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The DIRECTV Group, Inc. (NASDAQ:DTV)

Q3 2007 Earnings Call

November 7, 2007 2:00 pm ET

Executives

Jonathan Rubin - Investor Relations

Chase Carey – President, CEO

Patrick Doyle – CFO

Bruce Churchill - President of DIRECTV Latin America

Mike Palkovic – VP, Service

Analysts

Analyst for Jeff Wlodarczak - Wachovia Securities

Anthony Noto - Goldman Sachs

Doug Mitchelson - Deutsche Bank

James Radcliffe - Lehman Brothers

Craig Moffat - SanfordBernstein

Benjamin Swinburne - Morgan Stanley

Jason Bazinet - Citi

Tom Eagan - Oppenheimer

April Horace - Janco Partners

Kit Spring- Stifel

Operator

At this time I would like to welcome everyone to The DIRECTVGroup’s third quarter 2007 earnings conference call. (Operator Instructions) It is now my pleasure to turn the floor overto your host, Jonathan Rubin, Vice-President of Investor Relations. Sir, you may begin your conference.

Jonathan Rubin

Thank you, operator, and thank you everyone for joining usfor our third quarter 2007 financial results and outlook conference call. With me today on the call are Chase Carey,our President and CEO; Pat Doyle, CFO; Bruce Churchill, President of DIRECTVLatin America; and we also have Mike Palkovic on the call.

In a moment I’ll hand the call over to Chase and Pat forsome introductory remarks, but first I’m obligated to read to you the following:

On this call we make statements that may constituteforward-looking statements within the meaning of the Private SecuritiesLitigation Reform Act of 1995. Theseforward-looking statements involve known and unknown risks, uncertainties, andother factors that could cause actual results to be materially different from thoseexpressed or implied by the relevant forward-looking statements.

Factors that could cause actual results to differ materiallyare described in each of the DIRECTV Group’s and DIRECTV US’s annual reports onForm 10-K, quarterly reports on Form 10-Q, and our other filings with the SECwhich are available at www.SEC.gov.

Additionally, and in accordance with SEC Regulation G whichrequires companies reporting non-GAAP financial measures to reconcile thesemeasures to the most directly comparable GAAP measure, we providereconciliation schedules for the non-GAAP measures. These schedules are available and attached toour earnings release which is posted on our website at DIRECTV.com.

With that I’m pleased to introduce Chase.

Chase Carey

Thanks, John and good day, everybody. The third quarter was really a good one forDIRECTV and we delivered strong results really across the majority of our keymetric s. Clearly one of the Q3highlights was the strong growth in net subscribers additions. While thenumbers were good, the real story was the high quality of thosesubscribers. Just to try to give you asense of that quality through a couple of insights:

Over half of our new subscribers in Q3 took our HD and DVRproduct versus about 25% to 30% a year ago.

We had the highest percentage of our customers with annualincome over $75,000 which is one of our key quality measures in a number ofyears, and it was well above national average.

One of the really important factors in our success andtargeting the right customers has become our increasingly strong direct saleschannel which generated almost 45% of our new customers in Q3, and this channelhas really become an increasingly effective tool for both targeting customersand targeting the right customer asks taking advantage of market opportunities.

One of the most encouraging metrics for us in Q3 was churnand certainly we have expressed our frustration with churn in prior quarters,and while it is still not where it should be, the third quarter was one wherewe made real progress in terms of getting on top of churn with almost a 0.2%reduction in the monthly churn rate.

Clearly the quality of the subscribers we brought in, thedemand for advanced products were key factors in this progress on churn andother recent initiatives including social security numbers and credit cardmeasures also began to pay dividends.

ARPU was another really strong metric for us Q3. ARPU was bolstered a bit by timing benefits drivenby Sunday Ticket, we had an extra game in September, but even if you take thatbenefit out, our ARPU was up about 7% year on year. This result is all the more impressive whenyou realize that our year-on-year ARPU growth was actually adversely affectedby the increase of use of discounts and credit attributable to market competitionand by decrease in ARPU from premium services; essentially HBO Showtime and Starsprogramming services in that category. So ARPU I think was a metric we really felt very good about inthe third quarter. In addition, we’re also just speaking about revenue. We’re also finishing off another successfulseason of Sunday Ticket with results in line with our targets.

We also began to make a bit of progress on key costs likeservice, broadcast, operations, and G&A, although they weren’t thatmeaningful in the third quarter and we do expect more significant improvementsin the coming quarters. Again, one waywe have to ensure we improve our efficiency in the service area is to put ournow ex-CFO Mike Palkovic in charge of service which we did last month, so weexpect to see progress quickly there.

Two costs that clearly increased in Q3 were SAC and upgradecosts. These increases were driven by the enormous growth and demand foradvanced products. Although they’re not the only factor, they’re clearly areasof both SAC and upgrade where we have room and need to improve. If I was going to try and visual it I’d sayusing an old 80/20 rule probably about 80% in both those categories, 80% of theincrease was really attributable to demand for advanced product and 20% --again as a rough visualization – was probably due to issues where we have toimprove and tighten up some of the things we’re doing.

On the SAC side I already mentioned the almost doubling ofadvanced product take rate. However thisadvanced products wallet drove the SAC increase, we are pursuing initiatives totighten up spending in sales and installation which should help us continue tomanage SAC. In addition, we will get SACsavings in the coming months as hardware costs, particularly hardware costs foradvanced products, decline significantly over the next few months.

In the upgrade side, we saw the same increase in demand foradvanced products with a number of customers adding advanced products up over35% year on year in Q3. If you focus onthe most expensive upgrade, the HD DVR, the number of customers upgrading withan HD DVR was up over 80% year on year.

Now as we have said many times before, we view the increasecosts for advanced products to be a value-creating investment as the higherrevenue and lower churn generates a great return on that incrementalinvestment, so we really do continue to view this as an important dynamic in drivingour business forward and the success we had certainly in the quarter.

That being said, there are still issues in upgrade andretention that we need to address. Ourupgrade and retention costs for servicing customers replacing boxes are toohigh. We’re doing too many of them andwe have a lot of initiatives focused on bringing that down.

We’re also finding more and more customers taking more thanone advanced product so we’re taking steps to address the economics of theseupgrades since we really charge on a household basis for HD and DVRs.

Before turning over to Pat, spending a minute on LatinAmerica, much like the US, DIRECTV Latin America had an extremely strong thirdquarter in most of its key metrics more than doubling gross adds to 289,000; asignificant reduction of churn from up 1.55% to 1.41%; a fourfold increase in netadditions to 161,000 and an 18% increase in ARPU to $48.84. As a result, revenues were up 67% to $442million and operating profit before depreciation and amortization, excluding aone-time gain booked last year, was three times higher at $105 million.

Clearly the completed merger in Brazilis behind much of this success, however we’re also seeing really strongperformance in many of our other key countries like Venezuela,Argentina, Columbia. I’ll also add that while we don’t consolidateSKY Mexico’sresults, they also had a solid quarter and we saw good growth in places likerevenue and net subscribers.

With that I’ll turn it over to Pat and then I’ll come backand make a few closing comments.

Patrick Doyle

Thanks, Chase. As youjust heard, the rapid growth in consumer demand for HD and DVR services ishaving a material impact on both our top line and bottom line results. We’re getting the desired economic benefitfrom these advanced services in terms of better subscriber growth, ARPU, marginand churn, but at the same time we’re also investing to upgrade customers’homes.

The benefits from this strategy are particularly evidentwhen looking at DIRECTV US revenues which increased 14% to $3.9 billion. Much of this increase was due to our bestever ARPU growth rate of 8.3%, bringing ARPU to $78.79 in the quarter.

In addition to the usual ARPU growth we get from annualprice increases, we’re continuing to see strong equipment and service revenuesfrom the significant increase in HD and DVR customers.

For example, in the third quarter we added a record 600,000new HD and/or DVR subscribers, up over 60% both sequentially and versus lastyear. To provide some perspective onthis number, Comcast reported that they added 325,000 HD and DVR customers inthe third quarter. We now have advancedproduct penetration of just under 40% for our subscriber base compared to alittle under 30% a year ago.

As Chase mentioned, this quarter we had an extra week of NFLSunday Ticket revenues versus last year, and we also booked some additionalrevenues this quarter related to a lease we had with Telestat on one of ourolder satellites. If you exclude theseitems, our ARPU growth was around 7% in the quarter.

Turning to subscribers, the improvement in both grosssubscriber additions and churn reflects favorably on our competitive strengthin the marketplace as well as the higher advanced product sales. As you saw in the earnings release, thebetter gross adds in churn drove a 45% increase in net additions to 240,000 in that quarter.

The increase in gross additions to a little over 1 millionwas largely due to the significant growth in both advanced products and salesthrough our direct channel. Over half ofour gross adds in the quarter signed up for HD and/or DVR services. This is quite an impressive statisticparticularly if you consider that the previous high for this metric was in theprior quarter when sales of advanced products were just under 40% of grossadditions.

Also contributing to the increase in gross adds was thecontinuing strong performance from our direct sales channel which attained 40%more gross additions than a year ago. This increase drove our contribution to nearly 45% of total gross addsin the third quarter, up from 33% a year ago. These absolute and relative levels represent all-time highs for thischannel.

This is important because the direct sales channel brings inhigher value subscribers including a richer mix of HD and DVR subscribers whichhelps drive better ARPU and churn.

In terms of our monthly churn rate of 1.61%, we’re pleasedthat we’re finally starting to capture the improvements that we had talkedabout when we first provided our 2007 outlook earlier this year. Over half of the decline in third quarterchurn was due to lower voluntary churn which as I mentioned earlier, reflectsour competitive strength and appeal of our advanced services.

However, we also saw a nice reduction on our involuntarychurn resulting from the ongoing efforts to refine and tighten our credit policies. For example, we recently implemented amandatory credit card policy for new subscribers, and also increased ourminimum commitment from 12 months to 18 months for subscribers with basicservices. We have also implemented newsystems and procedures to improve our screening of new customers.

As a result of these ongoing changes, we are seeing amaterial improvement in the credit quality and income levels of newsubscribers. With these trends, weremain confident in our ability to continue reducing churn going forward.

Moving on, operating profit before depreciation andamortization was up 11% to just over $900 million. OPBDA margin of 23.6% was down 600 basispoints from a year ago, due in large part to the increase in both new andexisting subscribers upgrading to HD and DVR services and in particularupgrading to the HD DVR combination receiver. Also included in our upgrade and retention expenses were higher cost ofabout $52 million for MPEG-4 swaps compared to only $19 million a year ago.

I’ll remind you that for customers upgrading to advanced services,we continue to charge upfront fees ranging from $99 to $299 while alsorequiring a two-year commitment. Theseinvestments remain a high priority for us because we continue to earn roughly twicethe return from households with HD and/or DVR services due to the materiallylower churn and higher ARPU generated. To be clear, it is these customers that are driving a significantportion of the improved ARPU and churn results that I talked about earlier.

In addition to the upgrades and marketing, programming costswere also higher leading to a lower programming margin in the thirdquarter. This is consistent with theoutlook we provided earlier in the year when we predicted lower programming marginsin 2007, due mostly to the NFL Sunday Ticket, the NFL Network, Fox News and theabsence of the Showtime purchase accounting. It’s also worth mentioning that we’re starting to gain some of theefficiencies we had expected to see in subscriber services and G&A.

Looking at costs as a percentage of revenues, subscriberservices improved due in part to increased scale and efficiency at call centersand billing. Similarly, G&A costs asa percentage of revenues were also lower due to improved bad debt expense. Looking quickly at our cash and balancesheet, The DIRECTV Group generated a bit over $300 million in cash beforeinterest and taxes in the quarter, bringing our year-to-date total to about $970million, or flat with last year.

On a consolidated basis, the main use of cash in the quarterwas for the repurchase of about 35 million shares for $849 million. At the endof the third quarter, we had approximately $480 million remaining on ourcurrent $1 billion share repurchase program. Also in the third quarter, capital expenditures of just over $700million were higher than last year, primarily due to the increased number of HDand DVR set-top boxes that were capitalized at DIRECTV US.In the quarter, DIRECTV US’s CapEx for set-top boxes was $417 million comparedto $325 million a year ago.

Finally we ended the quarter with net debt at the corporatelevel of about $2.2 billion.

With that, I’d like to turn the call back to Chase for someclosing remarks.

Chase Carey

Thanks, Pat. Lookingforward over the next couple of months as we round out the year, our focus onHD certainly remains our top priority. We intend to continue to adding channels, HD channels to the nation’salready best HD service, and do expect to end the year with close to 100 HDnational channels and we will also continue during this period to continue toadd more HD locals as we launch more markets, add markets to the mix in termsof HD local signal availability.

We’re also excited about launching our new VOD service whichis now publicly available in a beta format.

In terms of the financial outlook for the fourth quarter, inmany ways it should look a lot like the third quarter. We expect to continue to attain strong salesof HD and DVR services. As a result, weexpect most of the key metrics: net subscribers, ARPU, SAC, upgrade, to besimilar to the third quarter.

In summary, I believe the third quarter results provide uswith a good gauge of our competitive positioning in the marketplace and thestrength we have, and we obviously feel very good about our ability to competehead on against both the cable and telco bundles.

We also believe that over the coming months our videoadvantage increases as we continue to add more HD and other features to ourline-up. I’m also very confident in ourability to continue to increasing margins on a quarterly basis goingforward.

Next year will be an extremely exciting year for us as wefinally begin to tap into DIRECTV’s potential and most importantly begingenerating the significant cash flow growth that we all expect.

Finally, before turning the call back to John, I’d like tobriefly mention that as far as we know, the Libertytransaction while frustratingly slow, remains on track to be completed thisyear. Of course predicting what happensin Washington is never easy, butwe’re optimistic that we’re in the final stretch, and we’ll get approval beforeyear end.

With that I’ll turn it back to John.

Jonathan Rubin

Thanks, Chase. Beforemoving into Q&A, investors should note that we have members of the media onthis call in a listen only mode. I’dlike to remind the media that they are not authorized to quote any participantson this call either directly or in substance other than the representatives ofThe DIRECTV Group.

In addition, we are webcasting this call live on the Internetand an archived copy will be kept on our website.

Finally, I’d like to ask callers to limit their questions toone or two until everyone has had a chance to ask their questions.

Operator, we’re ready for the first question.

Question-and-AnswerSession

Operator

Your first question comes from Jeff Wlodarczak - WachoviaSecurities.

Analyst for JeffWlodarczak - Wachovia Securities

Recently you have been very aggressive in your new HDTVmarketing. Is this driving a big pickupfrom your existing MPEG-2 base looking to switch to MPEG-4? If so, how are youmanaging this process? Clearly the longyou hold off the cheaper the boxes will be.

Can you provide more color on your higher upgrade andretention costs? How do you think aboutthe total upgrade and retention cost as a percent of revenue for Q4 in 2008?

Chase Carey

First managing the MPEG-2 upgrade, we are continuing toupgrade. I think Pat actually gave youthe financial number which gives you some sense. I think it was roughly from $20million going to about $50 million year on year and so it has picked up. I think we expect to see it continue to pickup, though again, this is something at this point that will continue throughcoming quarters.

I think in terms of managing it, at this point I’d end upsaying largely letting it be demand driven and letting customers that have thatequipment that obviously are not getting the full 100 channels now that they havebecome more aware they’re not receiving something they could, to let thempursue us. I think selectively we’ll tryto pick, like in LA’s market where we’re reaching out a bit more proactively totry to educate those customers that there is HD programming that they’re notreceiving that they could.

But I’d say it’s been pretty manageable. We continue to work that universe down buthave a ways to go. But again, mostlywhat we do at this point is let it be demand driven by the customer anddepending on that level of demand will determine how proactive we are topushing the switch. We do want to make sure we’re educating, we’re providing onthe websites and other places information for the customers so when they readthe hundred channels and they’re not confused and sort of saying, where isit? I’m only getting 20, which may bethe case with somebody with an older box.

In terms of upgrades and retention, as I said, clearlydemand for advanced product which we think is a good thing is the largest forcethere, and demand will drive that. Ithink you’ll see pretty good demand through the holiday season. You usually do with HD, and I think we arenow expecting demand certainly in the third quarter demand exceeded ourexpectations if I looked at what I would have thought what was the take rate ofadvanced product at the beginning of the year. I’d say that it’s probably above our expectations, which in many ways isa good thing, and I think it has pretty good momentum.

In terms of managing it, I think what we will continue to dois make sure we capture all the inherent savings we should. One of the biggest ones will be hardwarecost. In the next few months, our HD DVRwhich we’re still putting out as we’ve been working through inventory is still a$430 or $440 box, and by the end of thefirst quarter, I think that HD DVR is down a bit over $250. So you get real savings that are comingthrough on the hardware side.

I think we can tighten up some of the policies around thetruck rolls to upgrade those customers. Thereare places we can probably move more towards drop shipping a box to a home thatis already set up for the upgrade and not require a truck roll so we can lookat ways to manage that.

There are areas which are not as large as the upgrade thatagain we’re not as effective and efficient as we should be. The one I would cite is we’re rolling toomany trucks to replace boxes and fix boxes in a home and better than we were,but we have got real room for improvement and certainly with Mike going intothe service area, it’s one of the top priorities.

He’s got to bring that number down and get it improvedsignificantly, what we’re spending on the equipment replacement side of theupgrade and retention process. Those are factors that will help us manage it,probably in ‘08 more than in the fourth quarter. One of the benefits that will really start tocome through an area like that will be the benefits of the box leasing programwe put in place in ‘06. In many ways, ittakes a while to accumulate and work through and start to recapture some ofthat inventory, and so we do think in ‘08 we’ve gotten some benefits in ‘07,but we knew they would not be as significant. I think in ‘08 we really start to capture some of the benefits from theredeployment of set-top box as we get a larger percentage of our universe outthere that we’re recapturing and redeploying.

I’d say on the upgrade and retention side, it is making surewe’re as efficient as possible, it is making sure we capture the savings likehardware costs we should, it is fixing some of the problems where we’re notoperating as effectively as we should and capturing some of the benefitsinherent in some of the things we’ve invested in over the last year plus likethe leasing program to capture the benefits inherent in that.

Operator

Your next question comes from Anthony Noto - GoldmanSachs.

Anthony Noto -Goldman Sachs

You mentioned that half of the churn reduction was due tovoluntary churn. I was just wondering,do you think that represents the fact that a smaller percent of your subscriberbase had a catalyst to change?

I’ll throw in an anecdote to illustrate what I’m gettingat. A year ago there was probably ahigher percentage of your subscriber base that was in the process of making atransition from narrow band to broadband and in that transition they had atriple bundle offering that may have been more appealing. Now a year later asmaller percentage of your existing sub base is not making that transitionbecause they’ve already made it to broadband and so by definition, there isless of a reason for them to be open to a new offering from a competitiveservice.

The second question I have is on your gross adds. How much of the gross adds do you think isdue to the benefit of your high definition HD offering versus your outboundmarketing?

Chase Carey

I guesses in terms of the first question, churn which I’mnot sure I fully got the connection to the anecdote, but I’ll try and addressit. I do think that the churn, clearly one of the significant benefits is thequality of the subscriber base we have and the advanced products, that againwhen you look at the churn that exists on an advanced product customer, it’sstill well below 1% so as that universe grows, we get customers that have a richerexperience.

It is certainly one of the things I think that is helpingmanage voluntary churn. I think the terms in the bundling, what is theimpact on the bundling aspect, I think there is in general the marketplace hasgotten more educated and informed about the choices that are availablethere. Again, as you said, many havetaken the choices, have already done the upgrade. I think as some of the cable guys have said,the telcos have now really gotten well established in the market with alternativesfor broadband that match up well with us, whether it’s just matching up bydefinition as opposed to through a contractual relationship.

I think we said all along and continue to believe that thebundled is mostly about price. That isthe attraction of it. I think customershave increasingly gotten educated and informed about the ability to findsolutions for their needs for broadband in a way that is compatible with us andat a reasonable price.

So I do think the maturing of the broadband market and thesophistication of the broadband market and the education of the broadbandmarket and the education of the consumer in the broadband market are all thingsthat have helped us and have helped the customers get smarter about how do theymeet their demands. No question theywant broadband, but meet that in a way that is compatible with us and again, Ithink we continue to believe we’re in the right price in the market that videois the place people care deeply about, has the richness, has the ability todifferentiate, and the broadband telephony side continues to struggle withbeing more commoditized and being more dependent solely on priced to compete.

As we have established and tried to move to build aleadership position in video, obviously adding things like HD on top of whatwas already we believe a very strong position, it has enabled us to continue todrive that advantage.

In terms of HD, it’s certainly a big part of it. We talked about the advanced product growth,and I think that’s a testament to the HD. I mean it’s not the only thing that is driving it. Again, I think we tried to make leadership intelevision a multidimensional story, certainly content, sports, HD DVRs,service I think are all parts of establishing leadership and certainly the HDis a very important part and I think in many ways HD has become the top of thelist in today’s marketplace.

If you ask customers, what is at the top of the list of whatthey want to have? HD sits right there,and I think DVR sits right beside it, so I do believe that those two forces HDand DVR are going to continue to be the forces that drive the videomarketplace.

Operator

Your next question comes from Doug Mitchelson - DeutscheBank.

Doug Mitchelson -Deutsche Bank

Good afternoon, gentlemen. First are there any negotiations taking place with AT&T related to yourdistribution relationship with them or strategic in nature?

Second question, to the extent you talked about programmingmargins falling this year, it seems to be it kind of follows a pattern for thepast five years or so where you have made a pretty massive investment inprogramming, you had a rash of new RSNs get developed. You’ve had the sports box obviously, you’vehad step ups in successful networks but it seems like you carry just aboutevery channel under the sun and you carry all the RSNs that have been created.

So looking forward, should we expect either next year or theyear after return to programming margins expanding? Thanks.

Chase Carey

We certainly are talking to AT&T about the bundlingrelationship. I think they have said atleast my recollection is they said they were trying to somewhere aroundyear-end try and make decisions about where they were going and I’m surethey’re talking to EchoStar. I thinkthose are the substantive conversations are really around where they’re goingto go in terms of the bundling relationship going forward. Not a whole lot more than that to add.

On the programming, thisyear I think as Pat said, we had I don’t know that they’re what you call uniques. We certainly had a handful of significantprogramming increases that I guess they were outside the ordinary, I think we citedthem. The Showtime agreement, the FoxNews, and NFL Network kicking in. Wedon’t have long visibility, but certainly as we look out at ‘08, there aren’tthings like that coming, so clearly that is a benefit.

I think you will continue to have dynamics that are more ofan ongoing nature like sports teams going out and launching regionals and whichI don’t know whether I want to call those ordinary course, but put them more inthe world of the ordinary course, but probably certainly don’t have themagnitude of the three I mentioned that we encountered in ’07. I think it’s aplace we expect to make headway as we go forward.

Operator

Your next question comes from James Radcliffe - LehmanBrothers.

James Radcliffe -Lehman Brothers

First off the MSOs have been saying that a lot of their netsubscribers loss has been lower end customers, the life line video customers,but you’re showing greater than 50% take rates for new customers for advancedservices. Can you help me reconcilethat? I’m trying to figure out how thatworks. Where are those other subs going?

Chase Carey

They’re certainly not the ones coming to us, because I don’thave the cable guys’ numbers. I gave you a couple of the metrics. We got over half our customers upgrading intoHD and/or DVRs, and as I said, we obviously track a lot of metrics to measurequality. The one I cited was number ofcustomers above $75,000 income, and we were taking probably in the quarter the highestpercentage we’ve had in years, and well above the national average.

So almost anyway I would look at it, when you look at creditratings, credit risk, we were probably at a low that I can cite goingback. I’d have to go back on pages thatI don’t even have here anymore to find a number that I think our high creditrisk customers were down in the low single-digit percentages. So almost any way I look at it, and I thinkagain the numbers bear it out, when you look at churn and you look at ARPU,these are customers that obviously have the capability and appetite and desireto have a great video product, and a rich video product and stay with it.

I can’t reconcile. All I can do is look at ours, and we feel great about the quality thatwe’re getting right now.

James Radcliffe -Lehman Brothers

Are you seeing any difference in the kind of subs you’regetting from people switching from for example cable versus switching from dishor people who are new to pay TV?

Chase Carey

I probably don’t have great visibility in that. The deeper you try to get into it, we dotrack where they come from and we track where our customers come from and wherethey go to and try to look a bit at the differences amongst those versus comingfrom dish coming from cable coming from analog versus digital cable still someobviously coming from no paid TV service. Certainly there is nothing in thecable number there that would reconcile that either. It’s not certainly like we’re getting low endcustomers from cable and all the quality is coming through from dish. It just doesn’t work that way in reality. Cableis too big a chunk of it overall.

We’re getting a pretty good slug still of digital cablecustomers so it’s not just like we’re getting analog cable customers. We’re getting customers coming from digitalcable.

Operator

Your next question comes from Craig Moffat - SanfordBernstein.

Craig Moffat - Sanford Bernstein

About a year ago your analyst day you talked about retentionmarketing costs of around $1.2 billion, and then I think you raised thatguidance to about $1.4 billion as I recall last September. Your run rates currently close to about $2billion, I guess, total. I’m wonderingif that has any impact on your expectations of free cash flow that you guidedto at the analyst day back in ‘06?

Chase Carey

First the $2 billion is certainly not the run rate we’relooking at, so I don’t know what you’re extrapolating too, and I guess just tocorrect a couple of them, the $1.2 billion also did not include the MPEG-2 swapson top of it which is a number on top of it, so the $2 billion probably isn’tright and the $1. 2 probably isn’t apples to oranges on it.

That being said, is it running higher than I expected a yearago? Yes. Most of it is a higher level of demand, andI’m not saying everything is right where we thought it would be, but I think weactually hopefully tried to be pretty clear all the way along in saying that ifdemand for HD and DVR product exceeded our expectations, then there is a costto it. We think it’s a good investment,and we are not going to turn away those customers for the sake of managing to anumber.

Again I think I said 20 minutes ago those numbers haveexceeded our expectations. We think it’sa testament to the strength of our service and we think we’re creating value bydoing it. That being said, I think thereare certainly things we can improve. I’mnot going to be a broken record. I thinkwe cited the replacement of boxes in a home is an area we have to improve, andI think as we go forward next year we’ll get other significant benefits likethe benefits from leasing that really will start to come through in ameaningful way that really has not been material in the ‘07 numbers that willhelp us manage that number. I think wefeel still in general, again, I’m not going to get too far into re-updatinginvestor day here, but I think our vision of that business that we laid out westill feel very good about.

I think there will always be ebbs and flows when you getinto quarter and factors, so we’ve got a really high demand and in many ways ismostly a good thing for us. But we do feel confident as well that we willcontinue to find ways to manage it, but you painted a view of extremes that probablyis high on one end and don’t take some factors into it on the other end.

Craig Moffat - Sanford Bernstein

How much do you expect to get in terms of recovery of set-topboxes? Is that starting to helpsignificantly at this point given that you just started that program about ayear ago, I think that’s starting to improve significantly now and into nextyear?

Chase Carey

I think it becomes a meaningful factor in ‘08. We get a little bit now and it will get alittle bigger but it’s certainly not a significant factor if ‘07. I think it will become a much moresignificant factor in ‘08, and it’s actually starting to sort of between Q2,Q3, Q4 it starts to build and with that growth rate, it really sort of is whereit really starts to become material when you look at it in ’08.

So again, it certainly helps a bit in the fourth quarter,but it’s almost a multiplier effect as you start to accumulate that. We do geta little bit of help in ‘07, but it will be a meaningful factor for us in ‘08.

Patrick Doyle

Just as a guide for the third quarter, we ended up withabout $55 million of net savings from redeploying boxes in the quarter.

Operator

Your next question comes from Benjamin Swinburne - MorganStanley.

Benjamin Swinburne -Morgan Stanley

Just a quick question on the MPEG-2 upgrades. I might have the number off, but I think youended last year with about 800,000 of those in the field. Just trying to get a sense of how many havebeen done and how many are left and what you think timing of that remainingupgrade is?

Chase, if you could just talk strategically about your viewon owning content or owning programming. It’s not been a part of the DIRECTV business model in the past and I waswondering if you have a different view going forward as the business evolves?

Chase Carey

In terms of the MPEG-2, as I said at this point we’re mostlymanaging more through letting consumer, largely being consumer demand driven. Ithink we’ll end the year probably with somewhere a bit over half a millioncustomers that remain. Now, that goesdown into sort of 500,000 to 600,000customers and probably remain at the end of the year. That will go down and continue.

Two forces drive it down. We get churn, so some of them we don’t replace because our HD churn islower, we still have churn in that category, and then some will swap. Iwould think we’ll do a fair bit of that in ‘08. I think as somebody said on one of the calls, in many ways the longer wecan stretch it out the better it is for us, and I gave you the cost reductionin HD DVR, so of a customer is going to swap out I’d rather be swapping them out on an HD DVRthat costs $250 instead of one that costs $440 and I guess today I think our HDbox is still about $210 to $220, and I think by end of first quarter beginningof second quarter next year, it will be $140.

So when you get that type of reduction coming in hardware,we certainly would rather stretch it out. We don’t want to stretch it out to a place we’re frustrating customers whichis why we try and be selectively proactive to the right customers. But if we’ve got that half million and change,some of those again will churn out and never swap. The majority we will, and I would think we’lldo certainly probably over half of it in ’08.

One of the things we have to say, obviously the noise, thepress around and publicity around and the reality around HD has only reallybeen in place for a couple weeks, and we only really sort of went public with it.We have had the campaign, but really the focused campaign that started with theJournal and USA Today ads in the middle of October, so how much that sort ofdrives customers that haven’t come to us to date to do so, we’ll see. So it may pick up, but then again it would besomething we would monitor as we go forward.

I think in terms of content, I wouldn’t say we’re thatdifferent today. I think that’sright. With News Corp as a largeshareholder we had a unique relationship with a content owner. I think their content, I do believe in synergies between content anddistribution, but we’re really not focused on anything specific right now, so Ithink it’s sort of continuing to evaluate the marketplace and evaluateopportunities as they go.

Obviously part of any sort of where we’re goingstrategically in the life, we haven’t closed the Libertything, so we’ll have a new significant shareholder whenever that closes, andprobably look at things afresh there. But for us, we’re probably not doing anything different than we havedone in the past at this point.

Operator

Your next question comes from Jason Bazinet - Citi.

Jason Bazinet - Citi

I think most investors agree your balance sheet is prettylean and most expect you to generate a material amount of free cash flow overthe next couple years.

Chase Carey

So do we.

Jason Bazinet - Citi

If I understand the standstill agreement with News Corp thatLiberty will inherent is correct,you’re sort of prevented from buying back too many shares that would passively pushMurdoch or Malone over 50%. So my question is in that context, what is yourpriority for free cash flow other than just paying down debt even further?

Chase Carey

As I said before, I think that the discussion that really welook to have post the completion of the Libertytransaction where we have the shareholders in place and the board in place thatwe will be looking forward in a long-term basis. I agree with the observationson the balance sheet and the cash flow, but I think at this point really Ithink the where we go and obviously there will be ranges of options issomething that we need to have as a discussion we would look to have at a boardlevel once we have the Liberty deal closed and then appropriate representative shareholdersand board members.

Operator

Your next question comes from Tom Eagan - Oppenheimer.

Tom Eagan -Oppenheimer

If I could just ask the previous question a differentway: Chase, what do you think thecompany or the board’s willingness is to significantly lever up in order to saynot just maybe buy back shares but also provide some sort of cash dividend toshareholders?

Secondly, if you could remind us what the partnership sayswith Bell South and AT&T about if T decides to choose Dish as theirexclusive partner, how long will these existing or the current subscribers getthe service? Thanks.

Chase Carey

Again, probably on the question of the cash flow, I think we are comfortable with I’d guess I’dcall it an appropriate level of debt, that I think we feel we would feelcomfortable on the books. I think wehave given some broad base again. Wehaven’t really gone back into the market to see if it has changed. Since the summer obviously there have been arange of well-publicized issues in the credit markets, but our credit rating,you could probably have 3.5 and change in terms of terms that probably wouldn’tgo all the way there, but something that would be more 2.5 and change wouldcertainly leave you flexibility.

What you do with it again is probably for the same reason asI said I’m not going to repeat and probably would not get into far into whatare the options of what you do with the liquidity, but I do think we’d becomfortable with an appropriate level of debt on the business.

AT&T, certainlyexisting customers won’t be affected. Imean it prohibits specifically trying to switch out or target customers fordifferent offers so the existing base will obviously go prospectively, and tothe degree we will look to compete, if they choose to go EchoStar, then wecompete in that manner, then we’ll compete as we do in the AT&T regiontoday. We find ways to compete andcompete pretty effectively in the AT&T region today, and some of ourmarkets that we feel really good about are sitting in the AT&T region now.

I’m not saying the telco relationships don’t have benefitsto us, but clearly we would move to make prospectively put other initiatives inplace much as we do today competing in a historical AT&T region. But the specific question in terms ofcustomers, that the customer base that would be in place, they would not beaffected. There are protections toensure that.

Tom Eagan -Oppenheimer

Is there a time period by which say AT&T can’t directlymarket to those DIRECTV customers after they choose their partner?

Chase Carey

I don’t have the agreement in front of me. I think the answer is no. If it is, it’s a long enough time that you’reprobably way beyond anything that is relevant. So it’s certainly not measured in months. It’s years and multiple years, so it isreally protection that we are very comfortable with in that light.

Operator

Your next question comes from April Horace - Janco Partners.

April Horace - JancoPartners

I was wondering with all the new initiatives that you havegot with respect to driving churn down the two-year commitment the upfrontpayments, do you have some sort of goal as to how far down you can drive thatnumber?

Chase Carey

I think we have had a broad-based vision. I think what I talked about in the past on anannual basis that we would shoot for something that would be down the road --this is not an ‘08 number -- a 15% to 16% churn, and again I think thosetargets are ones you always have to continue to reevaluate, so there are sortof visions of where you can get to at a point in time and the competitivefactors and those things are part of the market, but if I was going to sit heretoday what would be our long-term vision of where we would look to get to, Ithink that probably is still would be my feel for what we would be holding outthere as a goal.

April Horace - JancoPartners

Can you also tell me how many telco subscribers or totalbundle subscribers that you guys have to date? That would include people like ClearWire and WildBlue.

Chase Carey

Most of them, the large, large majority are telcobundled. It is not the Clear Wire andthe WildBlue numbers are quite small.

Patrick Doyle

2.4 million total, about 15% of the base.

April Horace - JancoPartners

Can you give us any thoughts as to what’s going on with ClearWire and Sprint and how you guys are going to fit in or not fit in and updateon the new option?

Chase Carey

In terms of fitting in, we have a deal with Clear Wire, andwe will move forward to offer a bundle where Clear Wire is available to offer abundle of Clear Wire services with DIRECTV. I think that generally is how we’recontinuing to approach broadband overall is at this point really looking moreto create commercial arrangements with broadband players that enable customersto access a bundle of services, and I suppose to an investment in oneparticular.

Again,not to say we don’t continue to engage and look at are there other places weshould consider an investment, but again our focus is trying to create thosecommercial arrangements that enable us to provide a bundled service and that’swhat we’re doing with Clear Wire.

I thinkthe Sprint side of it, I don’t know much more than you do reading the papers,obviously the Sprint situation has gotten a bit more fluid, and I think we’llcontinue to be engaged in monitor and evaluate are there opportunities, issues,what have you, things we should consider as that goes, but I think at thispoint our focus really the only substance is with Clear Wire where we’re movingforward to provide a bundle of Clear Wireservices.

April Horace - JancoPartners

And the 700 megahertz?

Chase Carey

700 megahertz again I think we’ll continue to monitorthat. I think that’s a tough field forsomebody to compete with the incumbents, and when you look at what the rumoredprices are for that spectrum and the benefit the incumbent has in terms ofpaying for it and deploying it, I think there are obviously challenges for newentrants, but there are an array of players rumbling around and I will use theterm opportunistic. If there issomething that makes sense, we’ll evaluate it, but I think at this point itseems much more geared from my perspective towards much more realistic thatsome form of incumbents that bring the existing infrastructure are in the bestposition and likeliest as players in it.

Operator

Your final question comes from Kit Spring - Stifel.

Kit Spring - Stifel

Hopefully it’s the best for last. Can you talk a little bit about your plansfor VOD competing with cable and maybe some new CapEx guidance for this yearand next?

Chase Carey

I don’t think we’re going to get into ‘08. I probably will talk about ‘08 at the end ofthe fourth quarter, so I probably would not get into ‘08.

I with VOD as I said, we’re launching what you call a betatest which is actually we are providing it to customers. It’s probably a quasi-test still that is inour VOD offer willing be a combination of product pushed to a DVR and productpull by customer via broadband connectivity to that DVR. We actually think it’s a great product. We think it will be a very attractivealternative to cable. I think we’relooking to really distinguish ourselves by making it having an ease of use andchoice and accessibility being something that is uniquely attractive, so it isstructured, it’s packaged, it’s presented, available to customers, and they canfind their way through it in a much easier way than other options that existtoday, and I think it will help people grow into VOD.

I think VOD is going to be something, we’re not going torush it into the market. VOD issomething that’s still going to take time and you have issues around windowsand product and you’re not getting the right movie windows and you have allsorts of complications in terms of availability of product.

I think VOD will continue to emerge, but I think it’s sortof in some ways the bigger forces in the market short-term are certainly HD andDVR. I think the VOD will bring out and reallycontinue to move forward with it as that market evolves, but I think it willtake a while longer to evolve and again probably move from an array of playersbefore you get a more attractive VOD offering.

We think we’ve got a very good, competitive product and insome ways we will be opportunistic. Wedon’t want to be scattered too widely. Whilewe want to be a broad based content leader, we do want to make sure we canfocus our resources on the things that give us the biggest bang for the buck,and so I think probably there are places we think in the short term you’regoing to get a lot more bang for pushing it than others will let it sort of getled by the consumer and move forward to be more proactive with it as thatmarket evolves.

Kit Spring - Stifel

Have you seen any acceleration in October and November sinceyou’ve actually had the 70 channels I believe for most of 3Q you really didn’thave an HD advantage, you had a coming HD advantage? Have you seen a recent change over the lastmonth since the HD advantage has truly been there?

Chase Carey

I think what I said about the fourth quarter I will probablystick with. We look at the fourthquarter continuing to look a lot like the third quarter with certainly a partof it being strong demand for HD and DVR and for advanced product, and I thinkat this point probably not get too much deeper into week-to-week numbers.

Patrick Doyle

I think on your CapEx question on DIRECTV US, I think weexpect to come in around $2.4 billion total. Still about $800 million of kind of the non-lease so it’s a little bithigher and it’s again driven by the lease set-top boxes, and I don’t think asfar as looking forward, we’re not prepared to look into next year yet.

Operator

This concludes today’s DIRECTV Group 2007 earningsconference call.

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Source: DIRECTV Q3 2007 Earnings Call Transcript

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