Glenn Britt - Chairman and Chief Executive Officer
Tom Robey - IR
Robert Marcus - President, Chief Operating Officer and Chief Financial Officer
John Hodulik - UBS Investment Bank
Jessica Cohen - BofA Merrill Lynch
Laura Martin - Needham & Company, LLC
Benjamin Swinburne - Morgan Stanley
Richard Greenfield - BTIG, LLC
Stefan Anninger - Crédit Suisse AG
Jason Bazinet - Citigroup Inc
Douglas Mitchelson - Deutsche Bank AG
Jason Armstrong - Goldman Sachs Group Inc.
Craig Moffett - Bernstein Research
Time Warner Cable (TWC) Q4 2010 Earnings Call January 27, 2011 8:30 AM ET
Hello, and welcome to the Time Warner Cable Fourth Quarter and Full Year 2010 Earnings. [Operator Instructions] Now I will turn the call over to Mr. Tom Robey, Senior Vice President of Time Warner Cable, Investor Relations. Thank you. You may begin.
Thanks, Candy, and good morning, everyone. Welcome to Time Warner Cable's 2010 Fourth Quarter and Full-year Earnings Conference Call. This morning, we issued two press releases, one detailing our 2010 fourth quarter and full-year results, and the other announcing an increase in and the declaration of our regular quarterly dividend.
Before we begin, there are several items I need to cover. First, we refer to certain non-GAAP measures, including operating income before depreciation and amortization or OIBDA. In addition, we refer to adjusted OIBDA and adjusted OIBDA less capital expenditures. Definitions and schedules setting out reconciliations of these historical non-GAAP financial measures to the most directly comparable GAAP financial measures are included in our trending schedules and earnings release.
Second, today's announcements includes certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, which are based on management's current expectations and beliefs and are subject to uncertainty and changes in circumstances. Actual results may vary materially from those expressed or implied by the statements herein due to various factors, including economic, business, competitive, technological, strategic and/or regulatory changes that could affect our business.
These factors are discussed in detail in our SEC filings, including our most recent annual report on Form 10-K and quarterly reports on Form 10-Q. Time Warner Cable is under no obligation to, and in fact, expressly disclaims any such obligation to update or alter its forward-looking statements, whether as a result of new information, future events or otherwise.
And finally, today's press releases, trending schedules, presentation slides and related reconciliation schedules are available on our company's website at timewarnercable.com/investors. A replay of today's call will be available beginning approximately two hours after the call has ended and will run through midnight Eastern Time, February 1.
With that covered, I'll thank you and turn the call over to Glenn. Glenn?
Good morning, and thanks for joining us today. 2010 was a year of significant accomplishment for Time Warner Cable. We achieved healthy growth on the top line and delivered record free cash flow. At the same time, we enhanced our products and services, increased the sophistication of our marketing and accelerated the growth of our Commercial business.
We also delivered on our shareholder-oriented capital allocation strategy. We returned more than $570 million through our dividend in 2010, and we have spent roughly $0.75 billion on a repurchase of our own shares since November. In addition, this morning, we announced an increase of 20% to our quarterly dividend. This increase is yet another signal of our confidence in our business, and reinforces our focus on returning capital to our shareholders while continuing to invest in long-term growth.
We also made a lot of progress in our product offerings. We completed the deployment of video switches, enabling a dramatic increase in the availability of HD channels across our footprint. We launched Look Back, providing our digital customers with on-demand access to three days of programming on 59 networks using our network DVR technology.
At the same time, we made our Movies On Demand offering even more attractive by doubling the day and date availability of new titles. We invested in a wireless broadband offering in 2010. The investment is providing us with key insights into the operation of a wireless business and how it fits with our Wireline business.
In 2010, we continued our ongoing efforts to build a more vast marketing tools and additional analytical capabilities. Specifically, last year, we introduced a more sophisticated product pricing regime and our first products targeted at specific customer segments. We launched Signature Home broadly across our footprint in December, and we're currently engaged in trials of TV Essentials in New York City and Northeast Ohio. We expect this to be but the first in a series of products designed to more closely fit the individual needs of our customers.
Now turning to 2011, we entered the new year with aggressive plans, and we're optimistic about our prospects, although weakness in employment and occupied housing will continue to provide a headwind. Competition isn't new to our business, and we expect continuing competitive pressures from the telephone and satellite companies in 2011. But with better products and better marketing than we've ever had before, we're ready.
On the regulatory front, we'll continue to press for reform and retransmission consent where 20-year-old statutes effectively tipped the competitive scales of the broadcasters' favor. Regarding broadband regulation, we're pleased that we've avoided Title II Reclassification. However, many parties at both ends of the political spectrum remain unsatisfied, and we expect this issue to remain in the news.
I'm really excited about our rapid progress in harnessing the power of consumer electronics devices to give our customers a better experience and more control as they use our services. Earlier this month, at the Consumer Electronics Show, we demonstrated our ability to deliver video directly to IP-connected devices, such a Smart TVs, tablets and Blu-ray players, all without the need for set-top boxes. This ability to deliver TV to virtually any device in the home is a logical extension of our video product. We expect to launch this capability in the coming months.
For years, our video user interfaces have been constrained by the limited capabilities of set-top boxes. By taking advantage of more powerful consumer electronics devices, we can offer a much more compelling navigation experience, one that offers more functionality and is more aesthetically pleasing than anything we've done in the past. Perhaps most important, we're building processes that will enable us to rapidly update the user interface and response to customer feedback. We believe the ability to deliver video to all the screens in the home, a much improved user interface and all that, coupled with TV Everywhere capability, will address many of the perceived advantages of over-the-top video offerings.
There is tremendous value in our broadband network. Our customers continue to use it for new applications, and they're demonstrating that they're willing to pay more as this utility in their lives expand. In the year ahead, we'll continue to invest in the network's capabilities in a variety of ways, including expansion of our DOCSIS 3.0 footprint, so that we can continue to be the best-in-class broadband provider.
Our broadband network is also a flexible platform for new products, coupled with our installation and call center expertise, it provides us with an opportunity to enter the Home Monitoring and Security business. We've actually been in the Security business in parts of our footprint for many years. But recent advancements in technology have made the application much more interesting. We've trained installers in several cities, and this week, we began taking orders for our Smart Home Security product as part of a soft launch. We used the feedback we get from the early customers to fine-tune our product and processes, and we expect to launch this product broadly across our footprint later this year.
In the commercial space, we're pleased that we grew revenues by more than 20%, breaking through the $1 billion level for the first time in 2010. However, we're not resting on our laurels, and we think we have the opportunity to create a lot more growth, both through the sale of existing products and by exploring new products and new segments.
In summary, 2010 was a year of new products, accelerated growth and record free cash flow. We look forward to the challenges and opportunities of the new year, as we strive to better serve our customers and continue our quest to be the open, transparent, shareholder-friendly company that our owners expect.
I want to acknowledge the terrific job that Rob has done as our CFO in the past three years. I have full confidence in him as he takes on the role of President and Chief Operating Officer. For the next several months, as we conduct the search for his successor as CFO, Rob will do double duty.
So now let me turn it over to Rob, who will give you some additional details on the financial performance.
Thanks, Glenn, and good morning, everyone. We've got a lot to cover, so let's jump right into our 2010 highlights on Slide 3. As Glenn said, 2010 was a really good year for Time Warner Cable. We grew full year revenues by over 5.5%, as residential subscription revenues increased nearly 4%, while commercial and advertising revenues each jumped over 20%. Adjusted OIBDA growth accelerated to nearly 6% in 2010, reflecting our strong revenue growth and slightly higher margins. Operating income was up over 11%. Adjusted OIBDA less CapEx increased 21%, and free cash flow was up over 19% to $2.3 billion or $6.35 per diluted share.
Diluted EPS increased over 19% to $3.64, exceeding what we projected at the beginning of the year. True to our commitment, we continued to actively manage our balance sheet. We returned $1.1 billion of capital to our shareholders during 2010, paying cash dividends of $576 million and repurchasing $515 million of our common stock. And demonstrating our confidence in our business, this morning, we announced a 20% increase in our quarterly dividend to $0.48 per share or $1.92 on an annualized basis.
Let's move on to Q4 subscriber trends in the next slide. Before I get into the numbers, let me say a few words about the environment in which we're operating. While we've seen some modest improvement in certain macroeconomic indicators in several of our regions, overall, we continue to feel the effects of weak housing and high unemployment across our footprint. The competitive landscape also remained pretty much the same in Q4. The telcos continued their fiber build-outs, but probably at the slowest pace we've seen since they began.
We estimate that U-verse is now marketing video to about 24% of our footprint and FiOS to about 10%. Marketing and promotional intensity among our telco and satellite competitors was pretty consistent with what we've seen in recent quarters. For our part, we broadly executed on our $33 x 3 Triple Play marketing program, targeting both new and existing customers.
So let's turn to our sub performance. We added 94,000 high-speed data subscribers in the quarter, bringing total HSD subscriber base to over 9.8 million or 35.8% of passings. That's a five 5.5% year-over-year increase in our HSD sub base. Our residential HSD subscriber mix continued to improve, as customers continue to choose our higher-speed tiers. We added 147,000 Turbo and 5,000 Wideband or DOCSIS 3.0 customers. And for the first time this quarter, our total Turbo and Wideband subs combined exceeded our aggregate basic and light tier customers. Commercial HSD net adds were 11,000, which was more than 5x year-ago net adds.
As I've previewed on our third quarter call, Digital Phone net adds rebounded strongly in the fourth quarter, as we more aggressively marketed the Triple Play bundle. Total Digital Phone net adds were 72,000, and we ended the quarter with almost 4.5 million total voice subscribers, 16.7% of homes passed and a 6.5% increase from the end of 2009. We had 11,000 Business Class Phone net adds in the quarter for a total of 111,000. That's more than double the number of subs we had 18 months ago.
Video subscriber performance continued to be impacted by the challenging competitive and economic environment. For the quarter, we had a net decline of 141,000 video subscribers. The video sub declines were once again driven by losses in analog Single Play video customers. Actually, net additions for both digital video subscribers and bundled video subscribers were positive during the quarter. In addition, there were some signs of life in the Pay TV category, as we added 77,000 pay units. That's the first growth in pay units we've experienced in 10 quarters. Demand for DVR has also picked up in Q4. Net adds of 47,000 were significantly better than in Q3.
Primary Service unit net adds were a positive 25,000 for the quarter, an improvement from the third quarter loss. PSU churn was flat year-over-year. As I mentioned, we continue to focus on getting customers into bundles and had 72,000 Triple Play net adds during Q4, up from 64,000 in last year's fourth quarter. At quarter end, just under 60% of our customers were either Double or Triple Plays. Once again, we fared much better with our more affluent customers, our highest income segments drove the net gains in Triple Plays, while our lower-income segments accounted for most of the declines in singles and doubles.
Despite the challenging economic and competitive environment, full year 2010 PS unit additions were 344,000, with 515,000 HSD net adds and 278,000 Digital Phone net adds, offset by 449,000 video net losses. So far, this January's sub-performance looks a lot like January of 2010. But remember that the bulk of the net adds last year occurred in February and March, so it's still really early to project Q1 subs.
Let's turn to our financial results and start with revenue on the next slide. Fourth quarter revenue increased 5.9% year-over-year to $4.8 billion, and full year revenue increased 5.6% to $18.9 billion. During the fourth quarter, total subscription revenue, that's residential and commercial combined, grew 4.6%, driven by increased PSUs and a 3.1% increase in subscription ARPU per PSU. Advertising revenue increased nearly 34%. In dollar terms, total revenues was $269 million higher than in Q4 '09, with $145 million of that growth coming from our Residential Subscription business, $68 million coming from Advertising and $56 million coming from Commercial.
Let's first focus on residential subscription revenue on Slide 6. Fourth quarter residential subscription revenue grew 3.5%, and full-year residential subscription revenue grew nearly 4% year-over-year with both driven by a combination of subscriber growth, improved subscriber mix and price increases. Of the $145 million of year-over-year residential subscription revenue growth in Q4, HSD contributed 60% or $87 million, with video and Digital Phone contributing 25% and 15%, respectively.
Year-over-year residential HSD revenue growth accelerated throughout the year, culminating in Q4 growth of 8.7% over last year's fourth quarter. The growth was driven by subscriber increases, as well as a year-over-year increase of close to 3% in residential HSD ARPU. This is the seventh consecutive quarter of year-over-year residential HSD ARPU improvement, as we benefited from price increases and the improved subscriber mix I talked about earlier. Residential video revenue increased as a result of price increases and higher digital video and DVR revenues, partially offset by the decline in video subs. Residential video ARPU increased nearly 5% from Q4 '09. Residential voice revenue grew 4.5% due to continued subscriber growth. Year-over-year ARPU declined just 1.2%, which was the smallest decline in the last couple of years. On a sequential basis, residential voice ARPU was pretty much flat.
Now let's flip to commercial revenue on the next slide. We're very pleased with the progress we made in our Commercial business in 2010. We set out to deliver commercial subscription revenue growth of more than 20% for the year, and we did just that. Fourth quarter commercial revenue was just under $300 million, a 23% increase over Q4 '09, marking the highest-growth quarter of the year. Full year commercial revenue was more than $1.1 billion, up 21.1% versus 2009. Each of commercial data, Business Class Phone and cell tower backhaul contributed about 30% of the $56 million year-over-year revenue improvement in the fourth quarter, with video revenue accounting for the balance. Commercial data revenue increased almost 13%, driven by growth in shared and dedicated Internet access and Metro Ethernet revenue. Business Class Phone revenue increased nearly 73%, driven by subscriber growth, and cell tower backhaul revenue in the fourth quarter was $26 million. That's as much cell backhaul revenue as we generated for all of 2009. As of quarter end, our total installed base was 6,100 radios, and we had a meaningful backlog of radios under contract.
We continue to make investments in our commercial capabilities throughout the year. And in 2011, we are focused on continuing to improve sales productivity and increasing service ability to expand the number of commercial establishments we reach. We expect these investments to enable us to continue to drive commercial revenue growth in 2011 at a rate similar to what we achieved in 2010.
Moving to the next slide. We had a terrific year in advertising, topped off by a fourth quarter in which we generated an all-time high $269 million in ad revenue, up 33.8% over Q4 of 2009 and up 39% on a per video subscriber basis. Full year ad revenues of $881 million were 25.5% greater than in 2009.
Strong political advertising certainly helped the cause. We generated $42 million in political advertising in the fourth quarter and $74 million for the full year. Political accounted for half the growth in the quarter and about 30% of the growth for the full year. That said, non-political advertising revenues grew strongly in their own right, up around 18% for the fourth quarter and the full year. In the fourth quarter, the automotive category generated a little over $50 million, and media advertising added about $45 million, both jumping well over 30% versus the fourth quarter of 2009.
During the quarter, we they began to benefit from our new ad-rep deal with FiOS, under which we sell regional advertising on behalf of FiOS TV in the New York City, Los Angeles and Dallas markets in exchange for a percentage of the revenue generated. We expect that the FiOS deal and others like it will increasingly contribute to ad revenues in 2011. As we look forward, given strength in our core Advertising business and our new ad-rep deals, we do expect that we'll be able to grow ad revenues in 2011, despite the usual non-election year fall-off in political advertising.
Let's turn to adjusted OIBDA on Slide 9. Fourth quarter adjusted OIBDA grew 1.6% to $1.7 billion, and full year adjusted OIBDA increased 5.9% to $6.9 billion, right in line with what we projected on our last earnings call. Full year margins improved 10 basis points.
Total fourth quarter operating expenses grew 8.5% compared to the fourth quarter of 2009. The growth in OpEx and the resulting margin contraction and slowdown in adjusted OIBDA growth in the fourth quarter were driven by a number of items that I'll walk you through, several of which I've mentioned previously. First, bad debt expense was up in the quarter due to the reversal of a reserve in Q4 '09, which significantly lowered bad debt in that quarter. Similarly, casualty insurance expense increased year-over-year due to a favorable adjustment to casualty insurance expense in the fourth quarter of 2009.
Next, fourth quarter employee expense was increased by an executive severance charge. Additionally, fourth quarter cost of revenues increased due to the reclassification of certain amounts previously recorded as depreciation. And finally, as expected, wireless losses and programming expenses grew faster in the fourth quarter than they did in prior quarters. In aggregate, these items accounted for a $90 million swing in year-over-year adjusted OIBDA.
Programming expense increased 7.2% for the quarter, as video subscriber declines only partially offset contractual rate increases and incremental retrans costs. Remember that Q4 was the first full quarter under our new Disney contract. For the full year, programming costs increased 5.4% in aggregate and 8.2% on a per subscriber basis. We expect total programming cost growth will be in the same ballpark in 2011.
Employee costs were up 3.9% year-over-year in Q4, reflecting higher commercial headcount and compensation expenses and the executive severance cost I mentioned earlier. Fourth quarter marketing expense of $166 million was $11 million higher than last year. Marketing spending for the fourth quarter and the full-year remained fairly constant at about 3.5% of revenues. Voice costs were up 5.5% due to growth in Digital Phone subscribers. As you may recall, during the fourth quarter, we began the process of in-sourcing various voice support functions. The financial benefits of this process will flow in as our Digital Phone subscribers are migrated to the new platform over the next several years. When we're all done, we expect to see our voice costs cut roughly in half.
We continued to invest in wireless in Q4. As of today, we're offering our wireless data service in almost 3/4 of our footprint, and we have almost 15,000 subscribers. Still early days, but as Glenn mentioned, we're gaining key insights into the Wireless business, as well as the wireless needs and desires of our customers. Q4 wireless losses were approximately $20 million, and full-year losses were around $50 million. In 2011, we plan to continue investing in wireless, as well as several other new initiatives, including, as Glenn mentioned, our Smart Home Security offering. We expect our total 2011 startup losses from wireless, home security and other new business projects to be in the $75 million range.
Before I move on to CapEx, I should note that operating income for the quarter increased 11.6% to $994 million, driven by higher adjusted OIBDA and decreases in depreciation and amortization expense. For the full year, operating income grew 11.2% to $3.7 billion. Looking forward to 2011, we expect once again to generate double-digit operating income growth.
Turning to capital spending on Slide 10. As Glenn mentioned earlier, we continue to make great strides in enhancing our products and services in 2010. We completed the rollout of Switch Digital, launched Look Back across our footprint, deployed over 1.5 million HD set-top boxes, added to our DOCSIS 3.0 passings, continued the rollout of wireless data and invested heavily in our Commercial business, and we accomplished all this while still reducing the overall capital intensity of our business for the full year by 260 basis points to 15.5% of revenue. Our capital spending in the fourth quarter was $782 million, bringing our full-year CapEx to $2.9 billion, consistent with our full-year guidance and down approximately 9% from the full year 2009.
Full year residential capital expenditures were 14.6% of residential revenue, and were down nearly 15% year-over-year to $2.5 billion, driven by declines in CPE, support capital and scalable infrastructure. Commercial CapEx was $470 million, up nearly 34%, with about 40% of the commercial CapEx attributable to expanding our cell tower backhaul footprint. Looking forward to 2011, we'll continue to spend more on our Commercial business as the residential capital intensity continues to decline. And once again, we expect that full year capital spending will be less than $3 billion.
Onto cash flow on the next slide. Adjusted OIBDA less capital expenditures for the fourth quarter was $956 million, resulting in adjusted OIBDA less CapEx of $3.9 billion for the full-year 2010, a 21% year-over-year increase. Free cash flow for the quarter was $665 million, driving our full-year free cash flow to $2.3 billion or $6.35 per diluted share. Full-year free cash flow increased 19% over 2009, as higher adjusted OIBDA less CapEx and lower pension contributions and working capital requirements more than compensated for a jump in cash taxes of $351 million and an increase in cash interest of $138 million. Remarkably, for the full year, we converted more than 95% of incremental adjusted OIBDA into free cash flow. For 2011, including the benefit of the bonus depreciation, we're expecting another year of double-digit free cash flow growth.
Turning to the next slide. Full year diluted earnings per share of $3.64 increased 19% from $3.05 in 2009 and exceeded the high end of the range we provided at the beginning of 2010. Looking forward, we expect that 2011 full-year diluted EPS will be in the $4.25 to $4.50 per share range.
Moving to the balance sheet. During 2010, we returned $1.1 billion to shareholders through our dividend and share repurchase programs. We paid out $576 million or $1.60 per share in dividends, and bought back $515 million of common stock during November and December alone. Through yesterday, we repurchased almost $750 million worth of TWC common stock. Even after returning capital to shareholders, our year-end net debt and preferred equity totaled $20.4 billion, a reduction of $1.2 billion from year-end 2009. Our leverage ratio at year end was 2.96x.
And last, but certainly not least, as Glenn discussed, we're very pleased to have announced this morning a 20% increase in our quarterly dividend to $0.48 per share. That's $1.92 per share on an annualized basis, which at yesterday's closing stock price represents a 2.8% dividend yield.
So to summarize. We performed very well in 2010 from an operational and financial perspective. We generated substantial free cash flow, invested in our business for future growth and returned a significant amount of capital to shareholders. And we entered 2011 well-positioned to compete and to deliver strong growth in operating income, free cash flow and EPS.
Thank you. And with that, I'll turn it over to Tom for the Q&A portion of the call.
Thanks, Rob. Candy, we're ready for Q&A. We would ask that each caller ask just a single question so that we can accommodate as many callers as time permits. First question, please?
Our first question is from Craig Moffett, Sanford Bernstein.
Craig Moffett - Bernstein Research
I'm going to break the rule and see if I can ask two. One is, I just wanted to see if you could update us on your thinking about usage-based pricing with the SEC having expressly validated usage-based pricing as a strategy. And then if you could also update us on your thinking about Clearwire and your own holdings in the AWS spectrum.
Craig, this is Glenn. I'll take both of those. First of all, on usage-based pricing, I think I've been pretty consistent over several years on that. The good thing about broadband is that the usage is growing very rapidly as it has ever since we started the business in 1996. So people are finding it more useful. They're doing different things that make their lives better. That has, and will over time, require incremental investment by all of the infrastructure providers. And I think that implies that over time, as speeds get faster and faster and what have you, that there'll be upwards pressure on prices. I think a corollary of that is there is clearly a distribution in how people use the Internet. Some use it a lot more, some use it a lot less. And I think you're going to see over time that people who use it less will desire and expect to pay less than people who use it more. For our part, obviously, we paid attention to the announcements by the SEC. We're watching the market, and you are seeing in the wireless space, the beginnings of volume-based pricing. So we'll keep touching that and stay tuned. On wireless, again, I think we've been pretty consistent. We are basically exploring whether packaging wireless data with our Wireline offerings is something that consumers want and if there's a formula that people want. So we're trying different models, different products, what have you. And to date, I would say our results are not very impressive and pretty inconclusive. So we're going to stick with that for a while. We're trying to spend not too much money while we're doing it. So that's basically what we're up to.
Craig, on the AWS spectrum, we have no current plans to divest of the spectrum or otherwise monetize it. And at this moment in time, we don't have specific plans to utilize it either. What I will say is that notwithstanding all that, we're always keeping our eye on what the market for spectrum is, and I would note the recent AT&T acquisition of the media flow spectrum from QUALCOMM, and I think the price was somewhere in the mid-$0.80 per megahertz pop, which is a pretty healthy number and certainly, more than what we paid for the AWS spectrum. And I would concede it's not exactly comparable spectrum, but I think it certainly bodes well for the value of what we're holding.
Next question, Jason Bazinet, Citi.
Jason Bazinet - Citigroup Inc
I just have one question for anyone that would like to answer it. As far back as I can remember, the mix of sort of bundled customers versus Single Play has been pretty consistent with bundling rising and Single Play subs falling. This seems to be the first quarter where we saw sort of an inflection point where the Single Play subs actually increased. And I was just wondering, do you view that as an inflection point and indicative of broader trends? And if so, what trend are you seeing?
Yes, Jason, I think that what you're reacting to are some adjustments we made to our subscriber metrics in the quarter. In fact, bundled subs increased in the quarter and Single Play subs declined. The reason in the trending schedule as you might see that the percentage didn't increase is that we adjusted our sub-numbers, and this doesn't flow through the net add calculation, just affects the pending subs. But we decreased the number of Triple Play subs and increased our customer relationships, so both the numerator and denominator resulted in a lower-bundled percentage. But that's not reflective of activity in the quarter. As part of our consolidation into two regions, we're doing some work to standardize our subscriber counting methodologies and work to standardize across various instances of our billing systems, and that resulted in the adjustments to the sub counts . But it's really not reflective of what's going on organically in the business. Bundles continue to increase.
Next, Richard Greenfield, BTIG.
Richard Greenfield - BTIG, LLC
Question on the broadband side of the equation. Could you comment on whether you get paid right now by CDNs like Level 3 and Akamai, and whether as more and more video traffic gets dropped off at your door, whether charging for it or charging more for it is actually an opportunity, Netflix commented on this issue last time in their conference call, and so I was curious for your thoughts on the matter. And then just in terms of housekeeping, Rob, did you say that free cash flow would be up double digits from the $2,284 that was reported this year? And then you also just stopped reporting digital videos subs, I assume that was on purpose?
Well, let me deal with the first one, and then Rob can answer the second. There's been a lot of reading about Internet backbone economics recently in CDNs. And I think there's a lot of confusion about it. And quite frankly, the way that the economics of the money back and fourth is pretty arcane. But I think to simplify it, just start with the idea of the Internet is a collection of a bunch of privately-owned networks that are interconnected using standards. That's all it is, there's nothing -- the Internet per se doesn't exist. It's a collection of things. So each of these private networks generates traffic and receives traffic, and has different negotiated relationships with the people that it interconnects with. In general, if somebody is handing off and receiving roughly equivalent amounts of traffic, there's also an agreement not to charge because the bookkeeping is more expensive than what it's worth. But usually, if the traffic is out of balance, then whoever is delivering more traffic pays the other party. Again, I'm making broad generalizations. So that's how it works. And in the world of telecom, that's quite common, and that's how it's worked for many, many years. So there's nothing really new here other than people were delving into it in public more than they have before.
Richard Greenfield - BTIG, LLC
Well, but Glenn, it seems like there's an opportunity where the incoming traffic is a lot larger than the outgoing traffic, just given the explosion of video. And so is it fair to say that the opportunity to start getting paid more for that imbalance on your end is a substantial opportunity over the next couple of years?
I don't know if it's substantial. Again, the other interesting thing about it is the amounts of money that change hands in this whole space are pretty small. So it's something, but I would not say it's material or a big deal. And quite frankly, the fuss that's been made about it in the press is way overblown relative to the dollars involved.
Rich, on the two other questions you asked, the answer is yes, we're talking about double-digit free cash flow growth over the $2,284 that we disclosed for 2010. And as for Digital Video subscribers, while we haven't been proactively placing as much emphasis on digital recently, we added 6,000 digital customers. So we're not trying to be secretive about it in any way. It's just with certain markets becoming all-digital, it's just a less relevant number.
Next, John Hodulik, UBS.
John Hodulik - UBS Investment Bank
First, quickly, on the buyback, I may have missed it. But is this a good rate going forward for us to sort of factor that into the numbers? Then Glenn, you talked a little bit at the beginning about the move to use more consumer electronics in the home as opposed to a set-top boxes. Could you talk a little bit more about that initiative and maybe what the benefits you might see from both the financial and operational standpoint?
Sure, let me take the second one, and I'll refer the first one back to Rob. If you step way back from all of this, the only reason we have set-top boxes is that there are a vast array of TV receivers in place in people's homes. And most of them, historically, can't receive and display all of our services because they don't really have any intelligence. They're just display devices. And they receive all different -- they use all different standards and they have different kinds of input places and what have you. So the only reason we have set-top boxes is to make sure that our services can be displayed. So the set-top boxes have intelligence, they can do things like display program guides, and they can also decrypt signals that are encrypted for piracy protection. What we are seeing is a new generation of consumer electronics devices that have intelligence in them. And I think that's just going to get more and more as we go forward. That's number one. And number two, they are standardizing around a series of hardware inputs and around Internet Protocol, which is nothing but a bunch of standards. So that means that we can deliver television to those devices and deliver new innovative user interfaces that can be changed rapidly using these standards, so in effect, you get rid of the need for a set-top box, which we would just as soon not have in the first place. I think that we demonstrated this at CES. So couple of consumer benefits. One is, all of these devices, and there's an array of them, it's not just TVs, but it's tablets like the iPad and the Galaxy Tablet and so on. Blu-ray players now have this intelligence in them. So you're beginning to see, you can see video on any video display in the home. And all we have to do is simulcast using IP standards, just like we simulcast on analog and paid digital today. And then, we need to be able to redo our user interface very rapidly, which we can using our IP Internet kind of standard. So I think this is a win-win for the consumer. And for us, over a very long time period, as these devices replace all of the TVs that are in people's homes today, which is obviously a couple of decades at the minimum. But over a very long time period, we may be able to not have set-tops at all. And that means a less capital-intensive business, fewer service goals and happier consumers. So I think this is all good.
John, on the buyback question, I'm going to more or less say what I said on the third quarter call, when we announced the original authorization. We're going to disclose what we bought in each quarter in hindsight, but we're really not going to say much about going forward purchasing plans, except to say that the guiding principle here is managing the balance sheet to 3.25x, and that continues to be the driver.
Next, Ben Swinburne of Morgan Stanley.
Benjamin Swinburne - Morgan Stanley
Glenn, I wanted to ask you about -- you made a lot of comments over the years about sort of arguing why the media companies should behave in a way that protects the broader ecosystem. And I think all those arguments make a lot of sense. And so when you sit here today and look at where we are, and shortly after you did your Disney deal, they did a deal with Netflix, I think Netflix added like 5 million, 5.5 million gross adds last quarter, over 1/3 were streaming only. And so I'm just wondering if you think that the industry is becoming more or less aligned? There is also an article in the Journal about Hulu launching a sort of virtual cable operator product if they can convince their owners to do it. And actually, when you think about your IP-delivered video service you were just talking about in the last question, and certainly, a lot of people could probably do that who don't necessarily own a network to sort of play the string out. So just curious, when you think about where the media companies are in your negotiations and you think about the contracts you're signing, are we in a better place or worse place than we were six, nine months ago? And what do you think is happening at the customer level as we get all these internet-connected TVs sold? And obviously, your product development path is aimed at trying to address a lot of that. I just wanted to get your thoughts on that big topic?
Sure. I think as whenever there's a lot of new technology running around, there's always a lot of confusion on all sides. So I think everybody in this space is a little confused about what's going to happen including consumers and companies, investors, et cetera. I actually think -- and we go through waves of this and we certainly went through one in the late '90s, and everybody gets enamored with new things. I think it is useful to step back and think about it all on a common sense way. So if you think about all forms of media, they are delivered in some physical way, going back to movies and movie theaters. And historically, those two -- the retailer sort of bundled together the content and the physicality. You don't go to a movie theater and pay one price to rent the seat and another one to buy the movie. You buy a ticket and you get both. So all of the things you're talking about are really attempts to separate the sale of content from the sale of the physical infrastructure. You need both. You can't survive without both. And really, what's happening is you're creating new middleman in a business that if you start at the production level, there's already a whole lot of middlemen. And I think the question is whether there is any real value added there by creating yet a new group of middlemen. And maybe all they have is better user interfaces, which is why we're addressing that. So I think it's all very alluring, but I think when you step back and say what's really going on here? Is there any real value being created? And therefore, is it sustainable? I think it's pretty questionable. So we'll see how it plays out, again, uses our infrastructure. So it's not a horrible thing for us at the end of today.
Next, Doug Mitchelson, Deutsche Bank.
Douglas Mitchelson - Deutsche Bank AG
I guess, first, Rob, if I aggregate your comments, it seems EBITDA margins in 2011 should be at least flat. Is that accurate? And sort of given the timing around Sprint and ESPN and political advertising throughout the quarters, are margins stable year-over-year throughout the year, or is there some volatility? And then not to take the over-the-top discussion too far, Glenn, but relative to the comments you just made, I would say Netflix certainly has created some value or new product in that. They're offering consumers content that they haven't been able to readily get at a price point that's pretty attractive. So, again, relative to your commentary, would you look at the content that Netflix has and think there's a business model for Time Warner Cable to acquire that content as well and offer to subscribers? Or do you think that maybe there will be some middlemen that create some incremental value?
Let me do the Netflix thing, and then Rob can do the margin question. I think it's dangerous to be too specific about a given company. But since you drove me into this, yes, Netflix started with a very clever model built on the first-sale doctrine. So I think most of you are familiar with that. But essentially, if you buy a DVD under the first-sale doctrine, you can rent it as many times as you physically can without paying for it again. So they're using a very clever interface on the web and the first-sale doctrine and the power of subscriptions, which we all know about. They built a wonderful business, which they now are trying to extend into online. And then the online part of that, what I said before, they have a wonderful interface, which anybody can hire a bunch of web designers and do that. I question what the ultimate value of that, what's the value add of what they're doing. So I'll stop with that.
Doug, on margins, I'm not going to be too specific about 2011 margins, I think you shouldn't expect any material deviation from what we have experienced over the last couple of years, and I'm certainly not going to get into quarter-by-quarter margins. I think you know the puts and takes and what flows in when and can probably draw the right conclusions.
We have Jessica Reif Cohen, BofA Merrill Lynch.
Jessica Cohen - BofA Merrill Lynch
Two questions, first, I was wondering if you could put a little more -- be more specific on TV Everywhere? What rights do you have for streaming outside of the home? And generally, just talk about your plans, your specific plans. And then on the subtrends, data was obviously a little bit soft in the fourth quarter. Do you think that's the overall market or is there a share shift going on between competitors? And Bob, you specifically -- you know, you said on the Q1 subtrends that -- I just wondering if your comment was across all product categories? Because if so, it seems like there'll be healthy sequential improvement at least in data and voice. So if you could just give a little more color on that, that would be great.
Jessica, I'll start with the TV Everywhere question. We have launched with the ESPN product, and I think I see TV Everywhere from the distributor view point as just a piece of offering services that are more flexible and give consumers more control. Meaning, that they get to see their video on every device and whenever they want and they have access to ever broader announced material. TV Everywhere is really directed at viewing over the Internet outside of the home. And in order to do that, we need to negotiate with all the rights holders. So we're engaged in doing that. I think there's been a lot of confusion about it. And there'll be more to come. And I know other distributors have made deals with different people than we have. So it's underway, but it's not quite there yet. The technology is not an issue, by the way. Rob, do you want to...
Yes, on data subs, I'm not sure I would agree, Jessica, with the characterization of the data net adds as soft. We did add another 94,000 units, comparing them to Verizon's HSD net adds yesterday, I think we were about twice as many on a footprint-adjusted basis, haven't had a chance to digest the AT&T numbers yet, but at least with respect to what we had through yesterday, performing comparatively well. And we did that well improving the mix and improving the ARPU. So we feel pretty good about HSD. In terms of your comment about extrapolating from my comments on January, I would counsel against that. While the comment I made about January looking like January of last year applies to all of the PSUs. Again, I would mention that, really, most of the net add activity last year was in February and March. So I think we have to wait for the months to play out.
Next, Laura Martin, Needham.
Laura Martin - Needham & Company, LLC
I want to look at capital spending here for a little bit. Lot of these capital spending numbers down 17% in the quarter and down 9% for the full year. And it occurred to me when we were talking about the commercial revenue, with commercial revenue at $300 million and $1.1 billion for the year. That capital spending, not only is going down, but is becoming more efficient. It feels like the capital efficiency is getting better. So, I'm interested, you said full year CapEx will be below $3 billion. I'm actually interested in you guys talking about the return on that capital, feels like it's going up as the mix shift away from residential and towards commercial. So if you could give us guidance on that, that would be interesting. And then, Glenn, when you we're going into your answer when you're talking about CES stuff, one of the questions that raised to my mind is, is there some reason you're constrained to your own footprint in this over-the-top solution that you were talking about at CES? Can you actually deliver this through the CE devices to a Comcast home, to their iTablet? Or is there some reason that this new technology to the CE continues to limit you to your existing cable footprint?
Let me deal with the last one, and then on the capital spending issue, there is a lot of moving pieces there, so I'm going to let Rob deal with that one. The answer to the question about the CE devices is that right now, we purchase the rights from the content companies to distribute programming inside our cable footprint. So that's what we're talking about doing. Clearly, as I think a couple of people pointed out earlier, this technology allows you to distribute beyond somebody's footprint over the public Internet. But that's quite different than what we're doing. We're using Internet standards, but we're using it within our cable system, and it's not the public Internet.
Laura, on the CapEx point, I agree with your takeaway. Not surprisingly, we've been investing in the Commercial business for the last couple of years fairly heavily, and we're now really starting to see the benefits of that investment. And as with any business that sort of has been an investment cycle. Once you start to generate revenue from the investments that you've made, you see a more favorable relationship between returns in the capital you're spending. So I think your takeaway is 100% spot on.
Laura Martin - Needham & Company, LLC
So with dollar invested in commercial, does it have twice the return on capital than residential or 50% better return?
I actually thought you were talking relatively speaking commercial against commercial. The returns on commercial, I've mentioned this before, the margins on the Commercial business are better. The capital profile is a little bit different. But on balance, I think your second point, which is that commercial returns on capital are better than residential are also accurate. I'm not going to give you a multiple.
Next, Stefan Anninger, Credit Suisse.
Stefan Anninger - Crédit Suisse AG
So you've seen very nice ARPU growth in HSD, and I believe you mentioned 3% growth as 4Q's residential growth. Can you talk a little bit about your continued ability to take price increases on your HSD products in 2011 and beyond? And then just a quick follow-up and you may be hesitant to do this given your discussion earlier about margins, but could you provide a bit of guidance as to how to think about the long-term potential for voice margin improvement as you move away from your agreement with Sprint?
Okay, so on HSD price increases, first of all, I would mention that the ARPU improvement in residential HSD in particular is the product of two phenomena, one is the price increases, the other is that we are seeing improved mix in our HSD subscriber base towards the higher speed tiers, which generate more revenue dollars. On price increases, I think Glenn hit this in various of his comments. But as customers continue to use HSD for more bandwidth-intensive applications and require more and more speed and place a greater value in short on what it is we're offering, it stands to reason that, that value will correlate with their willingness to pay more for the service. So we feel that, that should drive an ability to increase prices going forward. With respect to voice, the process by which we migrate away from the Sprint contract and onto our own platform for providing support functions will occur over really the next four years through 2014. So the first year where we'll see the full run rate, full year benefit of the entire project is 2015. And what I've said is that when we get to that point in time, we'll see our voice costs essentially cut in half. It's probably best to speak of it in those terms because margins carry with it some assumptions about revenue, and I don't think we're prepared to make those assumptions over a five-year time horizon.
Jason Armstrong, Goldman Sachs.
Jason Armstrong - Goldman Sachs Group Inc.
Can you comment on early uptake you're seeing in the TV Essentials package, and maybe help us think through the path here in terms of the push into other markets. And then, does it make sense to evolve it into maybe a package essentials with low-end broadband or look for different varieties that maybe have a bit more category depth in terms of video content?
Those are all good questions, and it's really too early to address -- it's not too early to address them, but it's really too early to talk about it. We're testing this in two markets, in New York and in Northeast Ohio. The tests are not that old at this point, so stay tuned. We'll report back when we have more data.
Candy, I think that's probably all we have time for this morning. Thanks, gentlemen, for joining us.
Thank you. That does conclude today's conference. You may disconnect at this time.
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