPU has been up roughly 6% in both Q1 and Q2, do you think that trend can continue for the rest of the year? Or do you think there can be kind of a pullback in Pay Per View?

Michael White

I'll let Pat take the second one. On the first one, Tim, I mean our ad environment was quite strong, and we had high-teens growth in our ad revenues. And we're also doing some things differently. We've got a terrific ad sales team under Bob Riordan. And there are a number of things on the ad sales part that you got to separate. It's been a good market for ad sales, certainly, but I also would say, historically, at DIRECTV we've been a little under penetrated in ad sales. And frankly, I still think that's a huge strategic opportunity for us, and it's one of the areas of strategy that we're flushing out is how we capture more of the ads space, particularly, local advertising we think is a big opportunity, as well as interactive adds as we go forward. On the ARPU, Pat, do you want to?

Patrick Doyle

On the ARPU, I guess, in the first half of the year, a couple of things to remember though. The first quarter was helped by the extra NFL game that we hadn't seen in the past. But yes, I think the ARPU in the second half of the year also goes with some of my comments I made earlier. We started to see ARPU improve in the second half of last year, even more like Mike was talking about ad sales. Ad sales was doing very well, but it also started to improve in the second half of the year. So again, I see that we feel good about our revenue growth in the second half of the year in ARPU, but we probably won't see a strong a growth in the second half just because of the kind of the year-over-year comparisons.

Operator

Our next question comes from Richard Greenfield with BTIG Financial.

Richard Greenfield - BTIG, LLC

One on your cable peer seem to now be kind of openly admitting with their interface or user interface for their product is really not so good, and that they're actively looking for ways to improve it using what they call simple technology on Android phones and iPhones and iPads. I'm just curious how you think about that, what you're doing in that space? And whether you think they're simply catching up to where you are or you need to move substantially further as well. And then just, Mike, you were talking about the SUNDAY TICKET and kind of just your gut reaction of how to price it. I was wondering, you've got this product in Manhattan called SUNDAY TICKET Manhattan for online only. I'm curious, what do you think of the pricing of that? I think it's a $3.50 for this coming season, and whether you're going to try to roll that out more broadly than just New York City?

Michael White

Sure. On the first question, on user interface, it's a whole connected-home strategy. You'll be seeing a lot of work coming on our user interface both later this year when you see the new Cinema interface. You'll get a little peek into how we're thinking about user interface, but I can tell you that we're not standing still. Well, I don't think you can stand still in our business. The world's constantly changing, and you got to run faster. And I'm very excited about some of the work that Romulo Pontual's engineering team is doing in looking at some significant improvements in our user interface next year. We're working on ways to increase the speed for changing the channel. We're looking at picture in picture. We're looking at how you personalize potentially the interface to your TV. We're looking at recommendation software. We already have the best smart search, the best search engine out there. I think there's lots more that we can do with our user interface that you'll be seeing over the next 18 to 24 months, I would say, that I'm very excited about, and it's a big priority for us as part of our connected-home strategy. On the NFL SUNDAY TICKET, we did the Manhattan thing a year ago. We didn't get a huge take on it, frankly. I'm not sure whether that was just that there's not much demand for it or whether we didn't market it as well as we might. We're going to extend it a bit this year, and we'll see what we learn this year. I think, certainly, as we look beyond this year, it's kind of late to go in and try wholesale change things. But as we look beyond this year, we continue to look for ideas for ways to monetize our NFL SUNDAY TICKET rights to help pay for the contract, and there are number of ideas that is probably a little premature for me to talk about as we're really not sure yet which next idea we might chase as we look at ways to provide that experience to more customers. So I think for this year, we'll take that Manhattan test a little bit further, make it available on a national basis. Let's see what kind of a take we get, but it's a bit of a slippery slope on the pricing part of it because -- I mean if I'm controlling it, we're out to see. I mean it's a little bit of one that -- we got to see how much of a demand there is. I'm not convinced, frankly, from a price elasticity standpoint that if I price it $300 to $350, it would make that much difference in the number of subscribers. And to price it much below that, I'd undercut them either mine or existing 2 million customers that take in NFL SUNDAY TICKET. So I would say we're in a learning mode on that. But rest assured, it is an area that we're looking at and try to figure out what the right next step would be, which I think you'd more likely see anything more aggressive we would do next season, not this season.

Operator

Our next question will come from Doug Mitchelson with Deutsche Bank.

Douglas Mitchelson - Deutsche Bank AG

You mentioned 2.5x total debt to EBITDA, Michael, as you target -- wasn't it U.S. EBITDA last call? I just want to make sure that was accurate and...

Michael White

That's right.

Douglas Mitchelson - Deutsche Bank AG

What's your understanding of why Global is choosing to sell the minority interest in Brazil at this point. I mean it looks like you got very strong growth down there. It seems like the wrong time to sell, so what are we missing there? And then further to Jason's latter question on facilities-based competition, you talked about connecting more boxes to the Internet. Historically, in the U.S., it seems that you had -- your customers have been more likely to be DSL customers, and cable customers are even more likely to cable high-speed data customers. And with cable high-speed data taking pretty meaningful market share right now, does that clearly the headwind for you at some point, given that history?

Michael White

First on the Global thing, I think you have to ask them why they want to sell. But certainly, I think you should be aware that they sold down in cable before. So I mean it sold down all of their distribution equity positions, and at least in my discussion were report to Murano [ph] when he brought it me was more about the kind of the state planning, I think, for the family than any judgment about the business. And frankly, they also have a contract with us where they're going to have to exercise somewhere between now and 2014 anyway. So I mean it's just kind of a matter of how you game-plan when you do that. On the second question, we're well aware of that. And as part of our strategy, again, I think you'll see more of it later this year. But we're looking at that as, frankly, more of an opportunity than as a threat or a headwind. I think it is certainly something that we want to make sure that we can provide competitive broadband services with a good price value to all of our customers in a synthetic bundle that is as good an experience as what they might get from someone else. And frankly, there are any number of ways you can look at finding ways to get higher-speed broadband services out there, and we're looking at the whole waterfront. And I'd say it's a little early for me to talk more about it than that, but certainly, it's an area that we're looking at as part of our strategy in our work there.

Douglas Mitchelson - Deutsche Bank AG

If I can follow-up on Brazil then, no change in your view the competitive environment or the growth opportunities in Brazil, right?

Michael White

No. If anything, I see more opportunities over the next couple of years, not less.

Patrick Doyle

Doug, I just want to elaborate, on the 2.5x, I think as we've said, our plan was first to get the U.S. business at 2.5x. We are also thinking about how we leverage off of the Latin American business and how we handle that asset and whether we bring it into the credit. So it's not like we're going to stop at 2.5x U.S. We'll look at it on a company-wide basis.

Bruce Churchill

Absolutely. Our focus was, let's get the U.S. one done first, and meanwhile, gives us a little time to figure where we are us vis-à-vis Latin America. But obviously, long-term, we'll have a target ratio for all of DIRECTV.

Operator

Our next question comes from Tom Eagan with Collins Stewart.

Thomas Eagan - Collins Stewart LLC

Mike, just a question following up your comments on local advertising. I recall, you guys talked about rolling out a local advertising service using spot beams in the beginning or early of 2011. Could you give us some sense of what the potential could be for DIRECTV on that? And then I have a follow-up.

Michael White

Look, we've done some benchmarking to compare how much we get from advertising versus our cable competitors, and we're quite a bit below them, I would say. So it's a significant opportunity for us. I think the question would be how quickly we can ramp it. I certainly expect that we'll see some payback next year out of that initiative. But if I look at it over three, four, five years, I think it could be a very, very significant profit opportunity for DIRECTV. I'd rather leave it at that right now, but it's not tens of millions of dollars, it's more than that. So I think we're talking a significant opportunity, but we got a lot of moving parts when you're selling local ads to make sure that it works. But I certainly expect we'll see kind of the first fruits of that initiative next year. And as we see how well that's going, we can then go for there, but you can kind of do the benchmarking. We're quite a bit below where our cable competitors are in terms of the dollars per sub of the advertising revenue.

Thomas Eagan - Collins Stewart LLC

And I just want to confirm that there isn't any incremental CapEx here and that your spot beams cover the vast majority of the homes in the U.S.

Michael White

That's correct.

James Ratcliffe - Barclays Capital

Just secondly, on HD, on the FREE HD offer. If you could give a little bit color, if I missed it, I apologize, but on any -- the impact on June gross adds with that offer? And any impact you expect on ARPU for Q3 because of it?

Michael White

Yes, I probably don't want to be specific about June. But directionally, Pat, you might want to just talk about kind of the trends we're seeing and opportune was very strong.

Patrick Doyle

We definitely saw a lift and I think as Mike mentioned, I mean you always worry when you have something like that, whether you're just promoting kind of lower quality of customers, but what we saw in June is actually the quality of our gross ads improved in the month of June over May. So we did see some lift with that, which is carried into July as well. I mean because on ARPU, I mean any effect would be modest, because you're talking about $10 a month. So we just started in June, so there really isn't any meaningful impact on revenue.

Michael White

And we've also -- part of the deal was you had to sign up for Auto Bill Pay. So we've kind of really, in short, we get only good credit and higher quality packages on that deal.

Operator

And it appears we have time for one more question. We'll go next to Matthew Harrigan with Wunderlich Securities.

Matthew Harrigan - Wunderlich Securities Inc.

First of all, congratulations on your Russian baby giraffe commercial going viral. That maybe a net worth of a million customers just in the U.S. figures this year.

Michael White

Thank you. It's one of the top 40 most-watched videos in the world, I'm told right now.

Matthew Harrigan - Wunderlich Securities Inc.

One, I know you told me -- I think Jon Rubin told me that your ARPU down in Brazil for your one product is actually higher, then that's your diesel for their triple play. So you guys are pretty affluent people down there. I know at the World Cup, you showed 25 3D games in the U.S. I don't think you did it down there. When you look at how affluent you are, your customers are, in a market like Brazil, are you probably going to take 3D and even your network connectivity down to that market a little sooner than people think? And then the second question is, what would be the implications of an NFL lockout next year as far as your contract stipulations go and all that?

Michael White

Bruce, you want to talk a little bit? I mean, I think we're probably decades, at least, before we think about some of that stuff in Latin America given how low the penetration rates on fiber and even broadband down there, just tiny. And 3D, I don't think we see it in Latin America, but I don't know. Bruce?

Bruce Churchill

Yes, I guess if you're talking about -- you said, would it come to Brazil sooner? The answer may be well be yes, but that doesn't mean it's anytime soon. Just remember, we only launched HD last year. And much of the HD content that we have to date is actually international content, because it's content that's being shown in lots of large markets, in other places of the world that, therefore, they can afford HD. Local HD content is very early days still, in Latin America and even in Brazil. So I think we've got a long run ahead of us on HD and other advanced products before we need to worry about 3D. And yes, I will confirm that our ARPU in Brazil on our video products alone is higher than the ARPU that Televisa has on its three products, so whoever told you that was telling you the truth.

Michael White

I'd just add that in Latin America in general, there's no question that I think the satellite is structurally advantaged relative to urban areas of the U.S. where you have fiber optics that's been built out, and that's partly why I've felt so strongly about the opportunity in Latin America. Second, just the market alone, you got a rising middle class in many of those markets down there that's going to generate significant additional customers for us, as you see kind of the middle class increasing down there and the upper middle class. We're certainly looking at segmentation down there, recognizing that we need to service the high end with the same kind of HD experience that we offer in the U.S. At the same time, we recognize to service kind of, lets call it, the middle class or lower middle class, you need a more affordable offering. And that's part of what's been so successful for us this year, whether it's our Sky Digital Lite package in Brazil or whether it's our prepaid packages that we've had out there. So I think we're going to continue to segment. That's not to be confused with we're trying to chase the bottom of the pyramid. I don't think, at this point, we're focused on that, but it's really how do you make sure that you got a compelling offer for the middle class and ability to upgrade them. And I also think, whether it is broadband or whether it's content, given the strength of our competitive position in Latin America, we're certainly more open, I would say, to out-of-the-box ideas or investments are acquisitions if they were to come along than probably a more mature market like the U.S. But I don't necessarily say that, therefore, we're going to do something, I just -- we're more open minded, given what I think we've got to leverage down there. On the NFL lockout, look, I think it's way premature to talk about that. I think we've been clear that there are provisions in our contract where if there are games that get canceled, we get something back for that, either in a longer contract or whatever. I think probably when we get towards the end of this year and we talk about how we're planning for next year, we can talk a little bit more about it at that time, but I'd say it's bit premature.

Operator

And thank you, this concludes today's DIRECTV Group's Second Quarter 2010 Earnings Conference Call. You may now disconnect your lines, and have a pleasant afternoon.

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

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

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

Source: DIRECTV Q2 2010 Earnings Call Transcript
This Transcript
All Transcripts