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DIRECTV (NASDAQ:DTV)

Q4 2010 Earnings Call

February 23, 2011 9:00 am ET

Executives

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

Patrick Doyle - Chief Financial Officer and Executive Vice President of Finance

Analysts

Craig Moffett - Sanford C. Bernstein & Co., Inc.

Jessica Cohen - BofA Merrill Lynch

Bryan Kraft - Evercore Partners Inc.

Thomas Ernst - Deutsche Bank AG

Stefan Anninger - Crédit Suisse AG

James Ratcliffe - Barclays Capital

Marci Ryvicker - Wells Fargo Securities, LLC

Kunal Madhukar - Bear Stearns

Jason Armstrong - Goldman Sachs Group Inc.

Thomas Eagan - Collins Stewart LLC

Tuna Amobi - S&P Equity Research

Operator

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

Jonathan Rubin

Thank you, operator, and thanks, everyone, for joining us for our Fourth Quarter 2010 Financial Results and Outlook Conference Call. And with me today on the call are Mike White, President and CEO; Pat Doyle, our CFO; Bruce Churchill, President of DIRECTV Latin America; and Larry Hunter, General Counsel.

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 the Risks Factors section and elsewhere in each of DIRECTV's and DIRECTV U.S.' annual reports on Form 10-K, quarterly reports on Form 10-Q and our other filings with the SEC, which are available at www.sec.gov.

Examples of forward-looking statements include, but are not limited to, statements we make related to our business strategy and regarding our outlook for 2011 financial results, liquidity and capital resources.

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

So with that, I'm pleased to introduce Mike.

Michael White

Thanks, John. Good morning, everyone. I thought we had a terrific fourth quarter as you saw in the press release to cap off one of DIRECTV's strongest years ever. Both our quarter and, I would say, our full-year results were entirely driven by the strategy that we talked about at our Investor Day in December, which is essentially to continue creating significant shareholder value by leading our industry and top-line and bottom-line growth while also returning excess cash to our shareholders.

I think we also accomplished something pretty rare in our industry last year, which is to say we both increased market share and profitability in our U.S. business, and we also did both of those things with our Latin American businesses.

In terms of market share, our consolidated subscriber growth accelerated throughout the year, culminating with our best quarter in a decade with 667,000 net additions. For the full year, we added 1.9 million net additions or 3 million new customers if you include Sky Mexico, which easily qualifies as our best year ever. And while we captured market share throughout the Americas, we also generated the industry's best top and bottom line results in 2010. In fact, our full year 2010 growth and revenues and operating profit before depreciation and amortization of 11% and 13%, respectively, were somewhere around twice that of our key competitors. And equally important, free cash flow grew even faster at 18% to a record $2.8 billion.

Let me look first at our DIRECTV U.S. business. Our best ever fourth quarter for gross additions capped off a strong year in which we added over 4.1 million gross additions, nearly matching the levels attained in 2009 which, as I'm sure you’ll all recall, was somewhat inflated by the analog-to-digital transition of over-the-air signals. Equally importantly, the quality of new subscribers remained high. We ended last year with several favorable trends, providing us with excellent momentum as we start 2011. For instance, nearly 80% of gross additions signed up for HD and/or DVR services in the fourth quarter. This was the highest percentage we've seen in our history.

Increased penetration of advanced services, along with stringent upfront credit filters, also contributed to an eight-basis point reduction in our fourth quarter churn rate of 1.44%. The strong gross additions and healthy churn management drove a more than doubling of net additions in the quarter to 289,000. Our top line results were also boosted by strong ARPU growth of 4.6% for the quarter, and almost 5% for the year, which compares very favorably to the 2% growth we saw in 2009.

Pat's going to give you a bit more detail behind our fourth quarter numbers, but it's worth mentioning that we launched our enhanced DIRECTV CINEMA service in December and immediately generated our best month ever in terms of revenues and movie buys.

DIRECTV U.S. profitability was also solid last year as the strong revenue growth, coupled with higher margins, drove double-digit growth and operating profit before depreciation and amortization. Overall, I thought we did an excellent job managing costs, but I was particularly pleased with our programming upgrade, retention and subscriber services costs, which all increased at a slower rate than revenues. As I'm sure you know, however, that was not the case with subscriber acquisition costs where our strategy continues to be providing advanced products in broadband-connected services to our higher qualities customers. We continue to believe that these investments are not only strategic, but will generate attractive financial returns through higher ARPU and lower churn.

Turning now briefly to Latin America. It seems as if we're establishing new subscriber growth records virtually every quarter. We were all impressed by the subscriber growth generated during the FIFA World Cup, but in some ways, those numbers now look relatively small compared with the current run rate in a number of our countries. Brazil, in particular, is experiencing tremendous growth. Provide a bit more perspective, Brazil's fourth quarter was, by far, it's best-ever. It's gross adds were more than double the level of a year ago and nearly 40% higher than we saw in the second quarter when we were running up to the World Cup. These results fueled a full-year increase of 75% to about 1 million gross adds in Brazil last year.

But in addition to Brazil, we also saw full-year solid growth in several other countries, including Argentina, Colombia, Chile and also in Sky Mexico. Equally impressive was the eight-basis point reduction DIRECTV Latin America's postpaid churn rate last year to 1.47%; a level even lower than we see here in the United States. I think this is truly a testament to the strength of our brand, our service, our management team and the outstanding performance that Bruce and the entire team delivered across the region.

When you add it all up, DIRECTV Latin America attained a record 1.2 million subscribers in 2010 or 76% more than the prior year. But as I mentioned earlier, this market share and subscriber growth did not come at the expense of profitability as our operating profit before depreciation and amortization margins also increased, about eight percentage points to 32% last year. Now although much of that profit growth was due to lower repatriation fees in Venezuela, margins improved over 100 basis points, even if you exclude those fees. And as we said at our Investor Day, our goal is to maintain these strong healthy margins, while adding 1 million net subscribers annually over the next three years across Latin America.

Now before I turn the call over to Bruce, I thought it might be helpful if I spend a few minutes discussing our 2011 outlook and reminding you of our key strategic priorities.

From an operating and financial perspective, I expect 2011 to look a lot like last year in a number of respects. In terms of subscriber growth, I'm again looking for DIRECTV U.S. to, at a minimum, maintain market share, while in Latin America we're targeting for Bruce and his team to continue gaining share.

Although we'll likely have modestly lower net additions in each region for the full year, I'm expecting another stellar year in terms of management of both gross adds and churn in both the United States and Latin America.

Financially, as we shared with you in December, DIRECTV U.S. OPBDA growth is expected to be a bit more modest in 2011, probably pretty similar to what you saw in the fourth quarter. Most of that slower growth is attributable to higher programming costs, which continue to represent our industry's biggest challenge and most especially will put pressure on our P&L in the second-half of this year. As such, we need to have a more heightened focus on capturing productivity improvements across our company in order to maintain healthy margins.

In Latin America, we're targeting another strong year of 20% top line growth while maintaining healthy margins similar to last year. Adding it all up from a consolidated view, we're expecting to again lead our industry with both outstanding top-line and bottom-line growth across the enterprise in 2011.

Now in order for us to continue this trend and reach our longer-term targets, we've implemented a product roadmap and a strategic plan, most of which was shared with you in December at our Investor Day. And I thought I might just briefly provide you with an update so you'll have a better appreciation of our top priorities over the coming months as we continue to build our growth company.

In the United States, our focus will be on strengthening and growing our core business while taking major strides toward making DIRECTV the best video experience both inside and outside the home. Priorities for our core business include making the customer experience a real competitive differentiator, taking out more segmented marketing approach and offering our customers better options for bundling services.

In that regard, we've made great progress even since our meeting in December by recently completing deals with both AT&T and Verizon, which allows us to sell their broadband services over their fiber network to our customers.

Another key U.S. priority is to target incremental revenue streams as we said in December in three main areas: DIRECTV CINEMA, local and addressable advertising and commercial; all of which comprise an incremental $750 million opportunity for our company over the next three years. Strategically, our key 2011 objectives center around a broad set of initiatives designed to offer DIRECTV customers the best anytime, anywhere video experience. In this regard, we're going to be focusing on connecting up to 2 million of our customers’ set-top boxes to the Internet with a longer-term goal of connecting 40% of our base by 2013.

We'll also be launching key products and services that will provide our customers with the ability to port their favorite shows for viewing anytime or anywhere they choose. Also, to enjoy multi-screen experiences with both social and interactive applications and enabling our customers to personalize search and discover programming through my DIRECTV, our new entertainment portal that will also provide an ability to stream popular content as it becomes available.

Turning to Latin America. Our strategy in a nutshell is to profitably increase market share through a segmented approach, which aims to: First, extend our leadership in the higher-end markets with a particular focus on both HD and DVR excellence; and second, at the same time, to incrementally penetrate much deeper into the rapidly growing middle-market segments by offering customers attractive prepaid services along with lower-priced, postpaid packages.

We expect solid growth to continue throughout the region, but most especially, I would expect to see it in countries like Brazil, Mexico, Colombia and Argentina.

Finally, in regards to our balance sheet, our top priorities continue to be to reach 2.5x leverage ratio of total debts DIRECTV U.S. OPBDA, while continuing to aggressively repurchase shares. And I'm sure you noted our announcement of our $6 billion share repurchase program in our press release.

If we successfully execute on these strategies, and I'm confident we will, we expect to continue creating significant shareholder value while taking important steps toward reaching our long-term EPS target that we shared with you in December of $5 a share by 2013. It's an aggressive plan, but we think it's certainly entirely consistent with our track record, our performance-driven culture, and our world-class employees and management team.

So with that, let me turn the call over to Bruce Churchill. Bruce?

Bruce Churchill

Thanks, Mike, and good morning, everyone. By any measure, 2010 was a great year for DTVLA. When I sat here with you one year ago and discussed the outlook for 2010, I was quite bullish about our prospects because of the lift we anticipated from the FIFA World Cup. While we certainly did experience that lift, what we underestimated going in was the continued strength in the second-half. Our record quarters leading up to the World Cup this past June were, in fact, followed by a much stronger finish to 2010 than we anticipated; resulting in more than 2.3 million gross additions and 1.2 million net additions for the full year, while maintaining record level postpaid churn levels.

The other important event of the fourth quarter was our purchase from Globo of an additional 19% of Sky Brazil. We now own 93% of Sky.

Let me spend a few minutes providing some more details on the fourth quarter. Just as a reminder, unless otherwise noted, our results exclude those of Sky Mexico, which we do not consolidate. I will make a few comments separately about Sky Mexico towards the end of my remarks.

For the quarter, gross additions of 639,000 or 39% higher than Q4 of 2009 and near levels immediately preceding the World Cup earlier this year. In Brazil, Sky reached record levels of gross additions, growing 130% compared to Q4 of 2009 on the popularity of our middle-market products. These products represented approximately 60% of our Brazil gross additions in the quarter.

In PanAmericana, gross additions were slightly down compared to Q4 2009 because of the controlled growth strategy we are pursuing in Venezuela. Excluding Venezuela, PanAmericana gross additions grew 28% versus the prior year, with Argentina and Ecuador in particular, delivering strong year-over-year growth.

In addition, our growth is well-balanced across each of our product market segments. For example, about 20% of new customers signed up for advanced products, which is lower than the prior year, but consistent with our post-World Cup expectations. If you recall, we ran aggressive advanced product offers at the end of last year and the first-half of this year prior to the World Cup, which resulted in take-rates in excess of 25%. Approximately 25% of our 5.8 million subscribers now have advanced products.

The big story this quarter, however, was our success in offering products targeted to the middle-market segments, particularly in Brazil. Our SKY Light package remains very popular and we have already seen good results during Q4 from our recently launched SKY FIT package. As I mentioned last quarter, both packages are affordably-priced, entry-level postpaid products that allow the subscriber to add selected products and services on top.

Prepaid gross additions represented 18% of our 639,000 gross adds in the quarter. Cumulatively, prepaid subscribers now make up slightly more than 10% of our 5.8 million subscribers and are predominantly in our PanAmericana region.

We're also pleased with our postpaid churn for the quarter of 1.37%, which declined from 1.45% for the same period last year. Much of this improvement came in Brazil from better customer segmentation, operational improvements and the benefits of favorable macroeconomic trends. With regard to our prepaid services, we saw strong recharge rates across the region, predominantly in Venezuela, due to aggressive seasonal recharge promotions. We ended the quarter with 378,000 net adds, an increase of almost 50% compared to the same period last year. This is our second-best quarter ever in this regard, second only to Q2 of this year, immediately prior to the World Cup.

We also had excellent financial results in the quarter. Driven by strong subscriber growth, revenues increased 23% compared to last year, exceeding $1 billion in the quarter.

ARPU was down modestly in dollars due mostly to the currency devaluation in Venezuela. Excluding the impact of foreign exchange, ARPU would have increased around 5%, driven by price increases and higher advanced product penetration. OPBDA and cash flow before interest and taxes for the quarter were even stronger compared to last year's results. OPBDA increased $123 million or 56% over last year, due to the gross profit on the incremental revenues, as well as lower charges related to the repatriation of cash in Venezuela, partially offset by higher subscriber acquisition costs related to the increase in gross additions.

The higher OPBDA flowed through the cash flow before interest and taxes, which was $111 million versus $15 million a year ago. It's worth noting that last year, we received a $24 million dividend from Sky Mexico in Q4, which we did not receive this year.

Regarding Venezuela, as I have mentioned in the past, the government implemented a series of regulations earlier in the year that included banning the use of the parallel market for converting bolivars to U.S. dollars. This situation restricts our ability to repatriate dollars, which explains the lower foreign currency exchange losses this year compared to last. It is also the driver behind our controlled growth approach. Having said that, we did repatriate a total of $72 million from Venezuela in 2010. As of December 31, we had approximately $170 million of cash on hand in Venezuela that's currently awaiting repatriation, and that figure, by the way, is expressed using the official exchange rate of 4.3 bolivars per U.S. dollar. We continue to monitor the situation closely and it remains our policy to repatriate as much excess cash as we legally can.

As I mentioned, I would like to make a few comments about the results of Sky Mexico. Mike and I were in Mexico City last week to meet with the Sky Mexico team. We both came away, again, enormously impressed for the quality of the team and the job they have done to restructure parts of their business to profitably attack the middle-market segment in Mexico. As a result, Sky Mexico delivered another extremely strong quarter, adding 291,000 net subscribers in the quarter compared to 143,000 a year ago. That result put them over the 1 million net add mark for the year and above 3 million subscribers overall. The financial results of Sky Mexico were equally strong as revenue and OPBDA grew 15% and 18%, respectively.

In closing, I would just like to make a couple of final observations. If you add the results of our three platforms, the DTVLA companies added over 2 million subscribers in 2010. This is a pretty remarkable achievement. As of today, including Mexico we have more than 9 million subscribers across the region and we expect to surpass the 10 million subscriber mark during the course of this year.

On a consolidated basis, so excluding Mexico, for the first time in our history, our quarterly revenue exceeded $1 billion. That was of course in the most recent quarter. And for the year, we surpassed the $3.5 billion revenue mark and our business now delivers in excess of $1 billion in OPBDA. I think these subscriber figures and financial results represent important milestones for DTVLA.

So in summary, the fourth quarter was a strong finish to an exceptional year and we are excited to keep up the pace in 2011.

I'll hand it over to Pat.

Patrick Doyle

Thanks, Bruce. Much like Latin America, DIRECTV U.S. also had an excellent quarter to cap off a very strong year. By most measures, our fourth quarter was the strongest of the year, particularly when considering the acceleration and subscriber growth, driven by a significant improvement in both gross adds and churn, coupled with the increase in our Pre-SAC margin.

Starting first with subscribers. On the third quarter earnings Call, we talked about reversing a five-quarter trend of declining year-over-year net additions. We built on that momentum in the fourth quarter by adding 289,000 net additions, more than double last year's number. Gross additions of 1.1 million were particularly strong and represented the best fourth quarter in our history.

We attribute this strong demand to a combination of factors, including the continued popularity of our Whole-Home DVR service and Free HD promotion, as well as a modest benefit from competitor programming disputes. The strength in gross additions was broad-based as all of our main sales channels were up on a year-over-year basis, except for the telco channel. Specifically, we saw very strong results in DIRECTV.com, consumer electronics and also in our Commercial business. And this growth is not coming at the expense of quality. As Mike mentioned, our percentage of gross additions taking advanced products hit an all-time high rate of nearly 80% in the fourth quarter.

These trends help explain the eight-basis point reduction in our monthly churn rate to 1.44%, representing one of the lowest fourth quarter churn rates in our history. The majority of the improvement is attributable to lower voluntary churn, mostly because we're managing churn in a more proactive, segmented and targeted fashion.

As we talked about briefly on our last earnings call, we now have dedicated call agents that are specifically trained to deal with higher risk customers. These agents also have better tools and information to predict the likelihood of a customer leaving, so they can communicate more effectively with those customers.

Another contributor to the lower voluntary churn is that, frankly, we're providing our customers with fewer reasons to leave DIRECTV. For example, even though we still have a long way to go toward reaching our ultimate service goals, customer satisfaction levels have shown steady improvement in both our installation network and call centers. We've also seen steady improvement in the reliability of our set-top boxes.

ARPU was equally strong as the 4.6% growth was more than double last year's fourth quarter growth rate.

As we've seen throughout 2010, the key drivers of this growth, other than price increases, are strong sales of premiums and pay-per-view movies, advanced services and advertising. Fourth quarter pay-per-view movie buys were the highest of the year due, in part, to the launch of our enhanced DIRECTV CINEMA service. Also contributing was the December launch of our new entertainment portal named MyDIRECTV, which helps customers find their favorite movies and shows in an easy-to-use fashion.

In addition, we had a very solid quarter in the premium movie category where for the third consecutive quarter, our buy rates per customer increased over the prior year.

ARPU growth also benefited from the increased penetration by both new and existing customers of advanced services, including our Whole-Home DVR service. You heard that almost 80% of new customers are activating with these services. Although many new customers receive HD for free, virtually all of the advanced service customers are signing up for DVR services for an extra $7 per month and about 1/3 are taking our new Whole-Home DVR service for an extra $3 per month. We're seeing many of these same trends with existing customers, which helps explain the modest increase in fourth quarter upgrade and retention costs.

Looked at another way, at the end of last year, about 2/3 of our 19 million-plus customers had advanced services, which is about 50% higher than the penetration rate reported by Comcast last week.

Turning now to the bottom line, as I mentioned earlier, Pre-SAC margin grew year-over-year for the sixth consecutive quarter, but OPBDA margin declined by a percentage point to about 24% in the quarter, primarily due to the higher gross additions and related increase in subscriber acquisition costs. As we've seen all year, our programming subscriber services and broadcast operations costs were contained and well managed. G&A grew a bit faster than revenues primarily due to higher incentive compensation expenses, while the increase in upgrade and retention costs was primarily due to an increased demand by existing customers for advanced products and services.

This also explains the increase in our cash SAC rate to $821 in the fourth quarter. We've talked a lot about this trend in recent quarters, so I won't spend a lot of time repeating myself. But in summary, we attribute almost the entire increase in SAC to higher set-top box, dish, commissions and installation costs associated with the increased demand for advanced products.

Also, beginning in the fourth quarter of last year, our HD DVR customers no longer have to pay a fee to connect their direct receiver to the Internet. This is consistent with our connected home initiative and the extra $70 cost associated with the activity explains most of the sequential increase in SAC from the third to the fourth quarter.

I do think it's important to repeat, however, that connecting customer to the Internet is one of our top priorities, from both a strategic and financial perspective. The strategic benefits relate to our improved competitiveness since connected customers receive many new and exciting services. For example, with a broadband connection, our title selection for DIRECTV CINEMA is over 10x greater than without a connection, and perhaps more importantly, those movies are available on demand. Likewise, many of our new anytime, anywhere services that Mike touched on earlier also require a broadband connection.

In addition, we see many financial benefits including lower churn rates and incremental revenue streams related to greater VOD buys, the potential to charge for some of the new mobile services and additional advertising revenues.

Looking quickly at our full year consolidated results, adjusted EPS, excluding the Liberty and Malone transactions, grew 72% to $2.48, and free cash flow increased 18% to a record $2.8 billion. The major uses of cash in the quarter that were not included in free cash flow were the purchase of about 37 million shares of DIRECTV stock for $1.55 billion, bringing our full year repurchases to over $5 billion and the $605 million payment to Globo, increasing our ownership stake in Sky Brazil to 93%. These were partially offset by about $150 million tax benefit related to the latest federal economic stimulus program. We ended the year with about $9 billion in net debt, including a cash balance of $1.5 billion and a total debt-to-U.S. OPBDA ratio of 2x.

Finally, I'd like to make a few comments about our 2011 outlook. First and foremost, all of the guidance that we provided at our Investor Day remains intact. I would, however, like to provide a bit more color on how we expect the quarters to look for both our U.S. and Latin American businesses.

Looking first to DIRECTV U.S., our revenue outlook of mid- to high single-digit growth is expected to come in fairly evenly throughout the year. The same cannot be said about our OPBDA margins, which are expected to be lower in the second-half of the year compared to the first-half, mostly due to higher programming costs. As we talked about in December, we're expecting ARPU growth in the high single-digit range this year, mainly due to higher costs related to the NFL SUNDAY TICKET, Regional Sports Networks and retransmission fees.

Generally speaking, these higher costs impact the second-half of the year harder than the first-half, and as a result, our ARPU growth is expected to be significantly higher in the second-half, which of course has an unfavorable impact on our margins.

Regarding DIRECTV Latin America, our 20% outlook for revenue growth is likely to be achieved with higher growth rates in the first-half of the year relative to the second-half. OPBDA margins, however, are expected to be more consistent throughout the year.

As you know, our ability to accurately predict financial results in Latin America is much more difficult than in the U.S., particularly considering the volatility with currency exchange rates throughout the region, as well as repatriation fees in Venezuela.

Finally, regarding our balance sheet, you saw in the earnings release that our Board approved another $6 billion share repurchase program. At this time, we expect to continue repurchasing shares in the same $100 million-plus per-week range that you saw in 2010. We also expect this year to reach our 2.5x leverage target of total debt-to-DIRECTV U.S. OPBDA by opportunistically accessing the debt markets, while also refinancing our existing high-yield debt depending on the market conditions. We recently completed a five-year $2 billion revolver that we believe reflects the best pricing of any similar credit facility completed since the 2008 credit implosion.

With this facility, DIRECTV will operate more efficiently with lower average daily cash balances, while also providing us with greater flexibility if the market conditions deteriorate. Also, we have started talking with the rating agencies regarding the inclusion of DIRECTV Latin America into our credit profile. If we accomplish all of these and deliver the expected financial results shared with you at our Investor Day, I believe we will continue generating substantial shareholder value by leading the industry in revenue and earnings growth, as well as returning excess cash to shareholders.

So with that, I'll turn it back over to John.

Jonathan Rubin

Thanks. And before moving on to Q&A, investors should note that we have members of the media on this call in a listen-only mode. I'd like to remind the media that they are not authorized to quote any participant on this call either directly or in substance other than the representatives of DIRECTV.

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

Question-and-Answer Session

Operator

[Operator Instructions] We'll take our first question from Doug Mitchelson with Deutsche Bank.

Thomas Ernst - Deutsche Bank AG

It's actually Tom filling in for Doug. I just have a question of the 2011 sub-guidance, just trying to understand it better. If we're seeing improving trends with the DIRECTV CINEMA launch especially on churn, and given how you guys posted 4Q subs and post-3Q also, I just wanted to get some more maybe color on why you think the net adds should moderate in 2011? And then in addition to that, how confident are you that in 3Q in the event there is no NFL SUNDAY TICKET, you could come up with promotions that could maintain the gross adds as you expect them to be?

Michael White

This is Mike. Let me make a couple of comments, and then Pat, you can also chime in as well. Look, trying to forecast subscribers by quarter is a bit of an interesting art and we don't have a perfect crystal ball. I would say certainly we finished the year with excellent momentum. I would also say that we're starting out the year with a very good momentum in both Latin America and in the U.S. But this is -- we've got a lot of things ahead of us this year from whatever may or may not happen with the NFL, and I'll talk about that in a second. Our second-half overlaps are going to be far more challenging given the strength that we saw in the second-half last year. And also, I think we're seeing an increased competitive intensity in the business, overall. And as competitors ramp up their promotional activities, I certainly would expect that to create some challenges for us and we've got something on the order of 80 re-trans deals to get done this year, having done over 40 last year. So there's an awful lot of things that, in my mind, in all that productive to kind of speculative, I think what we're trying to set is a prudent set of goals for our U.S. business. But certainly, we're off to a very strong start in the first quarter. But I – we’ve got an awful lot of things to kind of navigate between Q1 and the end of the year. So I feel great about our outlook for the year. I certainly expect us to hold market share. We're off to a great start. But there's kind of a long year to go. In terms of the NFL SUNDAY TICKET, look, there are a lot of factors that will be involved. I'm not sure it's all that productive to speculate and certainly it's premature and we're all hopeful that both sides come to an agreement so that we continue as is with our program. But keep in mind; it was mostly a promotional vehicle in the third quarter. And if I remember correctly, about 25% of our gross adds took SUNDAY TICKET in third quarter this past year. So it's 25% of one quarter's gross adds. I certainly wouldn't sit here and say there would be no impact, but we're certainly working on contingency plans in the event we need to shift the promotion a bit. But, Pat, I don't know if there's you want to add.

Patrick Doyle

Yes, I think on the sub issue for 2011 I mean, a couple other things to keep in mind that we've expressed before is in the telco channel, we continue to expect that the gross adds coming from the telco channel will decline. I mean, that's been normal over the last few years as they have lose landlines so kind of mechanically, there's no doubt in our mind as we look into 2011 that those will be lower. And then also, we've instituted some things starting in December and in January and February to again refine quality. And so we've changed some of our filters and some of our compensation structures, which we know will reduce gross adds, but it's something that strengthens the company overall. I mean, and as Mike said, on gross adds, I think we're confident on the third quarter without the promotion because if you just look at the first, second and fourth quarters where we don't have the NFL as our lead, we do very well. So I think if there is an issue with the season, I think we'll come up with a promotion again that will be very attractive in the marketplace and keep us on an even keel.

Operator

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

Marci Ryvicker - Wells Fargo Securities, LLC

Just curious, you seemed to have done better than even you indicated during your Analyst Day. So you did you get accelerated subs in the back-half of the fourth quarter? And can you talk about where the subs are coming from? Is it DISH? Is it cable? And then secondly, if you connect your set-top boxes to the Internet, how do you think about the cost of using the pipe? And I guess, I'm asking about how the Level 3/Comcast dispute could impact you longer term and how you think about managing potential costs.

Michael White

Marci, it's Mike. Look, I think we were pretty clear in the December meeting that I was pretty confident we were going to have a pretty good fourth quarter. So I don't think -- if I think back on the trends during the quarter that it was kind of December back-end loaded, if you will, it was pretty even throughout the quarter. So we try not to kind of make, as I said, pinpoint forecasts of exactly how many subs are going to come in. But we certainly had a very, very strong fourth quarter, as Pat noted in his remarks. And the gains were pretty broad-based to be honest with you. Far and away the majority of new subscribers came from cable providers, but that's because they have 60% of the industry, so you would expect that. And so as I look at it geographically, it came from both urban and rural areas. They came from pretty much ratably from all our competitors, I would say. And in particular, I think what's more important, as you saw, it's the advance services higher-quality subs that we're tracking, and that's important because I think we continued to try and focus on the higher-quality subscriber that's interested in the kind of premium services and an outstanding technology that we can provide. In terms of the question on the cost of using the pipe, to be honest with you, there are a number of aspects of that, that we've been working, but frankly, as we've looked at our economies of scale and our negotiations, we're actually seeing reductions in those costs, quite substantial reductions in those costs. And I would expect that to continue. How much -- when you look at all of these changes that are going on as consumers have to pay instead of all-you-can-eat plans into these kind of plans where they've got to pay by the usage. How much that, over time, mitigates usage of video on mobile devices, I think remains to be seen. I think it's still pretty early days to speculate on that and frankly, I think most of the video on mobile devices is still commuters that are on trains, boats, planes and automobiles, not watching live streaming, but frankly, watching ported content.

Operator

We'll go next to Tuna Amobi with Standard & Poor's Equity Group.

Tuna Amobi - S&P Equity Research

So I guess, the first question for Mike, I thought it was very interesting that you called out the DIRECTV, the CINEMA product. And it seems like you alluded to the fact that it was a fairly meaningful revenue opportunity this quarter, this past quarter, which is the first time we're hearing that. So can you perhaps flush out a little bit more for us in terms of how you see that product evolving? And of those three incremental revenue opportunities that you highlighted on the Analyst Day, is it fair to say that this is kind of the most promising opportunity that you see relative perhaps to addressable advertising, the number of titles? Any commentary you have on the number of titles and any windows that you've already commented on in the past, the early windows, how's that kind of trending, right now? So just generally around that product to flush it out a little bit more would be helpful.

Michael White

Sure. Let me kind of remind everyone that Investor Day we talked about three significant growth opportunities: Movies; local adds, in particular, but also interactive adds and commercial. And in the fourth quarter, by the way, we made terrific progress on all three fronts. Our movies were up over 30%. Our Commercial business was up, if I remember correctly, Pat, 20% plus, I think. And our advertising revenues were up double-digit. So we had excellent performance across each of those strategic priorities for our business. And in terms of sizing each of them, they're all -- in terms of that overarching $750 million opportunity, I think it's kind of a third, a third, a third. So they're all equally big opportunities in my mind. Now as I look at specifically, DIRECTV CINEMA, when you connect the box, you get 10x more offerings in terms of variety and we've already increased our variety by 20x, even if you don't connect the box, with some of the changes in our technology. So one of the things that we're doing is, we're providing far more variety for our consumers than we've been able to do before. We also -- Paul Guyardo and Karen Leever have done an outstanding job, kind of redoing the whole website, the DIRECTV.com portal, and it's a much better experience for the consumer with kind of a search engine that will enable you to find the content you want. So we're very, very bullish on the opportunity that we see with movies. We continue to have discussions with the different studios about day-and-date. And I expect you'll see some trials this year with some of the studios probably around mid-year I would guess, where perhaps we'll try something that's four weeks or six weeks from theatrical release at some higher price than we currently charge and we'll see how big that market is. But we've had those discussions with all of the studios. But frankly, I think again, we're just scratching the surface on movies. I think it's still the best is yet to come. Pat, anything you want to add on that?

Patrick Doyle

Yes, I would agree on that. If you kind of look at the three opportunities we have, movies may be the biggest just because there's a lot of money in movies, but again, part of that is us getting a product getting it out in front of the customer and getting them attracted to it. On the advertising, I feel very good about it because we're talking about local adds that we've never been able to sell before, so that's a brand new revenue stream and we're confident in it because we're going to sell it. And then moving into addressable, obviously, gets excellent value for the advertisers. So kind of like Mike said, each one of them has their own story, but they all have great opportunities, some as share of wallet like movies, but it's nothing like some of the stuff like ad sales as brand new services that we can provide that we weren't able to before.

Operator

We'll take our next question from James Ratcliffe with Barclays Capital.

James Ratcliffe - Barclays Capital

Two if I could, one on the U.S. and one on Lat Am. In Latin America, Bruce, can you give us an idea relatively where you're seeing relative strength versus in terms of both subscribers and ARPU, which markets are performing better or worse than you might have expected the last time we looked at this at the Analyst Day? And secondly, regarding the U.S., you folks were much less aggressive in going after customers during the digital transition 2009. As we move into second and third quarter of '11 when the customers you did pick up would have two-year contracts expire, how much of an effort are you going to make to retain whatever customers you may have picked up from those promotions?

Bruce Churchill

Why don't I start with the Latin American question. To be honest, we're pretty much seeing growth across the region. Brazil is probably particularly strong in terms of sub growth just because we more recently introduced some of those middle-market packages that I spoke about, in particular, the least expensive of them all, the SKY FIT product, was introduced in October. So that had probably more of an impact in Q4 than some of the other territories. But having said that, as we mentioned Europe, you look at the full year we had growth pretty much in every territory. The bigger countries are going to be -- have more subs just because that's where the people are and probably the one exception to this is Venezuela, where we are just consciously pursuing a somewhat, I discovered is a controlled growth strategy, where to the extent we are able to repatriate dollars out of that country. We will reinvest them because the biggest issue is having money to buy new boxes. So we can repatriate the funds, we will reinvest it in the business. So that's the one that's probably not growing as fast as we have experienced, but it's not because the growth isn't there. We are definitely -- -- there's much more demand than we are choosing to meet.

Michael White

James, it's Mike. In terms of the digital transition, our whole approach was a bit different from the cable guys. Remember, our situation was different to start with, where they have these low-end packages, I don't know, $15 a month or something, and I think they made some transition deals that they're now trying to work their way out of and hence, I think that's some of the, if you will, cord-cutting that folks have seen is on the lower end, whereas, we never chased that business. And frankly don't intend to again later this year. So we have had -- I mean, Pat and his team put in place a rigorous number of credit screens, changes in our business over the last two years to ensure that we focus as much on quality as we do on quantity of new subscribers. And that's not something we just started a quarter ago or two quarters ago. Pat's team has been focused on that for the past couple years. And so I actually don't expect to see a significant change. We're certainly committed. We want passionate, loyal consumers for life. So rest assured, we'll be aggressive in trying to retain our customers but whether they’re came into the digital transition or otherwise, I don't see us doing anything different in that regard. Pat?

Patrick Doyle

Yes. I think the other thing, James, that we've talked and I talked about in my prepared remarks today is, we've established this new process to deal with certain high churn-risk groups and one of our top target groups is a group that we start looking at about a month 22 through month 36. Those coming up on the end of their commitment and we've identified all of them, we've bucketed them into value and so when they do call in, they're going to a dedicated agent who has the tools to try to save that person. Now it could be that we learned over that two-year period that it's a very low-value customer from their performance and that there's very little we'll do and as far as committing more money. But it could be that they've proven themselves to be a good customer and we will do some things to try to save them. So they would be in with that group just like anybody else rolling off of their two-year commitment.

Operator

We'll take the next question from Tom Eagan with Collins Stewart.

Thomas Eagan - Collins Stewart LLC

Mike, as you know, on the FCC's March agenda they will be talking about any changes to the transmission. What do you expect we might eventually see out of the FCC in terms of changes to re-trans? And might just the fact that the FCC is more interested in this, help you guys negotiate better deals?

Michael White

Tom, look, the retransmission issue is a really challenging problem. On the one hand, I think the broadcasters feel that their business model’s broken and you've got some anomalies that were created by Congress and the FCC 20 years ago and the way this system works that isn't working particularly well today when you look at the price increases that are being driven, which ultimately have to impact our customers. So we're part of the coalition that believes we need to change the system. Now realistically, change comes slowly in this area in Washington. So while there's a hearing in March or they may talk about some things, I think you're a year away before you'd see those things change. I mean our hope is that we can work together with our broadcasting partners to find win-win solutions here. We certainly recognize that re-trans is here to stay. We're not trying to fight that argument anymore, to be honest with you. I think we're more trying to mitigate the impact on our customers' bills. At the end of the day, what I'm more concerned about are the increases in the monthly bills that our customers are going to receive. And I think perhaps the best thing that the FCC could do is also add some transparency to this process. It's a crazy process. There's no price discovery. There's no ability to know what the real market is and so you can't even ensure you're paying market even if you're just trying to pay market. It's a screwy process and whether or not the FCC gets involved in things like arbitration or not, certainly, we'd be supportive of that. But I'm not sure realistically that's likely to happen. But I certainly think that they could work on improving transparency in the process for everybody.

Thomas Eagan - Collins Stewart LLC

So is your major network, ONO deal, up in the second-half?

Michael White

We don't talk about our specific negotiations, but as I said, I think we had 40 deals that we got done last year. We got 39 done. We're still working on one and we've got over 80 deals to get done this year and so again, we're trying to very carefully observe what we think the market is. I'm not trying to kind of do anything other than that ensure we don't pay more than market, that we have a level playing field versus all of our competitors, whether it is our satellite competitors, our cable competitors or digital competitors, for that matter, that we have digital rights so that we can provide TV anywhere, opportunities for our customers that are already paying for the service and that we can kind of mitigate as much of the impact on our customers' monthly bills in a tough economy as we can. But it's a journey, and I expect, along with the rest of the industry, we're all going to continue to wrestle through this, this year.

Operator

Take the next question from Jessica Reif Cohen with Bank of America Merrill Lynch.

Jessica Cohen - BofA Merrill Lynch

On the multi-service, can you tell us what the split is on VOD with you and the studios?

Patrick Doyle

Well, I mean, I think that it's probably in the industry, on linear, as you probably know, it's been more like 50-50. On VOD, it kind of depends on HD versus day-and-date, but it's generally -- the split's a little bit more towards the studio on that one, more kind of 60-40, sometimes 70-30. Again, it depends on a lot of the deals and whether it's day-and-day, whether it'd HD or not HD, so it's kind of all...

Jessica Cohen - BofA Merrill Lynch

And how does that change with the premium VOD that you’ll introduce later this year?

Patrick Doyle

I think we're still having those discussions, Jessica. We really haven't finalized that yet and furthermore, I think this whole arena on movies is in a bit of flux as they have to look at their economics vis-a-vis premium channels vis-a-vis what Netflix is getting it for and so on so forth. Our focus, again, is we want a competitive level of playing field versus Netflix in whatever it is we do.

Jessica Cohen - BofA Merrill Lynch

Can you discuss your ARPU outlook for 2011? I mean, are you comfortable with the fourth quarter rate given advertising trends and the things you've said about the studio you've got the movie service?

Patrick Doyle

I think we're comfortable with kind of the revenue number growth rate that we gave you out at Investor Day, which is kind of mid- to upper single-digits.

Michael White

Probably figure out what ARPU you'd plug in there, Jessica on your own. Kind of your projection for...

Jessica Cohen - BofA Merrill Lynch

You said advertising is up double-digits in the fourth quarter. Can you be any more specific? And can you talk about first quarter trends?

Michael White

Yes. I mean, first quarter trends, I've got one month or so, that's probably not useful.

Patrick Doyle

Yes, I don't know about first quarter trends. But as you know, generally, historically, we've been around $100 million a quarter. In the fourth quarter, we were more in the $125 million range on ad sales. And I think it’s like as Mike said, we think we can grow that double-digits.

Michael White

Keep in mind, Jessica, the big thing on ad sales is the targeted advertising where we're going to have, I think it's 50 channels in 50 cities and that doesn't hit until the second-half of the year, I think. So I think our ad sales team under Bob Riordan, does an outstanding job and is continuing to see good growth. But the real kind of jump-shift growth in ad sales won't come until we kind of light up the kind of local advertising capability, if you will, that we haven't had before to do addressable ads on 50 channels in 50 cities. And I think that, you'll see rollout beginning in the second-half and probably into next year.

Operator

We'll take our next question from Stefan Anninger with Crédit Suisse.

Stefan Anninger - Crédit Suisse AG

Could you provide us with a bit more detail on your new agreements that will allow you to resell Verizon and AT&T fiber-based broadband services? And can you talk maybe more broadly about what kind of an opportunity you see there longer-term? And how you might integrate those services into a sort of a new bundle?

Michael White

Stefan, look, I'm not going to get into the specifics of the deals and frankly we just completed the deals. What I would tell you though is, couple things: First, we're very excited about the opportunity to sell higher speed broadband and to create to your point some synthetic bundles with both AT&T and Verizon. They're terrific partners with us. Certainly, we're expecting to be able to offer broadband speeds up to 25 megabits a second in those kinds of bundles, if you will. And I would say, as we look at the bundles, we haven't really finalized our deals yet, but we're looking at the market and I don't know whether it ends up being $99 all in or $109 all in, or somewhere in that vicinity. But we haven't finalized the actual kind of commercial aspects. I mean, the deal is done, but the marketing and the kind of exactly how we're going to do it is something that we're really literally right in the middle of, as we speak. We just completed these deals, I guess two or three weeks ago. But I'm very excited longer-term that it opens up another option for us to ensure that a DIRECTV customer can get the best video offering in the market and still get a competitive bundle whether they want higher speed or whether they're happy with more moderate speed broadband services in the home.

Operator

We'll take the next question from Bryan Kraft with Evercore Partners.

Bryan Kraft - Evercore Partners Inc.

Just a question on SAC and retention spending this year, I mean, how do you expect retention spend to kind of trend throughout the year? Is just roughly $300 million a quarter run rate reasonable to expect? Do you think that's an opportunity for margin improvement? And then on the SAC side, do you think you'll start to get some relief as we move through the year from lower box pricing that could maybe start to bring that SAC back below the $800 million level?

Patrick Doyle

Yes, I think on retention spending, our expectations for upgrade and retention in 2011 is that it will be modestly higher than 2010. And again, part of that is an assumption that we will see demand for stuff like multi-room viewing and broadband connection. We'll see as we go through the year, but that's kind of why we're expecting it to go up in 2011. I think we said earlier that after 2011, we really do see upgrade and retention having the potential to flatten and even maybe trend down from a cost standpoint. On SAC, yes, I think that we do see SAC being higher in the first couple of quarters and then trending down. We have a lot of things that are going on, on the hardware side that are pretty exciting. We're introducing a new HD box, the H25, which will give us a more cost competitiveness. So I think kind of in the first couple of quarters with broadband connection, with the demand we're seeing for HD DVRs slightly higher and then third and fourth quarters you should start to see SAC trend down from the first-half of the year.

Bryan Kraft - Evercore Partners Inc.

And just to clarify, the back-half trending down, that's because of lower box pricing or because you think the DVR sell-in rate might decline somewhat from where it is here?

Michael White

Yes, it's from cost reductions because we really -- the demand’s pretty high, so I don't know if it can go much higher. But we don't think it's going to tail off.

Operator

We'll take the next question from Jason Armstrong with Goldman Sachs.

Jason Armstrong - Goldman Sachs Group Inc.

Maybe first on connected boxes, you guys have talked obviously about the value proposition being sort of closing the gap on pay-per-view versus peers. I know it's early, but are you starting to see that happen in the customer rates where you've deployed those boxes? And then second question just quickly on DISH, they obviously hiked rates substantial in January. I'm wondering if you have seen any sort of migration impact from that?

Michael White

Jason, it's Mike. I think on the first question, I think it's too soon to tell. Look, we really -- this is a fourth quarter initiative and frankly, to really make this thing kind of work, it's both connecting the box. It's adding the new entertainment portal which we launched the 1st of December, I believe, the DIRECTV.com. And then it's also kind of broadening the content offerings for more variety. And all of that -- we have about 850,000 customers that are connected and it's a wonderful service. And I hear rave views about it for those that have it. But I think it's a bit too soon to say because really, we had maybe one month for some customers where all of the pieces are coming together and you're going to see more of that as we go through this year. Our focus is, as I said, I think this is a multi-year journey, as I said in December at our Investor Day. We recognized this strategically. We want to make sure that we can provide the DIRECTV customer the best entertainment experience in the home with enough variety, whether it comes from the satellite or whether it comes across the Internet that we cobble together. And I think you'll see us focusing this year, number one, on getting what I call the plumbing and wiring, which is just getting more scale in terms of the number of customers that connect the box. Second, you'll see us launching a new HD user interface later this year that we're very excited about that will go with the entertainment portal. And then third, we're going to continue to work on content options, whether it's day-and-date, whether it's early release movies, or whether it's other things than movies, whether it's kind of library content like old television shows or what have you. And I think, look, this is a two- or three-year journey for us in terms of really getting that aspect of the service where we want it to be. In terms of our competitor, look, as an industry, we're all faced with higher programming costs and hence you're seeing somewhat elevated pricing, and I expect you're going to continue to see that from all of us in the industry as we all grapple with these higher content costs that we have to pass on to our customers. And I don't think anyone's immune from it. And I don't think it's in anybody's, certainly not in our interest to try and take advantage of programming disputes because this is a broad industry issue and that's why we're part of a coalition to try and see if there aren’t ways that we can create a more level playing field going forward.

Operator

We'll take our next question from Vijay Jayant from Citadel Securities.

Kunal Madhukar - Bear Stearns

It's Kunal for Vijay. Continuing on SAC for the U.S., how do see SAC trends especially with regard to increased competitor spending during the balance of this year, especially on marketing and promotions?

Michael White

Yes, I mean, I think that we've got a pretty well-established plan on kind of the marketing and sales side of it, And we don't anticipate moving off of that plan, obviously, we'll watch the market and see what's going on. But I think we're very comfortable with kind of the commission side of what we're paying dealers and how we're marketing and our marketing spend on the products. So, yes, we don't see -- for us, SAC is more really driven about the demands of the customer in the home and not so much commissions or sales incentives or marketing dollars.

Operator

We'll take our last question today from Craig Moffett with Sanford Bernstein.

Craig Moffett - Sanford C. Bernstein & Co., Inc.

This is a follow-up question to the question that was asked about the telco fiber initiatives. You're also trying some things with telco, LTE with Verizon in Pennsylvania, for example. Are you thinking that, that's a product you can market out of their regions? So would you expect Verizon to be marketing that in AT&T's territory, for example, and using LTE as a full-pledged replacement for a terrestrial broadband service?

Michael White

Craig, it's Mike. First of all, the test, the pilots are going very well. Technically, the product's working very well. We're also testing kind of -- that's kind of a unique bundle. It also includes some mobile broadband, as well as the residential broadband that's kind of like a -- it's a different kind of a triple play, if you will, and we're getting some learnings out of that as to what the customer thinks about that. It's primarily, however, I would say, a product that most likely will be focused on rural areas. And we're looking forward to working with all of our telco partners as LTE rolls out to see whether the concept would make sense. In terms of where we market it, those are discussions that are ongoing as we speak with Verizon, so it's probably premature for me to comment. But certainly, we have an excellent partnership with all of our telco partners and work hard to kind of maintain good relationships with all of them.

Craig Moffett - Sanford C. Bernstein & Co., Inc.

Mike, in your comments earlier, you said that you were expecting somewhat lower activity from the telco channel this year. Is that just conservatism? Or given the number of things that you're doing with the telco channel, is that just sort of the natural maturation of the channel?

Michael White

No, it's the natural maturation of the channel, Craig. I mean, in the fourth quarter, it was only channel that we have that was down, and it was down mid-teens. I mean it wasn't down more than that and that's kind of combination of some of our older providers being down a little more and some of our newer partners like Frontier and CenturyLink being up. So it's not a huge part of our gross adds anymore. I think it's around 15% of our gross adds, so it's an important partnership and a part of our overall approach, but it's not something that one way or the other, is going to materially change our trajectory. But, no, I think it's just the same. I mean, I'm excited about fiber, but we've got to see how big the idea is. So I mean, it's awfully, I mean, after a channel that's been kind of -- had four quarters of declines, hard for me to say we're going to turn around all at once, but we feel good about the initiatives that we're working on that should enable us to stabilize or improve that channel, over time.

Operator

That's all the time we have for questions today. This does conclude today's DIRECTV Group's Fourth Quarter 2010 Earnings Conference Call. You may now disconnect your lines, and have a pleasant day.

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