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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

Analysts

John Hodulik - UBS Investment Bank

Michael McCormack - Nomura Securities Co. Ltd.

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

Benjamin Swinburne - Morgan Stanley

James Ratcliffe - Barclays Capital

Stefan Anninger - Crédit Suisse AG

Marci Ryvicker - Wells Fargo Securities, LLC

Douglas Mitchelson - Deutsche Bank AG

Thomas Eagan - Collins Stewart LLC

Tuna Amobi - S&P Equity Research

Jason Armstrong - Goldman Sachs Group Inc.

DIRECTV (DTV) Q1 2011 Earnings Call May 5, 2011 2:00 PM ET

Operator

Good day, ladies and gentlemen. My name is James, and I will be your conference operator today. At this time, I would like to welcome everyone to the DIRECTV's First Quarter 2011 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 thank you everyone for joining us for our First Quarter 2011 Financial Results and Outlook Conference Call. With me today are Mike White, President and CEO; Pat Doyle, our CFO; Bruce Churchill, President of DIRECTV of Latin America; and Larry Hunter, General Counsel. In a moment, I'll hand the call over to Bruce, Mike and Pat for some introductory remarks. But first, I'll read to you the following: On this call, we'll 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 Risk 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 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 the SEC's Regulation G that requires companies reporting non-GAAP financial measures to reconcile these measures to the most directly comparable GAAP measure, we provide reconciliation schedules for the non-GAAP measures, which are attached to our earnings release and posted on our website at directv.com. So with that, I'm pleased to introduce Mike.

Michael White

Thanks, John, and thank you, everyone, for joining us on this Cinco de Mayo. DIRECTV is off to a very solid start, I think, in 2011 as we delivered another strong quarter of operating and financial results, extending our position as the world's largest video service, while also increasing market share and profitability in both our U.S. and Latin American businesses. I suppose from my perspective there were 3 main takeaways from the quarter.

First, the strength of the DIRECTV brand, along with our state-of-the-art suite of products and services, continues to drive strong consumer demand all across the Americas. Record-setting subscriber growth in Latin America this quarter exceeded our expectations, surpassing the previous high set during the run-up for the World Cup last year. This considerable achievement, along with solid customer gains in the U.S., culminated in a nearly doubling of consolidated net additions to 611,000 or 879,000 if you'll include Sky Mexico for the quarter. Strong subscriber and ARPU growth drove industry-leading top line revenue growth of 13%.

Second, our disciplined approach to improving the efficiency and productivity of our operations continues to generate strong overall margins. Despite a 28% increase in consolidated gross additions and related increases in acquisition costs, we managed our expenses effectively, capturing double-digit growth in operating profit before depreciation and amortization of 12%.

And third, the strength and continuing stability of our earnings and cash flow continued to create significant value for our shareholders. We improved our net income by 21% and we repurchased $1.4 billion of the $6 billion our board authorized in February earlier this year, fueling a lift in earnings per share of 44% to $0.85 in the quarter.

Now before I turn the call over to both Pat and Bruce for a more detailed review of our U.S. and Latin American businesses, let me offer just a few other observations about both the U.S. and Latin America.

Let me start with the DIRECTV U.S. Consumer demand for DIRECTV remains solid as net additions exceeded expectations by increasing 84% from the prior year to 184,000. The value of new subscribers remains high as nearly 80% of gross additions signed up for HD and/or DVR services in the quarter. Revenues from both advanced services and market share gains were key contributors to our 8% revenue growth in the quarter.

Also contributing were 2 of the key initiatives that we identified as new growth opportunities as you'll recall at our Investor Day in December. We saw a nearly 20% growth in commercial sales in the quarter, and DIRECTV CINEMA movie buys were at an all-time high. I'm also pleased with the way we managed our costs during the quarter. We generated the highest Pre-SAC margin ever for first quarter at 38.4%. Our OPBDA growth of 4% reflects the increase in gross additions and advanced products, and is consistent with our full year guidance. So overall, I think a very solid quarter for DIRECTV U.S. to start the new year.

Now before I turn to Latin America, though, let me just point out that as we exited the first quarter, we did see an uptick in the competitive landscape, as new customer promotions offered by both cable and telcos were more aggressive. To the extent these trends continue, we will see a modest impact on churn and net adds for the year.

However, an increase in competitive activity was fully contemplated when we put our 2011 guidance together and we're still on track to hit our key metrics for the U.S. business.

Turning now to Latin America. We knew that the economic demographic and subscriber trends in Latin America were favorable, but I think it's fair to say that net additions of 427,000 far exceeded all of our expectations. Not only did we nearly doubled the net additions of the year ago, but we surpassed the historic customer growth recorded during the run-up to the FIFA World Cup last year. The distribution of wealth continues to shift towards the emerging middle class in Latin America, which happens to be the demographic sweet spot for any pay television service. We have a unique ability to sell superior offerings of our differentiated products and services on a continent-wide basis at a lower cost versus our competition. This is particularly true in Brazil where it seems we report record growth almost every quarter.

For a bit more perspective, the quarter was, by far, Brazil's best ever as gross adds were more than double the level of a year ago and 73% higher than we saw in the second quarter of 2010 when we were heading into the World Cup. In addition to Brazil, we're seeing solid growth in other countries as well including Argentina, Colombia, Ecuador and Peru. Equally impressive was the 14 basis point reduction in DIRECTV Latin America's postpaid churn rate this quarter to 1.43%, a level even lower than we see here in the U.S. This is due in large part to the relatively stable macroeconomic conditions in the region, along with the strength of both our brand and our service.

With this strong subscriber growth and a nearly 12% increase in ARPU, revenue growth accelerated to 43% in the quarter. Importantly, this gain in market share did not come at the expense of profitability as our OPBDA margin improved by 320 basis points, and operating profit before depreciation and amortization grew 57%. With this strong start, I'm even more bullish about our growth prospects in Latin America. And in a few minutes, Bruce will provide you with an update on our full year outlook for DTVLA.

In summary, our first quarter results for DIRECTV reflect the continued execution of our financial and strategic initiatives that we outlined in December. Furthermore, the combination of both the DIRECTV U.S. and DIRECTV Latin America businesses provides the framework for what I think is a truly unique investment opportunity in our industry. By leveraging DIRECTV U.S., a business that provides solid and consistent returns in a more mature marketplace, with DIRECTV Latin America, an asset that's outperforming all growth benchmarks, we offer a rare diversified growth opportunity for our shareholders. The significant impact that DIRECTV Latin America is having in our consolidated results is particularly evident in our first quarter results, where DTVLA was the key factor in driving DIRECTV's double-digit revenue and OPBDA growth rates.

And at the same time, we're continuing to return cash through stock repurchases at an industry-leading clip. So with the strong start to the new year, we're well-positioned to meet or exceed the full year guidance for all of our key metrics that we provided at Investor Day.

With that, I'll ask Bruce to review DTV Latin Americas results and outlook, and then Pat will talk about the U.S. business. Bruce?

Bruce Churchill

Thanks, Mike. As you can see from our results, 2011 has started off pretty much like last year ended. DIRECTV Latin America delivered yet another record quarter of both gross and net additions, and all our key metrics showed strong year-over-year improvement. Just a reminder, unless otherwise noted, our results exclude those of Sky Mexico, which we did not consolidate.

For the quarter, gross additions of 765,000 were 55% higher than last year. In Brazil, Sky achieved record levels of gross additions growing 123% compared to Q1 2010, mostly on the popularity of our middle market products. These products represented approximately 65% of our gross additions in Brazil for the quarter. In PanAmericana, gross additions were also strong, growing 16% compared to Q1 2010. While not as impressive as Brazil, you need to remember that in Q1 of last year, rather Q1 of last year included the beneficial effect of the FIFA World Cup. And in 2011, we have been operating under a controlled growth strategy in Venezuela. If you exclude Venezuela, PanAmericana gross additions grew 23% versus last year, with Argentina in particular, delivering strong year-over-year growth.

Prepaid gross additions represented 16% of our 765,000 gross additions in the quarter. Cumulatively, prepaid subscribers make up slightly more than 10% or 6.2 million subscribers and are predominately in the PanAmericana region. Advanced products represented only about 18% of new customers, which is down significantly compared to last year. There were 2 factors which explain this figure.

First, take rates of advanced products in PanAmericana decreased 31% year-over-year, which reflects the fact that in the run-up to the 2010 World Cup, we ran aggressive advanced product promotions and achieved take rates of approximately 30%. Second, as we continue to see sales growth and lower price packages, by definition, advanced products become a smaller part of the mix. For example, in Brazil, the number of advanced product sales increased almost threefold compared to last year, but as a percent of total sales, advanced products were roughly flat year-on-year because of a tremendous growth in the other products.

Overall, approximately 26% of our 6.2 million consolidated subscribers now have advanced products. And they remain an important part of our product mix and something we remain very focused on selling. The growth of the middle market not withstanding, we have not lost sight of the fact that our traditional A and B households are our most profitable customers and the ones we work hard to get and keep.

Turning to churn. I'm pleased with our postpaid churn for the quarter of 1.43%, which declined from the 1.57% from the same period last year. Much of this improvement came in Brazil due to improved customer segmentation, operational improvements and the benefits of favorable macroeconomic trends. In addition, Venezuela contributed to our improved churn due to fewer sales and a renewed focus on churn in the context of the controlled growth strategy.

With regard to our prepaid services, our recharge rates are in line with Q1 of last year, but down from Q4 of 2010, which traditionally includes aggressive seasonal recharge promotions and the benefit from many second homeowners who use prepaid accounts during the Latin American summer holidays. We ended the quarter with 427,000 net additions, an increase of 93% compared to the same period last year and an all-time record for DTVLA, surpassing the record of 415,000 net adds in Q2 of last year immediately preceding the World Cup.

Turning now to financial results. I think it's fair to say that the numbers are equally impressive. Driven by a strong subscriber growth, revenues increased 43% compared to last year or approximately 40% if you exclude the impact of foreign exchange. ARPU was up almost 12%, principally reflecting higher pricing and penetration of premium packages. Excluding the impact of foreign exchange, ARPU would have increased around 9%. OPBDA and cash flow before interest and taxes for the quarter were also stronger compared to last year. OPBDA increased $140 million or 58% over last year, mostly due to the gross profit on the incremental revenues, partially offset by higher subscriber acquisition costs related to the increase in gross additions. Cash flow before interest and taxes of $157 million increased $91 million, reflecting higher OPBDA, partially offset by higher subscriber related CapEx. In addition, we received a $43 million dividend from Sky Mexico in the quarter versus $16 million last year.

Regarding Venezuela, the government continued to tightly regulate the repatriation of local profits out of the country. This situation restricts our ability to repatriate dollars, which explains the lower foreign currency exchange losses this year compared to last. In fact, we incurred no repatriation charges from Venezuela this quarter. The modest funds that did come out of Venezuela this quarter came out at official rates through the official Central Bank process. As of March 31, we had approximately $197 million of cash on hand in Venezuela, expressed using the official rate of 4.3 bolivars per U.S. dollar.

I never like to leave this call without reminding all of you to be sure to take note of the results of Sky Mexico, which were released by Televisa a few weeks ago. Sky Mexico delivered another strong quarter, adding 268,000 net subscribers in the quarter compared to 238,000 a year ago. And financial results of Sky Mexico were equally strong as revenue and OPBDA grew 22% and 36%, respectively. In total then, the DTVLA platforms combined, including Sky Mexico, now serve approximately 9.5 million subscribers in the region. We should comfortably surpass the 10 million mark by the middle of the year.

And finally, in light of our record Q1 results, I would like to give you my updated perspective on the 2011 guidance I provided back in December at our Investor Day. Back in December, I gave you both the 3-year outlook, as well as some fairly specific guidance on how I thought 2011 would shape up. I'm not going to change my 3-year outlook on just one quarter, but clearly, the results here today beg the question about what our view on the rest of 2011 is.

Barring any unforeseen change in the general macro economic environment in Latin America, and particularly in Brazil, and barring any large swings in foreign exchange rates, again, particularly in Brazil, we now expect both full year revenue and OPBDA to grow closer to 30% year-on-year versus the 20% we indicated last December. As assumed last December, this OPBDA growth rate excludes the effect of any repatriation costs in Venezuela. We believe these numbers are achievable in light of the continued strong growth we are seeing in sales and the continued performance on churn. We now expect total net additions to be in the $1,250,000 to $1.5 million range as opposed to the $1 million figure we indicated last December. As a result, there will be a modest increase in the total capital expenditures of $1 billion that we had stated previously.

In short, we look forward to another exceptional year in Latin America. With that, I'll turn it over to Pat to comment on the U.S. Pat?

Patrick Doyle

Thanks, Bruce. Overall, I thought DIRECTV U.S. had a very good quarter as we continued to generate strong subscriber growth while focusing on productivity and efficiencies to maintain solid margin.

Looking first at subscribers. Net additions exceeded our internal projection, delivering 184,000 new customers. This performance represents an 84% lift from last year's level and the third consecutive quarter of year-over-year improvement. Gross additions were strong, up 14%, as every major sales channel had a greater contribution than the prior year period, except the telco channel. Particularly strong results were seen in our commercial and consumer electronics channels, which more than doubled this quarter compared to a year ago. Our percentage of gross additions taking advanced products was nearly 80% for the second consecutive quarter and over 2/3 of these subscribers signed up for both HD and DVR services.

Also, about 1/2 of new subscribers signed up for Auto Bill Pay or about double the rate of a year ago. Our data shows that customers with Auto Bill Pay tend to churn at lower rates. Churn in the quarter of 1.5% was up 2 basis points over last year due mostly to a slight increase in voluntary churn, reversing a trend we saw over the last 3 quarters. We attribute this slight uptick to a couple of factors.

First, in the back half of the quarter, the marketing and promotional intensity from our competitors increased. We are seeing more aggressive cashback offers, triple play bundle promotions without contractual commitments and lower entry price points.

Second, we instituted a price increase in February that for the first time raised rates for both programming packages and our lease fees. As you've heard us say before, there's a close correlation between our upgrade and retention spending and churn rates, and this relationship is heavily influenced by both the economic and competitive conditions. We will continue to manage this trade off in an economically prudent fashion. As such, we will continue to prioritize our best offers to our best customers, while proactively managing higher risk customers by utilizing specially trained customer service agents to effectively communicate the value of our differentiated products.

Turning now to the top line. Our industry-leading revenue growth of 8% was solid and driven mostly by market share gains and ARPU growth of 3.9%. In addition to growth related to price increases, we had strong results in commercial sales, as well as premium and pay-per-view movie sales. Commercial revenues grew almost 20%, while pay-per-view movie buys through DIRECTV CINEMA reached an all-time high this quarter, with revenues up nearly 30% year-over-year.

We had a solid quarter in the premium movie channel category as well where for the fourth consecutive quarter, our buy rates per customer increased over the prior year. ARPU growth has also benefited from the increased penetration by both new and existing customers paying for advanced services, where approximately 2/3 of our customers now have advanced products. Partially offsetting these favorable trends in the quarter was lower sports ARPU, mainly related to the absence of the Mega March Madness package and the Pacquiao fight in the prior period.

Now let's look for the bottom line and in particular, our Pre-SAC margin of 38.4%, which represented a new first quarter high and marked the second consecutive quarter of year-over-year improvement.

The largest contributor to this increase was upgrade and retention marketing, which from a cash perspective was slightly lower than the prior year. Tying back to our earlier discussion about churn management. In retrospect, we probably should have spent a touch more on the quarter upgrade and retaining customers. As such, we are looking to modestly increase retention spending in subsequent quarters, assuming of course that the economics are favorable and the spending is targeted toward higher value subscribers.

Also contributing to the higher margin was a onetime benefit recognized in G&A related to an adjustment to our property taxes, which was larger than the onetime benefit gained a year ago due to a legal settlement. The G&A cost category often includes these kinds of nonrecurring items, making it difficult to predict cost trends. However, from a budgeting perspective, we establish targets so that G&A costs will grow more slowly than revenues.

The higher gross additions combined with the related increase in subscriber acquisition costs, led to the decline and OPBDA margin. However, OPBDA growth of 4% was in line with our internal projections and full year guidance.

Looking quickly at our quarterly consolidated results. Net income grew 22% to $682 million and diluted earnings per share improved 44% to $0.85. Also in the quarter, we recognized a $16 million after-tax gain on the sale of a 5% interest in the game show network, reducing our ownership stake to 60%. Additionally, it's worth noting that our tax provision in the quarter benefited from previously unrecognized foreign tax credits.

Free cash flow was down in the quarter due to higher working capital requirements, cash interest payments related to the increase in long-term debt and higher cash tax payments. The increase in interest and tax payments is expected to continue throughout the year, but that is not the case for working capital which is expected to be a favorable source of cash in the second half of the year. The working capital increase in the quarter was primarily driven by higher inventory levels that meet consumer demand compared with the HD box shortage we experienced last year, as well as the timing of vendor payments.

Said another way, we're expecting solid growth of roughly 10% and consolidated cash flow before interest and taxes this year.

Moving on to the balance sheet. This quarter, we repurchased 32 million shares of DIRECTV stock for $1.41 billion, bringing cumulative repurchases to over $16 billion or 46% of shares outstanding. Additionally, we syndicated a $2 billion unsecured revolver to replace the expiring $500 million secured credit facility, issued $4 billion of investment grade notes and tendered for $341 million of outstanding high yield notes. With these transactions, we ended the quarter with about $14 billion in total debt while reaching our total debt to U.S. OPBDA leverage ratio target of 2.5x.

Before wrapping up, I would like to make a few comments about our outlook. First and foremost, all of the guidance that we provided at our Investor Day remains intact. For DIRECTV U.S., our revenue outlook of mid- to high single-digit growth is expected to come in fairly evenly throughout the year. Please remember that the same cannot be said about our OPBDA margins, which we expect to be lower in the second half of the year compared to the first half, primarily due to higher programming costs.

We continue to expect programming costs per subscriber growth in the high single-digit range this year, mainly due to higher costs related to the NFL SUNDAY TICKET, regional sports networks and the new retrans [retransmission] agreement. Regarding subscriber growth, as you've heard earlier from Mike, we've seen an uptick in the competitive landscape. And as such, we're expecting growth additions to be relatively flat to slightly down, and churn to be modestly higher for the remainder of the year. Both of these estimates are relative to the prior year results.

I'd like to repeat the these estimates for DIRECTV U.S. are consistent with our full year guidance. The same cannot be said for DIRECTV Latin America, which as Bruce explained a few minutes ago, is even more bullish about its 2011 results. And as such, they are increasing their full year guidance for most of their key metrics.

Finally, we will continue to aggressively return capital to shareholders through our share repurchase plan. We expect to continue repurchasing shares in the same $100 million plus per week range that you've seen in recent quarters. If we're successful in meeting all of these targets, we expect to continue leading the industry in double-digit revenue and OPBDA growth as well as returning capital to shareholders.

So with that, I'll turn the call back over to Jon.

Jonathan Rubin

Okay, thanks. Before moving on to Q&A, investors should note that we have members of the media on this call in a listen-only mode. I'd like to remind the media that they are not authorized to quote any participants on this call either directly or in substance other than the representatives of DIRECTV. In addition, we are webcasting this call live on the Internet and an archived copy will be kept on our website.

So with that, operator, we are ready for the first question

Question-and-Answer Session

Operator

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

Douglas Mitchelson - Deutsche Bank AG

Actually I have a few questions for Bruce. Given the strong performance down in Latin America, does the guidance that you laid out 30% of revenue, EBITDA growth include any repatriation expenses for the remainder of the year?

Bruce Churchill

No. You have to exclude it from last year as well.

Douglas Mitchelson - Deutsche Bank AG

Got it. And then if I run your guidance right, it implies that ARPU barely grows the rest of the year after a strong growth in the first quarter. So can you just talk about the ARPU flow and why the change?

Bruce Churchill

Well, I think if you look at the ARPU in this quarter versus last quarter, it actually hasn't grown that much probably other than the impact of some foreign exchange that then continued strengthening of the Brazilian AI [ph]. So I think as we've discussed at the Investor Day and I've said a few times is that in general, our long-term view on ARPU is that it is sort of flat-to-down just because as we sell more and more of these middle-market packages, that offsets to some extent, the benefit we're getting from higher ARPU and price penetration with our A and B households to whom we're selling advanced products. So I think if you look at it sequentially, I don't think the change is all that dramatic. Just on currency alone, Doug, by the time, you get to the fourth quarter, your lapping a different currency. So you got to model the currency stuff if you want to get that specific.

Douglas Mitchelson - Deutsche Bank AG

Got it. Because I was just thinking the [indiscernible] you still had easy comps in the next couple of quarters. But I got it. And then I guess the last is, given the record at add growth, can you talk once again about the source of the sub growth? I think in the past you've talked about gaining share from cable. Can you give the split between share gains versus market growth?

Bruce Churchill

I don't want to be too specific about that. I would say that it is true that in Brazil, in particular, in this last quarter, we had actually quite a bit of share gain. Those figures are actually publicly available. And if you look at figures, you're required to report them. But I believe something in the order of the DTH market in general took something like 90% of all the new subs in the market in the quarter, and that Sky took a disproportionate share of that, something like more than half. So definitely, share gains is a big part of the story and I would say that's also true in Argentina.

Douglas Mitchelson - Deutsche Bank AG

So as a follow-up then, certainly, you're not worried about any sort of increasing competition in Lat Am [Latin America]?

Bruce Churchill

No. I get paid to worry, that's exactly what I do. But it doesn't mean that I necessarily think that the competition can be able to act on it.

Douglas Mitchelson - Deutsche Bank AG

Right. Okay, great.

Operator

Next, we'll hear from Craig Moffett from Sanford Bernstein.

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

I will make it 2 in a row. I have a question about Latin America for Bruce as well. As I think about this business growing scale so much more quickly than I think most of us had projected, how do I think about the long-term margins of this business? We don't really -- I personally don't really know the elements of the cost structure in Latin America quite as well as I do in the U.S. to say whether there are any material differences and whether there might be some scale benefits in programming, for example, as you get bigger and renegotiate. How do we think about those kind of margins longer term?

Michael White

Well, let me start and then I'll let Bruce kind of come in, Craig. Look, we have a remarkable business that kind of the big scale benefit has been in the run up over the last 5 years as we came out of the bankruptcy. We really have gained substantial scale. But we have very, very favorable margins today that are comparable or better than the U.S. all across the P&L. So it's not like there's a big, I would say, kind of one item or whatever where we're going to cross some other scale threshold. I mean we're at scale now. We have programming costs just like in the U.S. tend to be more variable than fixed. So I'm not sure -- I mean, with the kind of OPBDA margins that we already have down there, which are quite attractive, and comparable to anything you'd see in the U.S., I'm not sure I'd see another big uptick there. But Bruce, I don't know if you want to add anything.

Bruce Churchill

No, I agree with that. I think that the nature of the margin may be a little bit different in that. First of all, on the programming side, we actually enjoyed better programming margins in Latin America than in the U.S. We don't have anything like, for example, the SUNDAY TICKET, that we have to absorb. At the moment we don't have anything like retrans. So on the programming side, we definitely have a stronger position. And yes, there's probably some potential there to improve it a little bit, but we're topping out on a lot of these deals at the moment. I would say that the benefit we receive there is offset by the fact that we do operate in multiple different countries, so we don't get a lot of the scale benefits on some of the other sides of the business that you see in the U.S., for example, into some of the other cost items. So that's why in the end, the margins are still maybe marginally better. But I would agree with Mike, I wouldn't see a -- sort of big specular jump of any kind as we grow.

Operator

Next, we'll hear from Ben Swinburne with Morgan Stanley.

Benjamin Swinburne - Morgan Stanley

I wanted to ask Mike about the connected-box strategy. I don't think you discussed it in your prepared remarks. I think you had mentioned last quarter, targeting something around 2 million subs this year and getting to 40% of the base down the road. And I wanted to just get an update on how that's going and then the context of that, if you're seeing it come in cheaper than you thought at the subscriber acquisition cost per ad this quarter was a little lower than we were expecting. Just trying to figure out if that's been related to that. And then I have one follow-up for Pat.

Michael White

Ben, I think that we're very pleased with the progress we're making. We've crossed the 1 million mark. Our goal is to get to 2 million. But we're getting some learnings, kind of in terms of the operational aspects. Maybe you get to a home and maybe they think they have a router, but they don't or maybe we get there ahead of our telco partner, in which case, we got to make sure that everything gets kind of connected. So we've had some learnings, I would say, in the first quarter. But we are on track to where we wanted to go, maybe a little shy of our 2 million goal for the year. But we've already crossed 1 million, and I think we'll continue to accelerate that. In terms of the cost of the program, I don't know that I would say it's cheaper at the moment. We've got a number of things where we may get to some scale on some of the stuff later in the year. But I would say the -- I wouldn't necessarily say that the lower SAC was connected to our connect-the-box strategy, frankly. I think it's other factors.

Benjamin Swinburne - Morgan Stanley

Okay. And Pat, I don't know if I should be parsing your words this finely. But your 10% free cash flow growth consolidated target, that's cash flow before interest and taxes, I think that would suggest your U.S. EBITDA growth is coming in towards the higher end of that low to mid growth rate just because of the comments about the Latin American CapEx, which I think offsets some of the Latin American EBITDA out performance. I just wanted to ask that and see if you could give us any color at all.

Patrick Doyle

Yes, and I think you're reading a little bit more into that. I think we're, again, comfortable with our guidance we came -- gave for the U.S., which is EBITDA growth in the low to mid-single digit growth.

Operator

Our next question comes from Jason Armstrong with Goldman Sachs.

Jason Armstrong - Goldman Sachs Group Inc.

Maybe a couple of quantifications, then a bigger picture question. On the quantifications, you talked about some impacts to ARPU, putting March Madness and then the Pacquiao fight, if you can maybe just sort of break that out for us and how much that hit you by? And then the second on the upgrade and retention costs, talking about those needing to move higher. I guess in your mind, how light were you in the quarter and what's sort of the run rate we get back to? And then I guess just bigger picture question, in the U.S., obviously, sort of the content cost trajectory probably reinforces benefits of scale here and considering recent events where we've seen the announcement of a big deal in U.S. Wireless, we fully I think previously perceived to be problematic from a regulatory standpoint, but it was announced and framed in the right way. Does this cause you to think differently about either your ability or desire to think about acquisitions of either satellite assets or subscribers in the U.S.?

Michael White

I'll take those. Pat, you can chime in on the first few as I go through them. And I think first on the ARPU, look, there were a bunch of puts and takes in the quarter and I don't know if it's true for our competitors or not, but 80% of our ARPU is kind of the core business and then there's 20% of other stuff, which is everything from sports to premiums to protection plan to commercial to you name it. Actually, we had nice ARPU growth on our core business consistent with the pricing that we took in the quarter that actually was north of 5%. So some of the other stuff, we didn't quite hit the growth -- ad sales, all the rest of that in the quarter that we are expecting to get kind of later in the year. So but I think our guidance -- we didn't give any guidance on ARPU, but I think we're comfortable with where we came out in the quarter. Yes, there wasn't a pay per view event and there was a year ago, and March Madness also helped us on the cost side so you know with that change. But I think we're directionally in about the right place on ARPU. We're managing our pricing kind of very responsibly given the increase in programming costs. We took a fair amount of pricing, more than what I would've liked for our customers, but frankly, less than the content cost that we're being hit with. So we're quite comfortable. I think we're taking a responsible approach to that. In terms of upgrade and retention, I think Pat said we were down slightly in the quarter. Maybe we should have been up slightly in the quarter and then I don't see it as a dramatic shift. But here at DIRECTV, we have -- in terms of metrics, we are constantly looking at the dials and we want to make sure that if we're going to spend more money on retention, that we're spending it on high-quality subs and not business that's not that profitable that we don't want to chase. I mean, the industry has become very promotional and we're trying to be very disciplined in how we do that. I don't know, Pat, if there's anything else you want to add on ARPU or upgrade and retention, then I'll come back to the last questions.

Patrick Doyle

Yes. I think on the 2 items that I mentioned in my notes, yes, they will probably cost us about 0.5 percentage point of growth just from those 2 items. And as Mike said on upgrade and retention, I mean we're constantly looking at our customer offers there, the quality of the customers we're offering, types of behavior that we're trying to encourage. So I think in the first quarter, we made some changes that we thought were best for the business in the way of value, some of them probably we got a little bit more of a reaction from than we expected and then we react to that. So like Mike said, it's a constant dynamic process of looking at our base, deciding what kind of behaviors we're trying to encourage and then adjusting to it.

Michael White

We're going to be disciplined. We're not going to chase bad business. I think on the other question, look, we spent a day in December laying out, I thought a very compelling strategy for DIRECTV, with a particular focus on things like how we address the bundle challenge, how we address TV Everywhere, how we jump shift our commercial, our targeted advertising and our Movies business and we're on track with that strategy. We're, I think, I feel very good about our strategy. Obviously, the external environment is always changing and so you're always kind of looking at the external environment and seeing if you have to make any tweaks if we decide to make a big change in our strategy, we'll come talk to you about it. But I don't think it's productive for me to comment on acquisitions or rumors or whatever else.

Operator

Next, we hear from John Hodulik with UBS.

John Hodulik - UBS Investment Bank

First, just to follow-up on the competitive question. Is the increase in your competitive intensity you're seeing more on a sort of regional basis or something you're seeing sort of broadly across the U.S.? And then at this point, obviously you might not want to say much, but are there plans that respond to maintain the gross add momentum you saw in the first quarter. And then secondly, you mentioned that the telco channel had not really improved. Can you just explain maybe a little bit of some of the recent trends there? Is that something that maybe didn't shape up as quite exactly as you want, or you thought it would or is it just the sort of a normal course of business as these company builds out their own telco infrastructure? And maybe how you expect that to evolve over time?

Michael White

John, I would say, we analyze kind of the both churn and gross heads by region quite carefully. And I wouldn't say there was any one particular region. In fact, it looked like it was pretty across the board. I think a little bit more focused on bundles whether they're telco bundles or cable bundles, but some of the pricing on that stuff has gotten pretty aggressive. But I wouldn't say it was one geography. I'd say it was pretty broad-based, particularly fiber territories where you have seen a bit more competitiveness. In terms of gross adds, our gross adds were fine in the quarter. I mean I don't think our issue is gross adds. We've got plenty of people knocking on our door that want to take our service. I think our branding is strong, our marketing is strong, so we are quite happy with the gross adds. It's just that if you look at the full year and you look at overlaps and everything else, we set a goal in December, I think we laid it out and said, look, given the strength of the year we had last year and yes, we had a great first quarter, but I think as we look at the full year, we're on track to the guidance that we directed you to in terms of gross adds. So I don't see gross adds as something I got to go chase. We feel quite comfortable with the marketing that we've got and the consumer demand for our service. The telco channel is right in line with our targets. I mean, there's nothing kind of there out of our plans. What's happening is, as subs coming from Verizon or AT&T fall off a bit, our growth with our partners, our new partners, Frontier and CenturyLink, has been quite strong. So net-net, it's a pretty mature channel, I would say, in total. But there's some shifts going on within the channel, but it's performing right in line with our expectations. Do you have anything to add?

Patrick Doyle

Yes, no. And I think on gross adds, I mean just so you know, even in the first quarter and into the second quarter, we've also done some things that put a little bit of a governor on gross adds as it relates to quality. And as Mike said, when you've got a competitive environment and some of these heavy promotional offers, we find that there are certain segments of the population out there that if you give out those types of promotional offers, they'll really not give us a return, that's acceptable. So even during that time, again, we'd love to have growth, but we're also kind of trying to make sure it's really profitable growth. And then on telco, yes, there's nothing unusual there. I think as we said before, if you just look at the landlines of particularly Verizon and AT&T, as they lose landline, that's kind of how they sell our products. So this is nothing from telco. It's not like we're disappointed. I mean it's actually a very good channel that does well. It just has certain built in issues there that we expect and we've planned for.

Operator

Our next question comes from Stefan Anninger with Credit Suisse.

Stefan Anninger - Crédit Suisse AG

Just a follow-up on 2 topics that we just discussed. On the telco channel, can you discuss where you are right now with your deals to sell fiber HSD and how that's working. And if you haven't started, maybe you can talk about your optimism around selling a fiber-based HSD products with your core video product? And then just with respect to the operating environment and the pricing environment, do you see the pricing or the promotional pricing that you're seeing right now as a fee change? I mean, the competition ebbs and flows, but do you see the competition change, the nature of the change that you're seeing right now is more pronounced than in prior periods? In other words, do you see it as incrementally worse?

Michael White

I mean it's kind of the same point. I mean I think competition does ebb and flow, which is why I always believe it's competitive out there and it's certainly competitive out there right now. I don't think we've seen something dramatically different than we've seen before. I mean, I think it was that way in December when I'm first [ph] ramping onto the DIRECTV team. So, I mean, look, it's always competitive out there. It seems like it's gotten a tad more competitive in the last few months, but gosh, I don't remember a time when it's not been competitive. So I wouldn't say there's anything dramatically different that folks are doing that we haven't seen before. We're still getting great demand for our products, strong gross adds, that's really been more, a little bit of a churn factor. And frankly, as I said, we're making a very careful kind of decision looking at the quality of the subs as to what we will -- what business we want to retain and what we won't. And that's a constant kind of effort here at DIRECTV at kind of tweaking the levers, if you will, as it relates to churn. In terms of the question again on the telco channel was, we're already selling, we're already capable of selling fiber. But the ability for our call centers to sell one bundle, I think, is in June. So we'll see how that goes as we ramp it up this year. I think it's an important element in our arsenal strategically, but for those consumers that want higher-speed bundles, that they have access to it. So we're optimistic about that, but I would say it hasn't made a material impact up to this point in terms of our telco channel one way or the other. But I think you really won't see the impact of it until we get the full integrated bundle that our care or sales agent can sell, which will probably be in Q3, and then we'll have a more compelling marketing story to go with it.

Operator

Marci Ryvicker with Wells Fargo has our next question.

Marci Ryvicker - Wells Fargo Securities, LLC

Two questions, Pat. Now that you've hit your target leverage of 2.5x and it sounds like you picked up some high yield debt, is there any change to your outlook as to when you can wrap Lat Am into your overall leverage ratio? And then, Mike, any comments on premium VOD, preliminary thoughts you can share on takeaways from the price point?

Patrick Doyle

Yes. On the leverage, we were very pleased with our last offering. We went probably a little bit bigger in size than we had anticipated going in because the demand was high and the pricing was very good. So really, put us in a great position. I mean we're now sitting with cash on hand that will clearly fund our share repurchase program for the rest of the year and maybe in 2012. So we're still got that Latin America on our roadmap of bringing in to the credit. It's probably something kind of late 2011 when we address that as we start to think about kind of the next round of financing.

Michael White

On home premier, look, we're very excited about this. It's in keeping with the tradition of being innovative at DIRECTV, and it's, I think, a great opportunity for our customers but it's very early, Marci, so I don't have any results to report. The $30 price point 60-day window, we don't have any plans to change either of those at this time. But we're pleased so far and we'll see how it goes.

Operator

Next, we'll hear from James Ratcliffe with Barclays Capital.

James Ratcliffe - Barclays Capital

One for Bruce and one for Pat actually. Bruce, on the ARPU side, I was actually a little surprised that the growth was just 9% x currency. If it was that strong given you're going to middle markets and I would assume that would tend to be a downward drag on ARPU. Can you talk a little bit about how those moving pieces work in terms of how much impact the mixed shift is having, and also versus countries versus increased spend on a sort of apples-to-apples per customer basis? And Pat, for the U.S., similar to your ARPU conversation. You talked a little bit about if you're seeing, I know it's early, any sort of Delta in terms of spend for customers who have connected boxes versus customers of the same piece of hardware, the same of setup that don't have connected box?

Bruce Churchill

Okay, I'll start. We talked a little bit about this earlier. I mean I guess the first point I would make is when you're looking at prices, I think looking at Q1 of this year versus Q1 of last year, tends to make you forget what happened in the interim. So if you look at Q4, the bump up hasn't been that dramatic. And as discussed previously, you are right, that the increased sales in middle market products does tend to have a dampening effect on ARPU growth. Having said that, we still obviously pretty actively manage of all ARPU. We do put through price increases at least once a year in pretty much every market. In high inflation markets we tend to do it more often than that, so we're able to keep our prices up at least with inflation if not slightly above that. And then here we are, still investing pretty heavily in advanced products, both still in standard DVRs in submarkets and HD and HD DVRs in Brazil and some of the other markets as well. So that has a -- that's the countervailing effect to the middle market pressures. So longer term, I think as I've said, my view is that the ARPU growth will be sort of flat, flat to down over time. But as I -- this reflects more mix than anything else. And again, that's of course leaving aside any broad swings in foreign exchange.

Patrick Doyle

And then yes, James, on the connected boxes. I think as Mike said, we're still kind of early into that process and learning a lot. We've got now kind of 2 quarters where we've been aggressive at connecting. We certainly have empirical data that shows us that we do get higher usage and more pay-per-view activity. But I think until we get a little bit more scale and size to be able to evaluate that, we won't be able to make any conclusion. But at least preliminarily, it's doing what we had expected it to do.

Operator

Next, we'll hear from Tuna Amobi with Standard & Poor's Equity Group.

Tuna Amobi - S&P Equity Research

So I guess for Bruce, as I look at the dynamics of the Latin American market in terms of postpaid and prepaid, it just seems like Brazil clearly has been gravitating to the postpaid. And as I recall, the economics of the prepaid in PanAmericana was also pretty attractive. And then the question is, how do you see that divergence playing out and do you have any kind of proactive targeted market in to kind of shift the mix in some kind of a desirable way? So that's number one. And separately, you guys haven't called out a 3D channel launch as of late. So is that a function of some kind of -- did overall slowed take off in that technology? I know there's been a lot of noise on the CE front, so any kind of update would be helpful and I have a follow-up if I'm cut off.

Bruce Churchill

Okay. Just on the prepaid versus postpaid, you're absolutely right. Actually in Brazil as it turns out, even our lower price packages are mostly in postpaid and that seems to be largely a phenomenon of the market. We just really frankly haven't gotten a lot of traction with prepaid even though we offer it in Brazil. And part of that is probably because Brazil happen to have one of the more sophisticated banking systems in all of Latin America and many consumers, even those just emerging into the middle class, have access to the banking system. And therefore, the idea of having a monthly subscription does appeal to them. And the benefit there is that they have no upfront costs, lower upfront costs getting into the service. So I think the way to think about prepaid versus postpaid isn't necessarily distinction between lower price and higher price packages. It's really just a method of payment and it's something we offer our consumers who have different tastes and I think they are different segments and people in different situations to whom either prepaid or postpaid appeals. It happened -- it just so happens that in some of the other countries and it happens to be in PanAmericana, particularly probably Venezuela, the prepaid seems to be very appealing and for whatever reason, and a lot of it is just consumer driven. As far as managing the mix, we don't -- I don't get too concerned about that because what we do upfront is to make sure the return on investment, whether it's a prepaid product or a postpaid product are equally attractive, so that we are able to sell as much as either one as we can without having to worry that we're potentially damaging our margins or ultimately our returns on capital. So the nice advantage we have is that we can sell something that suits each individual consumer, without having to get too hung up about how much postpaid versus prepaid we sell.

Tuna Amobi - S&P Equity Research

Okay, that's helpful.

Michael White

The consumer electronics channel, we've had a terrific partnership with Best Buy in particular and we're very pleased we made some changes on how we sell in Best Buy stores, with the staffing and it's paying off big-time. So I think it's much a more focus on the channel that's helped to sell. Tuna, you were asking about 3D?

Tuna Amobi - S&P Equity Research

Yes, 3D.

Michael White

I meant to say CE, I'm sorry.

Tuna Amobi - S&P Equity Research

3D and CE as well, so I think Mike was on the right track there.

Michael White

Yes. I mean the CE channel it's really performed well. They tend to be, by the way, very, very high value customers, very high LTV customers as well that we are taking in from that channel. So we're real pleased with the performance, we made some changes in how we worked together with Best Buy in particular and it's paying dividends for us. 3D continues to be a part of the offering. We've got the N3D channel and I think you really need to see a lot more 3D television sets sold to build scale on that longer-term and it's still a relatively small percentage of our total subscribers that have 3D television sets.

Tuna Amobi - S&P Equity Research

And just lastly, quick follow-up, Mike. There seems to be some perception out there rightly or wrongly, maybe you can clear this up in the minds of investors, that should there be an NFL lockout that DIRECTTV may in fact, be, by far, on the way the most exposed to this. So if you can address that, any potential mitigating factors that you have in place and without getting into the details of the contract obviously, but any commentary that you can make along those lines would be helpful.

Michael White

Sure. I mean, the NFL situation obviously is very fluid and I don't have a better crystal ball than anyone else. We have an excellent partnership with the NFL. We expect that partnership to continue. It's very hard. I mean I can give you 100 scenarios in terms of what may happen or not happen over the next 3, 6 or 9 months. I think we've talked about, Pat in the past on what the contractual provisions are. Suffice it to say, I would say probably on our Q2 call, we can talk a little more as we get into kind of towards Q3 what the impact may be. I mean, clearly, we are working on contingency plans for third quarter. We will have a marketing pitch in the event that we're not able to do our normal start of season, which we typically do in third quarter. Last year, I think out of the 1 million odd gross adds we had in the third quarter, I don't know, 25% of them maybe booked the NFL package in the quarter. So I think there's some risk, but we've always had strong promotions. So I don't, frankly, expect you to take that number and say, that doesn't mean we're going to lose that many gross adds in Q3. I think it's very premature. We've got a strong promotion that we've got set up. The truth is, if the season is delayed, most of the stuff ends up pro rata, maybe there's a little bit of an impact on our gross adds and our P&L. But it's probably if it's kind of modestly delayed, it's not a big deal. If there's no season, it probably helps our P&L, hurts our cash flow a little bit. But I don't know, Pat, if there's anything you want to add.

Patrick Doyle

No, that's right. I think if it's a lost season because we wouldn't be reporting any NFL programming costs in 2011, it actually helps us and improves our P&L. As Mike said on the cash flow side, to the extent that the NFL asks for the optional payment, which is part of some of these court cases as well, cash flow is worse, not dramatically but slightly worse than our internal plan today. So it's not, nothing in there is dramatic. Like Mike said, the bigger issue is really just trying to get an offer out to customers with an uncertainty about a season is probably the thing trying to [indiscernible].

Operator

Next question comes from Tom Eagan with Collins Stewart.

Thomas Eagan - Collins Stewart LLC

With the higher content in sports costs, any thoughts to investing in regional sports network or investing more in a regional sports network? We're seeing [indiscernible] cable do that in LA. And then I have a follow-up.

Michael White

Well, Tom, I mean those 2 don't go hand-in-hand actually. I think the higher the sports costs, the less attractive the investment probably is to anybody except for the teams, the owners and the leagues. But I mean I think, look, we've said before and Derek said in our December meeting, sports costs are increasing at an unsustainable rate. I mean I don't think you can get consumers to pay these increases that we're seeing. It's quite concerning. We have a terrific regional sports network team. We look at opportunities. We have looked at opportunities, frankly, for the most part, the pricing from a shareholder value standpoint has turned out in the several things that we've looked at in the last year to not be attractive for our shareholders. But we'll continue to be opportunistic in looking at things if there was an opportunity in terms of regional sports network, city or team or whatever. We'll take a look at it. We'd love to expand our footprint from where we are, but we're going to do it in a disciplined way that has to create shareholder value for DIRECTV shareholders. And it seems at the moment, as I said, these sports costs were rising at an unsustainable rate from what I think customers are willing to pay. And that's a concern longer term.

Operator

We have time for one final question. That will come from Michael McCormack with Nomura.

Michael McCormack - Nomura Securities Co. Ltd.

Can you just sort of reconcile for us how you see sort of the elasticity of demand given the price increases and obviously, an uptick in churn? Just wondering how much of might be related to the price increase? And then secondly, just thinking about the investment SAC over the past several quarters, which is I'm guessing related mostly to the advanced services being sold in customers homes and try to reconcile that against sort of higher voluntary churn.

Michael White

Yes, Michael. I mean I think, clearly, as kind of the television is an integral part of every home in America, it tends to be a little less elastic than, let's say, selling Pepsi or Fritos. But I think what I continue to be concerned about with the rising content costs and with the kind of requirements that we bundle everything together, including small channels, that there are consumers out there, the bottom 40% of America, that are going to have a harder and harder time to paying for pay television and that's not in anybody's interest. So I think certainly, we've seen some elasticity. But you know, our price increases were pretty consistent with most everybody else's. We've tried to kind of be disciplined on pricing over the years, so it's not like we had a onetime step up that we kind of go after because I think we've always felt that our pricing reflects the premium nature of our product. But we felt that we needed to be disciplined and that if content costs are going to rise, at kind of those kinds of rates, that we have to be taking pricing because at the end of the day, there's only the consumer out there to pay for the stuff. And that's what we did. In terms of the SAC, I wouldn't draw too much of a conclusion there. Keep in mind, there's kind of a time lapse here. So when you start to see churn go up, those are probably longer term customers that are churning. And so a lot of the increase in SAC that we've seen over the last year or 2 was within the 2-year contracts that we have. But that's not really the issue. So I mean I don't, frankly, wouldn't draw any conclusion from that one way or the other. I think from the analysis that we've done, the competitiveness is across the board and we're reassessing all of our things just to make sure that we're continuing to be very smart and very disciplined that maybe we need to, as Pat said, increase our retention spend a tad and we will do that if that is what we think is right. But we're not going to chase bad business either. We're going to stay disciplined.

Operator

Thank you. This concludes today's DIRECTV First Quarter 2011 Earnings Conference Call. You may now disconnect your lines and have a pleasant afternoon.

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