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Charter Communications, Inc. (NASDAQ:CHTR)

Q2 2011 Earnings Call

August 2, 2011 9:00 am ET

Executives

Robin Gutzler - VP, IR

Mike Lovett - President and CEO

Chris Winfrey - CFO

Analysts

Jeff Wlodarczak - Pivotal Research Group

Jason Kim - Goldman Sachs

Benjamin Swinburne - Morgan Stanley

David Joyce - Miller Tabak & Co

Bryan Kraft - Evercore Partners

Michael Pace - JPMorgan

Amy Yong - Macquarie Research Equities

Lance Vitanza - CRT Capital Group

Richard Greenfield - BTIG

Rich Tullo - Albert Fried & Company

Ryan Vineyard - RBC Capital Markets

Presentation:

Operator

Good morning, my name is Rashira and I will be your conference operator today. At this time, I would like to welcome everyone to the Charter Second Quarter 2011 earnings conference call. (Operator instructions). Thank you. Ms. Gutzler, you may begin your conference.

Robin Gutzler

Thank you, Rashira. Good morning everyone and welcome to Charter’s 2011 second quarter earnings call. This morning we issued a press release over PR Newswire at 8:00 am Eastern Time detailing our results. This information is also posted our website, charter.com. The website also contains the presentation that accompanies today’s comments.

Before we proceed, I would like to remind you that there are a number of risk factors and other cautionary statements contained in our Form 10-Q, for the quarter ended June 30, 2011. We will not review those risk factors and other cautionary statements on this call. However, we encourage you to read them carefully.

Various remarks that we make on this call concerning expectations, predictions, plans and prospects constitute forward-looking statements. These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ from historical or anticipated results.

Any forward-looking statements reflect management’s current view only and Charter undertakes no obligation to revise or update such statements or to make additional forward-looking statements in the future.

During the course of today’s call, we’ll be referring to non-GAAP measures as defined and reconciled in this morning’s earnings release. These non-GAAP measures as defined by Charter may not be comparable to measures with similar titles used by other companies. In today’s earnings release, we reported results in accordance with GAAP as well as pro forma results for 2010.

The pro forma results reflect the divestitures of cable systems in 2010 as if they had occurred on January 1, 2010 unless otherwise noted. The year-over-year growth rates we will be referring to this morning are in a pro forma basis. Joining me on today’s call are Mike Lovett, President and CEO and Chris Winfrey, our CFO. I will now turn the call over to Mike.

Mike Lovett

Good morning and thank you for joining us today. I am pleased with another quarter of solid adjusted EBITDA growth and the substantial progress we have made on our strategic initiatives. Adjusted EBITDA rose 4.8% to $673 million and our margin improved to full percentage points to 37.6% versus last on revenues of $1.8 billion. And while we continue to make strategic investments in our business to set us up for long-term success, we generated $155 million of free cash flow.

We remain focused on improving the ways in which our customers interact with and perceive Charter. We conducted a number of successful pilot programs, which I highlighted for you on our first quarter call, including areas such as customer onboarding, technical issue resolution and CTE management. And we are rolling these initiatives out across our footprint. Even prior to these pilots fully taking hold, we have seen a 5% decrease in billing and service calls, as well as 8% lower service truck rolls compared to last year.

We achieved the best second quarter in year-to-date retention rates we have experienced since I joined Charter. And anecdotally, in markets where we launched these pilots, we are seeing an increase in the number of customer compliment letters.

We continue o leverage our Internet superiority as demand for fast and reliable connectivity grows. Nearly 95% of our residential customers are on 12-Meg or higher, which is double the fastest speed available from DSL. A fact that is beginning to be recognized by our customers as well as IP Content providers. We intend to maintain that advantage. As of June, we had deployed DOCSIS 3.0 to 85% of our footprint and we expect to be essentially complete by the end of the year.

As we operate a particular market, we launch our 60-Meg residential product and 50 and 100-Meg Coax for commercial customers. And similar to other cable operators in DOCSIS 3.0 markets, we have the capability to offer speeds of more than 100-Meg down the road as we see consumer interest.

Another strategic priority for us is to change the dynamic in our video business and to continue to provide innovative solutions for our customers. As of the end of the quarter, 68% of our Homes Passed were Switched Digital Video enabled allowing us to offer our customers more HD channels and additional VOD choices.

At the end of the second quarter, we averaged more than 60 HD channels across the footprint. While we are still in a bit of catch-up mode, we are on track to achieve our 75 average HD channel target by year-end. We also just announced new features that will be available for our customers such as HBO GO, BTN2Go and a remote record scheduling application and we are strengthening our sports offering with NFL Network and their extremely popular RedZone product in time for their 2011 season.

We are slating to file at the first phase of our next generation television strategy later this year with the integrated TiVo Premier Service and we will follow with soft launches to virtually all markets in the early part of next year. And the investments we are making in our commercial business are beginning to translate into strong financial results similar to the first quarter.

We stepped up the commercial services growth rate compared to last year and continue to have strong pipeline for future growth in small and medium business segments as well as the carrier space. I’m confident in our strategic direction and I believe we are making the right investments for long-term sustained growth. We are just beginning to see the benefits of some of these initiatives through higher customer service levels, retention and improved margin, however, it requires patience for the full benefits of the these investments to show up in our top line results. That being said, we have in place a number of tactics to boost top line growth and drive value during this investment phase.

We have introduced a number of new products and packages to help maximize the value of our services and bundles for both the higher end users as well as high credit risk households such as Charter Starter. We are focused on sales, both in our service centers and our direct response marketing mix. We will continue to reinforce the strong quality and brand messaging to consumers while layering on compelling price guarantee and bundled offers. The price increases previously now have started to take effect in July and we are also exploring some new nontraditional sales channels to grow Internet and phone market share.

Now for more specifics on the quarter, if you look at slide 5, on the residential side of the business, the growth in Internet customers and a modest increase in phone customers wasn’t enough to offset the decline in video customers resulting in our residential PSUs declining by 54,800 in the quarter.

When it comes to overall customer relationships, we are making significant strides, even in a soft economy. We saw a 74% improvement in reduced overall relationship losses during the first half of 2011 compared to the prior year. Again, reflecting the early benefits over strategic investments and focus on disciplined customer acquisition.

We continue to focus on driving bundled and advanced services penetration and we saw a 2.6% increase in overall residential ARPU as a result. In video, similar to all areas with residential business, we made significant strides in retention levels and took a disciplined approach to customer acquisition both through rate volume balance and segment marketing.

Second quarter seasonality and a competitive market place for stand-alone video pricing, however, drove a lower rate of customer acquisition offsetting those higher retention levels. Low housing starts in a soft economy clearly had an impact as well. Video customers were down 80,000 reflecting losses similar to prior year disproportionally driven by video-only analog customers and we are providing increasingly attractive offers and incentives to this space to upsell into bundles and digital.

The number of advanced digital customers taking HD and/or DVR and we continued to see a steady climb in both our digital and advanced services penetration. Video ARPU rose 3.4% to 7140. This is the area where we most see the economy having an effect on revenue growth, both with a decline in rate of upgrade activity as well as customer’s rightsizing their packages whether to taking lower digital tiers, premium channels or lower paid VOD usage.

As you can see in the chart on slide 7, we continued to see growth in Internet and Phone customers. For the second time in a row, our Internet service was ranked as the best performing ISP in the nation by Netflix in their quarterly rating. And similar to our popular home networking solution, we recently added another enhancement, Charter Cloud Drive, which allows our customers to safely and easily share and store data.

We are successfully selling this to our existing customers and we are seeing a 14% uptake with our new customers. As we stated strategically, we are leading with our strength in Internet and growing our non-video customers at nearly double the rate of growth in last year’s second quarter.

Given our broadband performance advantage, we see a tremendous opportunity to get our foot in the door and form new customer relationships with approximately 7 million Homes Passed where we don’t have a relationship today.

We have done two free speed upgrades in the past 18 months and we are seeing the benefits of improved customer satisfaction, better brand awareness and higher retention rates, which all support our long-term strategy. However, in the near-term, as we expected, we are getting less ARPU lift from higher speed tier upgrades. Internet ARPU declined 1% versus last year. That expected ARPU drive was nearly offset by the lift from our home networking service. More than 20% of our Internet customers now rely on us to be their solution provider in the home through our home networking offer with roughly a third of new customers taking this value-added service.

Particularly driven by fewer acquisition opportunities for movers in new housing, we saw a lower increase in the number of phone customers, but we see room for further growth by bundling phone for existing customers, both video and non-video and tend to get more aggressive on that front.

Moving to the ad sales business, revenue increased 7%, primarily driven by growth in the automotive and retail sectors and through the roll out of EBIT standard, we are well positioned to take advantage of interactive advertising streams as they develop. An area we are very pleased with is the progress in commercial services. Charter business revenues increased 17.5% in the second quarter and with an 8.5 billion market, we see opportunity for further growth.

We increased commercial PSUs by more than 8% compared to last year’s second quarter with 22% growth in Internet and phone customers. Revenues from carrier customers, which aren’t included in PSU has nearly doubled. In July, the number of cell tower sites we served surpassed the 1000 milestone. In addition, we currently have more than 650 towers under contract and scheduled for installation by the end of the year and the sales pipeline remains quite robust.

We are continuing to invest to enhance and expand the solutions and services we provide to this largely untapped market. Our commercial customers are benefiting from the strategic investments we are making such as DOCSIS 3.0 and we are seeing the results. In addition, our phone plus product proving such features as enhanced voice mail options, simultaneous rings, auto attendant and more is now fully deployed and we are seeing nice uptake there as well.

I will now turn it over to Chris to walk through the financials.

Chris Winfrey

Thanks Mike and good morning everyone. Looking at slide 9 in the second quarter, we continued to grow our high margin Internet, phone and commercial products with a 2.2% revenue growth over the prior year and while as Mike indicated, we have already implemented a number of top line tactics for the second half of the year, our principal focus is on making the investments and executing on our strategic initiatives to position ourselves for long-term growth.

Video revenue was down 2% in Q2 due to customer losses partially offset by growth and advanced services. Notably, we also saw a decrease in revenue per user from pay VOD and premiums. This highlights both the customer economic rightsizing Mike mentioned as well as the potential benefits from an improved video platform. With SDV investment driving increased linear HD and on-demand content and an enhanced user interface and search engine via the integrated TiVo premier box.

Taking a look at our total revenue base, we continue to see diversification with video now representing only half of our total sales and with our video customers digital penetration now stands at 77% with 56% taking HD and/or DVR. Internet rose 5% year-on-year with penetration reaching over 29%. The key highlight here is that 65% of our video customers use our Internet, but we have only 9% penetration of our non-video household so far, which is still nearly a 20% increase year-over-year.

Phone revenue increased just under 4% with triple play penetration continuing to climb and we are implementing a number of tactics to drive higher tax rates in both video and non-video households as Mike mentioned.

In the past year, we have spoken quite a bit about disciplined acquisition contributing to margin expansion, that discipline has improved customer retention rates by 8% driving significant efficiency not only in the P&L, but also in capital expenditures. What disciplined acquisition really means in not chasing volume with lower rate on a stand-alone basis and avoiding direct marketing and selling into segments of the population, which have formed a large percentage of our connects in the past, but a disproportionate percentage for our service cost and churn.

Unfortunately, most of our REIT acquisition discipline has been offset by customer rightsizing of their packages either through premium usage or at offer roll-off, both of which we see as the cyclical effect, but we will begin to more actively market it to the higher credit risk segment again in the third quarter with a light version of our triple play offering Charter Starter as Mike mentioned.

We believe a more suitable product can better service this segment without relinquishing the discipline that benefits our bottom line today. Our commercial business continued to demonstrate real momentum. Revenues increased a healthy 17.5% during the quarter led by higher sales to small and medium businesses and carrier customers. Keep in mind that our commercial segment includes approximately $43 million of video revenues in the quarter, primarily from MDUs and hospitality, so by excluding that revenue, we are still early on in the commercial space where growth Internet, telephone and carrier is actually 28% year-on-year.

For advertising, in addition to growth from automotive and retail., the increase in advertising sales also benefitted from a $3 million change in the way we account for certain revenues, now reflecting them on a gross basis and thus increasing both revenues and expenses by the same amount. We do expect to see the return of the Japanese automotive segment as their inventory returns post tsunami, though keep in mind we benefitted quite a bit in the second half of 2010 from a strong political year.

Moving on, the cost in adjusted EBITDA, I would like to provide some color on the key factors driving the 4.8% EBITDA growth and a 100 basis point improvement in margin. Total operating cost and expenses increased less than 1%, as higher programming costs were nearly offset by reductions in other operating cost and we are definitely seeing the results of our disciplined acquisition and extension strategy and early benefits from simplifying and enhancing the customer experience as evidenced by sheer truck roll, the recall volume offsetting programming increases.

Programming costs rose 3.5% as contractual increases were partially offset by customer losses and as we look to the rest of 2011, we do not expect programming cost pressures to abate. Marketing expenses were down $6 million year-over-year from a $7 million favorable adjustment for expenses associated with prior year marketing campaigns offset by higher spend on product and brand focus marketing. As operating improvements allowed us to fund growth areas like commercial, we were able to hold labor cost essentially flat year-over-year and we saw continued improvement in bad debt with a 14% or $6 million compared to the year ago quarter.

In total, adjusted EBITDA grew 4.8% to $673 million for the second quarter with a margin of 37.6% and excluding the marketing expense adjustment, the storm-related negative impacts of $3 million, second quarter EBITDA growth would have been 4.2% with a margin of 37.4%.

Let's move onto CapEx on slide 11. Capital expenditures for Q2 totaled $324 million or 18% of revenue. This was $15 million lower than 2010. The timing of strategic investments and bandwidth initiatives partially offset by $9 million of incremental capital due to the world publicized tornadoes in Q2.

Commercial CapEx increased by 32% to $45 million in the quarter primarily due to line extension and construction as we have invested for revenue growth both within the quarter as well as second half installs.

Our overall growth oriented capital expenditures continued to be approximately 75% of our total spend and our estimate for total year 2011 CapEx remains at approximately $1.3 billion to $1.4 billion. Although we saw growth and adjusted EBITDA in revenue, net loss increased $25 million on prior year from higher interest expense as we continue to extend our debt maturities, $19 million higher loss on extinguishment of debt, which is non-cash and an increase in depreciation and amortization.

Our income tax expense for Q2 was driven by $78 million increase of deferred cash liabilities and as a reminder, our taxed is predominantly non-cash due to our $10 billion tax basis and $6.9 billion loss carry forward position at the end of last year, and we do not expect to be a significant cash tax payer until after 2017.

Cash tax payments for Q2 and year-to-date were $3 million and $5 million respectively, reflecting certain state income taxes. We generated free cash flow for the sixth consecutive quarter shown on slide 13. Free cash flow for the second quarter 2011 was $155 million compared to a $125 million in 2010, driven by higher adjusted EBITDA and lower CapEx, partially offset by higher cash interest payments.

And looking at our capital structure and free cash flow, we remain comfortable with our liquidity, our maturity profile and our leverage target. And as of June 30, 2011, our net leverage was 4.7 times and our leverage target remains 4 times to 4.5 times, and we are comfortable plus or minus a half turn either way depending on strategic opportunities.

On the M&A front, we continue to evaluate opportunities and remain disciplined in using quantitative and qualitative filters for both acquisitions and divestitures. We currently have signed acquisitions totaling some 40,000 basic customers or 70,000 PSUs primarily in the Windjammer acquisition, which closed yesterday and a previously announced U.S. Cable transaction, which we expect to close in Q3. We also signed a few non-core divestitures for about 8,000 basic customers.

With that, I will turn it back over to Mike.

Mike Lovett

Thanks Chris. I'm pleased with the progress we've made in implementing our disciplined operating approach and executing on all our strategic priorities. I feel good about the strength of our business and remain confident that we're on the right path to unlock the growth potential that exists inside Charter to build value for our shareholders. Thank you.

Operator we are ready for Q&A.

Question-and-Answer-Session

Operator

(Operator Instructions). Your first question comes from Jeff Wlodarczak with Pivotal Research Group.

Jeff Wlodarczak - Pivotal Research Group

Good morning guys. I wanted to ask a question on Charter Starter package for data and video. Is that something you just launched? What's the price relatively speaking relative to your existing offers and do you do that more as a sage tool or are you out aggressively marketing? I have a follow-up.

Mike Lovett

Yeah Jeff, we haven't launched yet we're in the process of launching Charter Starter and the goal is really to drive connects from the high credit risk factor segments and as we have talked over the last several quarters, we suppressed marketing to those higher credit risk segments and I'll give you a few stats here to help better understand why. We looked historically at those segments and we are very focused on customer lifetime value as you're well aware, 70% of those households were gone within 9 months and a significant number that were gone through non-pay disconnects. This segment was financially upside down for us. So, we didn't want to market until we had a product that would be successful there. As we mentioned, we suppressed the direct marketing there for the last three quarters.

For competitive reasons, we're not going to share a lot of details on this, we'll have more to share probably as we end Q3 and have some returns on the marketing of this product, but we want to make sure that it limits the ability for customers to tap into higher cost elements until they establish a credit worthy relationship with us. The fact that 70% of them were gone within nine months tells us that 30% of those households still have an opportunity to be a credit-worthy customer with Charter. We just want to make sure that we are able to monitor that segment and move them into a credit-worthy status and then upgrade them into products over time.

Jeff Wlodarczak - Pivotal Research Group

Is that a data package? Is that going to be usage based? I think you discussed that last quarter potentially?

Mike Lovett

No. At this time, it won't be usage based.

Jeff Wlodarczak - Pivotal Research Group

Okay. Cablevision and Comcast have been quite successful with implementing new brand name strategies, is that something you might consider?

Mike Lovett

Yeah, we're looking at that. We actually when we emerged from our restructuring, we to look at brand shift and what we've been doing over the last three quarters is investing fairly heavily with our marketing media mix and refreshing the Charter brand. I think there is an opportunity somewhat similar to a Charter Starter to use sub-branding within products and packages.

Jeff Wlodarczak - Pivotal Research Group

Okay and then one last quick one. What was the storm effect on you video sub loss, I’m sorry if I missed that or if there was a significant video sub loss during all the storms?

Mike Lovett

There were, call it a few thousand customers who literally came off the network for a period of time, what we said in terms of the financial impact is that for the P&L inside the quarter, both from an operating expense as well as a revenue standpoint, it was about $3 million inside the quarter and from the capital standpoint, and you see that show up in the support line in capital $9 million effectively for client rebuild of truck and distribution as these storms have passed through particularly Alabama and Georgia, but also to a lesser extent Tennessee and a bit in New England.

Jeff Wlodarczak - Pivotal Research Group

Alright, thanks.

Operator

Your next question comes from Jason Kim with Goldman Sachs.

Jason Kim - Goldman Sachs

Hi good morning, thank you for taking my questions. Just two quick ones. First of all, I'm hoping if you can give us a little bit of preview into the trends so far in the third quarter. I know you have a lot of M&A shifts coming out and I just wanted to see if you have an early indication trends of what the volume trends looks like so far in the third quarter?

Mike Lovett

Yeah from a trend standpoint, we mentioned last quarter the price increases that we're implementing maybe Chris can give a little bit of detail on those.

Chris Winfrey

Yeah, so we have taken some very targeted price increases across different portions of our customer base. Those include a modem rental fee increased from $5 to $7 for cable modem customers, not in price guarantee, not taking home networking. It also includes a basic rate increase for our analog customers, which pushes the pricing of analog much closer to our digital tier, obviously an incentive to go more digital. And we've also taken an increase on our sports tier from $5 to $10 as well as the rolling increased to some of the existing customer base for some of the premium price increases picked up earlier in this year that will roll out for the existing customers. You know, really all of those price increases roll out sequentially through the quarter in Q3. So you certainly won't see the full impact of either the revenue increase or the churn related to that until the end of Q3 on a run rate basis. And again, to just reiterate, customers that are inside an existing price guarantee will not be affected inside for those rate increases until they hit a roll-off of their existing price guarantee.

Mike Lovett

And Jason, on the volume side, I touched on a number of the tactics that we're implementing relative to the pricing and packaging, it's a little early to see any type of trends and July has continued to be a seasonally soft month as well. Probably one thing to touch on though is the shift in media mix. Over the last two quarters, historically Charter spent 100% of our media on direct response marketing for a lot of obvious reasons.

Over the last two quarters, we've shifted to more brand focus and there is a lifetime value benefit, but you don't see that benefit for several quarters, and one of the things that impacted us and frankly, it was a bigger negative impact than we had initially anticipated, was the decrease in volume, incoming acquisition volume, because of that shift to more brand-oriented direct media mix.

We will be dialing up a more balanced approach in Q3 and Q4 of this year, still focusing on brand; we think strategically that's the right thing to do. Certainly, the results that we're seeing from a customer satisfaction standpoint are exceeding our expectations. Net promoter scores are increasing, customer sat scores are increasing and obviously having the best retention in any quarter that I've seen since I've been with the company, all very positive signs that our strategic investments are getting traction, but we'll balance that a little bit more with direct response marketing in Q3 and Q4.

Jason Kim - Goldman Sachs

Got it, thank you. And just a question on data ARPU. I think that data net as we are sort of the bright spot in the quarter relative to some of the other products, but ARPU for data turned negative year-over-year for the second quarter in a row. Is there a function of the existing customers actively treading down to lower price tiers, because they want to save money or is it more of a new growth that's coming in at cheaper tiers, because the incremental new subscriber maybe more price initiative than your existing base?

Mike Lovett

Now, the real driver here is, again it goes back to the strategic approach that we are taking from a customer sat standpoint. In the last 12 months, we've upgraded our speed tiers; we have doubled the speed tiers for free for our existing customer base. So, you see a slower increase of upgrades into higher speed gears, because they are getting incremental speed at no additional cost and that was not a surprise to us, but again looking at probably the best example I have here is looking at net promoter scores. Those customers that we surveyed that recognized that they got a free speed increase moved 37% up our net promoter score. So again, customer lifetime value benefit is not insignificant.

Jason Kim - Goldman Sachs

Understood, I have just one quick follow-up. On the $7 million of marketing with a favorable adjustment, you mentioned this one time, I think that’s only for the second quarter right? That doesn’t impact the second half of the year?

Mike Lovett

That’s correct.

Jason Kim - Goldman Sachs

Alright. Thank you.

Operator

Your next question comes from Ben Swinburne with Morgan Stanley.

Benjamin Swinburne - Morgan Stanley

Thanks, good morning. Chris, just a couple of things on the back half as you think about cost and actually ARPU as well. It’s sounds like you have been dialing on marketing a bit, I’m just trying to parse Mike’s words from just a few minutes ago about the mix between direct and brand and also programming cost, I realize you said they wouldn’t abate, but the growth on a personal basis I think there has been about 9% to 10% in the first half. Any expectations that that is going to maturely change higher or lower in the back half? And I’m just speaking in the context of the margin expansion we saw. And then, just lastly on ARPU, can we look at the price increases that you have put in and assume that ARPU growth will accelerate in the back half from Q2? Those are my questions.

Chris Winfrey

Okay. I think just technically given the adjustment that we had in marketing inside the second quarter, it would stand to reason that you are going to see an uplift in marketing expense in subsequent quarters, because you won’t have that benefit rolling through. I think what Mike was more talking about, and I’m not giving guidance here on marketing expense generally, but what I would say Mike is talking about shifting some of the above the line or more advertising or brand-related media spend more towards direct response. And so, the point there is less about overall spend and more much more about the mix in terms of growing direct response versus brand.

Mike Lovett

And Ben maybe a little more color on that to add some clarity. If you think about the mix, if we have 40% of our media spots, brand specific moving a mix to a more direct response of that 40%, maybe you cut that down to 20 and then, also getting a little granular here, but if you think of a 30-second spot, how many seconds of that spot are oriented to brand and how many seconds of that spot are oriented towards offer in triggering the phones to ring and those are the shifts that we are making in the second half of the year.

Again, we feel very good and if I was given the opportunity to do this again I would make the same decision, because strategically it’s gaining traction above and beyond what we expected, but it’s the balance of the mix and really what we saw the impact was more on our phone units as opposed to anywhere in the business. It was really a negative impact that caught us a bit by surprise on phone.

Chris Winfrey

Yeah. And the final thing on marketing is, always given so much of it is variable cost per order, to a certain extent we hope we are spending more marketing on acquisition. On programming costs, for the second half of the year, we said we don’t expect those programming costs to abate. Some of that is just the natural effect of the same contractual increases rolling through. You also have the trend that takes place when you have increased digitalization with a different mix in terms of your gross margin that is driving those higher direct cost on programming as well as, as we mentioned, some of the premium business being a little bit challenged and that happens with content on a relative basis.

On ARPU, I think the challenges are the one that we highlighted, so effectively customers trying to rightsize their packages, we don’t see that trend is related to the economy changing dramatically. On the other hand, you will see some of the price increases rolling through and given that we are going to reopen targeting that higher credit risk segment with some more suitable product related to them, I think there is a variety of different factors that are going to drive ARPU. So again to highlight, the economic pressures are not subsiding, we will have a rate increase to offset and in addition to that, either rolling out Charter Starters is going to be with the light products across the triple play, so you could see those factors driving the ARPU shifts.

Benjamin Swinburne - Morgan Stanley

Okay, great. And maybe if I could just follow-up Mike on the data product. I look at your broadband penetration of Homes Passed at around 29% at the end of the quarter. My guess is you are probably at 50% or so market share on high-speed data in your footprint residential, wondering if you would agree with that rough number? I’m trying to think about as you roll out DOCSIS 3.0, where is the opportunity in the data business? Do you think it’s ARPU related? Do you think it’s market share related? You have talked a lot about non-video sub penetration and how do you make it obvious to the customer that taking cable data with DIRECTV for example, is a smart decision versus the DSL product. And I ask that in the context of your peers often sell broadband stand-alone at a pretty big premium to the bundled price, so they are actually kind of going the other way just in sending that decision out. I want to know what your thoughts are on all that?

Mike Lovett

Yeah. First of all, I would agree that your percentage of market share is roughly in the ballpark with what we see. We looked at this a little differently, I think continued ARPU growth on the tier side of things, it’s got to be driven by customer selection, so it’s selection into home networking, it’s selection into Charter Cloud, it’s selection into higher speed tiers, I think that’s going to be the ARPU driver not rate and we eliminated the incremental fee for being a stand-alone Internet customer with us because, we did see that as a barrier and we really look at this as share play. We have got a superior product and we expect to leverage that. You touch on selling into DIRECTV; I will share a little bit with you about what we are doing with regards to non-traditional sales channels.

We formed a partnership with Dish and we have been running pilots and selling our voice and our data product into Dish households and both parties are extremely pleased with the results and we are expanding that relationship. We have done direct mail pieces in AB testing with Dish and this is where you have a Charter envelope and then you have a Dish envelope with a Charter offer inside of it, the response rate as you can imagine, because they have a relationship with that provider today is extremely favorable relative to a Charter direct mail piece.

Benjamin Swinburne - Morgan Stanley

That’s interesting. Thanks a lot.

Mike Lovett

Thanks.

Operator

Your next question comes from David Joyce with Miller Tabak & Co.

David Joyce - Miller Tabak & Co

Thank you. If you can just provide some more color on what’s going on competitively as we think about the fear of over the top usage by your customers. At first blush, it might seem to be putting the cart before the horse in terms of raising the speeds for your customers whereas, a lot of investors are looking for usage space building and what that’s going to do to improve ARPU. So were there competitive reasons in some of your markets that necessitated the price increases as a means to try to migrate people up from DSL more quickly?

Mike Lovett

David, did you mean the speed increases?

David Joyce - Miller Tabak & Co

Yes.

Mike Lovett

Yeah. The speed increases were two-fold strategically. One was to drive additional satisfaction and loyalty with our existing base by giving them something for nothing and frankly the response rates there as I mentioned from our net promoter score standpoint are significantly positive. The other is to really drive home the fact that we have got a far superior product relative to DSL and I think customers that are experiencing video streaming are seeing the real advantages of having true high speed associated with Charter and I think the fact the Netflix has highlighted us as being the highest performing ISP for two quarters in a row is not insignificant, we view that as bringing quality and value to our customer base.

David Joyce - Miller Tabak & Co

Thanks and if I could on video side, with the loss of a lot of video only customers as they are exiting, have you been able to determine, are they tending to head towards your satellite or towards the Telco providers?

Mike Lovett

I think it’s a bit of both. We saw a significant increase in Q2 media spend from the AT&T folks, roughly 7:1 ratio of spend in the markets that we are in today. And so, we saw an increase in media spend and very aggressive video offers. We also saw very aggressive video offers from the satellite players.

David Joyce - Miller Tabak & Co

Great. Thank you.

Operator

The next person comes from Bryan Kraft with Evercore Partners.

Bryan Kraft - Evercore Partners

Thanks. I just had a few questions. I guess first, can you talk about what proportion of your base is on the sports tier and therefore seeing that $5 rate increase on the sports package. Secondly, what is the impact of eliminating that unbundled broadband fee been on broadband ARPU? And once you annualize that change in the fourth quarter, should residential data ARPU then start to improve. And then lastly, how long do you think it will take for your team to reach that point where your video product is, you know, where you think it needs to be competitively? Thank you.

Mike Lovett

Regarding the sports data, we don't disclose the percentage of customers that we have within our tier structure, but we do anticipate with the sizing of NFL Network and launching the BTN2GO that we're going to drive additional satisfaction with our existing base, but also have great hopes that we will be upgrading customers into the sports tier. Do you want to take the ARPU question?

Chris Winfrey

Yeah, on the ARPU, on the end bundling of having that effective penalty fee for not taking a bundled video offer and that was done some time ago. And so, really at least a year ago before my time. So I think Mike was highlighting that the strategy for us has been different. We've been focused on this non-video household segment for some time and that we're looking at these alternative sales channels as a way to further get into customers thinking that even if they don't have our video product today, it's okay and it's possible to take Internet with us without an additional fee.

Mike Lovett

On the video side, obviously with the TiVo launch later this year and then soft launch across the enterprise earlier in 2012, we feel like that's going to close the gap significantly relative to our video product and really access to our on-demand library having an user interface that makes it easy to access. I think it's really a game changer relative to the video product. That along with our deployment of Switched Digital Video that allows us to add additional linear HD channels as well as additional HD VOD opportunities, I think really helps to close the gap. So, I think 2012 is going to be a bit of a shift for Charter relative to the video product.

Bryan Kraft - Evercore Partners

Has the whole home DVR expanded beyond the three to four markets or is it still?

Chris Winfrey

Yeah, we are launching in Q3, it is the entire enterprise.

Bryan Kraft - Evercore Partners

Okay and when will the TiVo interface be available for whole home DVR? Is that next year or is that long-term?

Chris Winfrey

That will be next year.

Bryan Kraft - Evercore Partners

Okay, great. Thank you.

Chris Winfrey

Thanks.

Operator

Your next question comes from Mike Pace with JPMorgan.

Michael Pace - JPMorgan

Thank you. I have two questions. I guess the first one is more for Chris, but Chris given that I guess most if not, all of your larger peers and competitors have really accelerated returning capital to the shareholders, I'm curious what your current thinking is on that front as you get into another target zone for leverage and acknowledge you need to tweak some covenants in order really get going on that and then I have a follow-up?

Chris Winfrey

Okay. Look, our thinking has not really changed. Today, we're setting 4.7 times net leverage. We've got a steady leverage target of being in the 4 times to 4.5 times range and again to just make it really clear, we are comfortable plus or minus and that really means plus or minus, half a turn either direction to enable strategic activity. So, as it stands today, there is no pressing need, because we're not inside that target leverage range and the way that we're going think about excess cash if you will, once you're inside that target leverage range is one, the pending organic opportunities for investment side of the business.

Two, the strategic opportunities that may exist through M&A and then to the extent that neither of those exist in a way that is more attractive then for example buying back your own shares, then you take a look at the use of any additional capital against either share buybacks, security buybacks including or dividends as well. So that's the way that we've been thinking about it, it hasn’t really changed and we are sitting about 4.7 times leverage today. So there is no real pressing needed at this stage.

Michael Pace - JPMorgan

And that's a good segue into my follow-up for Mike or Chris. In terms of M&A, it clearly feels like it's at least a little more robust than it has been in the last couple of years. I guess, what are the key logjams to the larger deals getting yanked in your opinion and maybe away from the obvious data spread, but is it the local competitiveness in those markets; commercial opportunities are sharing the synergies. I guess what are the key focus points for those discretions?

Mike Lovett

Well, I guess, may be it would be better to step back and kind of frame how we look at things relative to M&A, and then we could talk a little bit about what we view as some of the logjams to your point. So, we evaluate opportunities both on the acquisition and divestiture side through a set of strategic filters. For example, what it does to our footprint or the capabilities and that gets to some of the points that you made Mike relative to looking at an opportunity or a divestiture.

We also look at it from a quantitative filter standpoint and then include a relative comparison to buying back our own stock for acquisitions or selling our own stock for divestitures. In both cases, we take into the analysis the relative synergies. Again, getting to some of the things that you are talking about or the potential dyssynergies for a divesture and forecasted FCF growth relative to our own business plan. The key here from a charter perspective and I doubt that our peers think about this any differently as we will continue to be extremely disciplined when it comes to looking at any type of M&A and I’m not just talking about cable assets, we are looking beyond cable assets as well.

Michael Pace - JPMorgan

Okay. Thank you.

Operator

Your next question comes from Amy Yong with Macquarie.

Amy Yong - Macquarie Research Equities

Hi. Thanks for taking my question. CapEx seemed to be lighter than expected, do you think it will come in at the lower end of your guidance at $1.3 billion to $1.4 billion and should we expect free cash flow to grow at the same pace in the back half of the year? Thanks.

Chris Winfrey

So I think, look, the guidance remains at $1.3 to $1.4 billion. The drivers for the lower CapEx inside Q2 really were timing of some of those strategic bandwidth initiatives and so, we saw a significant impact. You can see that as most pronounced when you take a look at Q2 on Q2 of last year. So you see on that scalable infrastructure category, some real seasonality depending on when we were investing in some of those strategic bandwidth initiatives.

What we have done inside this year is to time those investments a little bit different outside the summer periods. And so that’s why you see some of the seasonality drop there, so the guidance hasn’t changed, we have got some seasonality there, but you did see a strong uptick inside a commercial and given the fact that it’s almost entirely success-based capital expenditure, we certainly hope that it sustains and increases in fact. So, I think that’s a little bit of the color I would give there.

The last one is just to highlight that in spite of a lighter quarter for CapEx inside Q2, in addition to that we had the $9 million that was inside there, inside the support category for the tornado CapEx. So that was your question as it related to CapEx. On free cash flow, again we are not providing guidance for the second half of the year. I think a lot of people have their own view as to what’s going to happen with EBITDA and CapEx, we have also stated in the past that we tend to be working capital neutral and inside of a particular year we did have the one-time effect coming into this year of having a negative cash balance driving a higher AP as one time, kind of $30 million working capital impact inside Q1. And so, it remains to be seen if we make that up through the entire course of the year. The other that people are obviously running into their models is the higher run rate interest expense as it relates to extending maturities of our debt profile.

Amy Yong - Macquarie Research Equities

Okay. Thanks.

Chris Winfrey

Thanks.

Operator

Your next question comes from Lance Vitanza with CRT Capital Group.

Lance Vitanza - CRT Capital Group

Thanks for taking the call guys. It’s nice to see you adding HBO GO, NFL Networks and NFL RedZone. Is there much incremental cost associated with those programs?

Chris Winfrey

Look, of course there is incremental cost associated with some of those programming contracts. What we have been trying to do in terms of our strategy is when we have taken rate increases is to be able to add additional content in there to support those rate increases that we had already announced a couple of months ago. And so, when you think about the additional content cost coming through you should also keep in mind that that sports tier is going from $5 to $10 and so, certainly it would be partially offset there.

Lance Vitanza - CRT Capital Group

Okay, great. And then just lastly, I did notice that the diluted share count, it looks like it was about 4 million shares lower this quarter, can you remind me what’s going on there?

Chris Winfrey

The outstanding shares have been at roughly 114 plus some decimal points, I don’t have in front of me right now, but we had done the 4.5 million share buyback from Franklin and so that was reducing the amount of outstanding shares because the company continues to hold those 4.5 million shares as treasury stock. And then you would take that 110 million shares outstanding and you would add back to that the treasury after the method relating the warrants and the options and there are issues that are outstanding today.

Lance Vitanza - CRT Capital Group

Any plans though for the Franklin shares going forward that you can disclose at this time?

Chris Winfrey

Look. I think the fact is that there is no negative tax impact to us holding on to those shares, it’s something that we are going to give some consideration to, we just haven’t made a formal decision as to what we are going to do from there. I think a lot of questions that have come to us over the past quarter or so has been early since the plan, now there is not at this stage.

Lance Vitanza - CRT Capital Group

Thanks a lot.

Chris Winfrey

Thanks.

Operator

Your next question comes from Richard Greenfield with BTIG.

Richard Greenfield - BTIG

Hi. A couple of questions. One, you have commented on the fact that Charter is now offering almost their entire sub base 16 megabits of downstream bandwidth. Curious when you look across, the average subscriber in terms of the competition. What do you think your average competition is, I mean I realize you have some premium products, but on average, what do you think the average tier is that you are competing against from the R Box. And then two, you have done deals now with HBO GO, where you are letting them authenticate charter service on HBO servers. I am curious how you feel about Fox doing it as well as Hulu, particularly whether an aggregator like Hulu, whether you have any issues with aggregated authentication going forward? Thanks.

Chris Winfrey

On the Internet 8 tiers I would, it is not quite 16, it is 12 megabits per second, so 95% of our customer base is at 12 megabits per second or higher included inside of that is predominantly is the 12-Meg product, but a fairly high amount that is sitting at 18 as well and then, a lower portion on the 25-Meg and 60-Meg products as those represent some of the more premium tiers.

What we compete against predominantly in the market if you take a look at our competitive overlap, which is somewhere between 31% and 34% of AT&T and FIOS overlap. And predominantly on the DSL side, we're competing against a 3-Meg product at $14.95 and a 6-Meg product as well. And then, on then on the Uverse and FIOS side, everybody is aware of the product that we're offering there, but, we save more competing against 6-Megs, which is one of the reasons that being in 12-Megs and above for all of our 95% customers. We believe this is the right thing to do in spite of some of the ARPU pressure that Mike mentioned.

Mike Lovett

From an authentication standpoint, clearly with all of our upcoming programming negotiations, we are looking to get authentication, keeping an keen eye on kind of the integrated authentication, I really don’t have a strong opinion on supporting it today, but I think that depending on how the business structure would be put together, I think there is an opportunity there, but our preference would be to work with our programming partners directly and get authentication into all of our agreements.

Richard Greenfield - BTIG

Thanks very much.

Operator

Your next question comes from Rich Tullo with Albert Fried & Company.

Rich Tullo - Albert Fried & Company

Thank you guys for taking my question. How do you Charter Starter will influence service cost as we look ahead. There were 8% lower truck rolls during the quarter. Are you going to do this in such a way as to be more cost efficient than perhaps you were in the past?

Mike Lovett

Yeah, that's absolutely the case to make sure we're getting the right customers in the door and from those higher credit risk segments, and that plays out favorably not only from a programming and lifetime value standpoint and on the revenue side, but probably as importantly and possibly more so on the OPEX side as you see in evidence in our decline in calls, the billing and service centers as well as the service truck rolls.

Rich Tullo - Albert Fried & Company

And just a follow-up on the TiVo. Could you just state what milestones are going to occur in the second half of the year with that implementation?

Mike Lovett

So, we will have pilot markets in the latter part of this year and then we will be doing soft launches in the early part of 2012.

Rich Tullo - Albert Fried & Company

And the pilot markets will be TiVo boxes and then as roll on, we will get the full integration of the software. Is that how it's going to go?

Mike Lovett

The pilot markets will have the integration as we deploy.

Rich Tullo - Albert Fried & Company

Okay, very good. Thank you very much.

Operator

Your final question comes from Ryan Vineyard with RBC Capital Markets.

Ryan Vineyard - RBC Capital Markets

Hi, thanks, good morning. Is the rightsizing of the packages you're seeing, is that primarily among the video only subs or are you also seeing in HSD and bundled service as well, thanks?

Chris Win

Yeah, we are seeing it obviously on the lower end of the video-only, we are seeing a bit more of that, but it is happening across our entire footprint both in single play, double play and triple play. And again, tough economic headwinds and you see consumers rightsizing their package on the video side of the house more than anywhere else.

Mike Lovett

Well, I would like to thank you all and we look forward to talking to you again soon.

Operator

This concludes today’s conference call, you may now disconnect.

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