Liberty Media Capital (LCAPA) Q3 2007 Earnings Call November 9, 2007 11:00 AM ET
Greg Maffei - President and CEO
John Malone - Chairman
Mike George - CEO, QVC
Bob Clasen - Chairman and CEO, Starz
Chris Shean - Controller
Robert Peck - Bear Stearns
Bridget Wyshar - JP Morgan
Jessica Cohen - Merrill Lynch
Jason Bazinet - Citigroup
Benjamin Swinburne - Morgan Stanley
Jeff Shelton - Natexis
April Horace - Janco Partner
Doug Mitchelson - Deutsche Bank
Good day, everyone, and welcome to the Liberty Media Corporation Third Quarter Earnings Call. Today's call is being recorded. This presentation includes certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements about financial guidance, business strategies, market potential, future financial performance, new service and product launches, and other matters that are not historical facts. These forward-looking statements involve many risks and uncertainties that could cause actual results to differ materially from those expressed or implied by such statements, including, without limitation, possible changes in market acceptance of new products or services, competitive issues, regulatory issues, and continued access to capital or terms acceptable to Liberty Media.
These forward-looking statements speak only as of the date of this presentation and Liberty Media expressly disclaims any obligation or undertaking to disseminate any updates or revisions to any forward-looking statements contained herein to reflect any changes in Liberty Media's expectations with regard thereto to any change in events, conditions, or circumstances on which any such statement is based. Please refer to the publicly filed documents of Liberty Media, including the most recent Forms 10-Q and 10-K for additional information about Liberty Media and about the risks and uncertainties related to Liberty Media's business, which may effect the statements made in this presentation.
On today's call, we will discuss certain non-GAAP financial measures. The required reconciliations primarily notes and schedules 123 can be found at the end of this presentation. Nothing contained herein shall constitute a solicitation to buy or an offer to sell shares of the reclassified Liberty Capital Stocks trading stock with Liberty Entertainment tracking stock. The offer and sale of Liberty tracking stocks in the proposed reclassification will only be made pursuant to Liberty’s effective registration, state registration statement.
Liberty Stock holders and other investors are urged to read the registration statement including the proxy statement, prospectus contained therein all by Liberty and the SEC because it contains the full information about the transaction.
A copy of the registration statement and the proxy statements prospectus are available free of charge at the SEC’s website http://www.sec.gov.
At this time, for opening remarks and introductions, I would like to turn the call over to the President and Chief Executive Officer, Greg Maffei. Please go ahead.
Hi, it’s Greg Maffei, good morning and thanks for joining us today. We remained busy in Q3 and we’ve had several ups and downs over the past three months and I am looking forward to sharing them with you this morning.
Today, I am going to talk a little bit about those recent events at Liberty and also discuss briefly the operating performance the assets and business has attributed to the LINTB and LCAPB tracking stocks.
On the call today, we have our Chairman, John Malone; QVC's CEO Mike George and CFO Dan O'Connell; Starz’s Chairman and CEO, Bob Clasen; President and COO Bill Myers; and EVP and CFO, Glen Curtis. And we also have several of my fellow senior Liberty Executives who will also be available to answer questions after the prepared remarks portion of the call.
Our first speaker on the call is going to be our Controller at Liberty Chris Shean is going to describe Liberty Interactive's result and Liberty Capital's results and also the liquidity picture of both of the attributed tracking stock. Then we will have QVC's CEO Mike George talk about recent developments at QVC, followed by Starz CEO Bob Clasen talk about recent events at Starz.
But I am going to highlight a couple of the other developments at the corporate level and some of you may remember we on October 23rd our shareholders approved the issuance of two new tracking stocks.
The first to be Liberty Entertainment has attributed assets that include our expected 40% stake in DirecTV, three regional sports networks those being in the Northwest, Rocky Mountain in Pittsburgh, Starz Entertainment, FUN Technologies are 53% of FUN Technologies, our 50% interest in GSN formerly the Game Show Network, and our approximately 33% interest in WildBlue satellite company.
In addition the Liberty Entertainment tracker will have about 551 of attributed exchangeable debt and about $1.87 billion of cash. So thinking about that new Liberty Entertainment attributed equity I want to first highlight how pleased we are with the excellent performance at DirecTV. They had a very strong quarter, growth adds up, churn down, net adds up, ARPU up. Clearly, the move to high-def and DVRs is requiring capital, but it's paying off with high quality subs. And we expect at the direct management team, that hardware costs are going to continue to fall, reducing the cost of upgrades and that they are working and will be successful to reduce the cost of truckloads and installs.
The regional sports networks, they were also going to be receiving in the expected News Corp. deal are also performing well. Good ratings of the (inaudible) performance and the Rockies performance. I think most importantly related to these assets, we are looking forward to closing that deal and moving towards the next phase of Liberty Entertainment.
The new Liberty Capital will have the remaining attributed assets, business and liabilities that were previously attributed to Liberty Capital, other than those that I just mentioned that are being attributed to Liberty Entertainment. These new trackers are expected to be issued immediately after the completion of our exchange with News Corp.
Just to highlight again, the purpose of these trackers is, first, to reduce complexity, particularly at Liberty Entertainment. To allow investors to further focus their capital in the equity that they find most attractive. To create a currency, particularly Liberty Entertainment, for enhanced dimensional flexibility and to further concentrate our remaining non-core assets at the new Liberty Capital.
Couple of other highlights to note during the quarter. Yesterday, at FUN Technologies we reached a definitive agreement to acquire the outstanding 43%. That agreement was unanimously approved by the independent directors.
Turning now to some of the operations at Liberty Capital. Revenue growth at Starz and the ongoing reduction of programming costs led to very satisfying increases in OCF. We are very pleased with that. We are also pleased with strong operating results in several of our other Liberty Capital affiliates, including the Braves.
At Liberty Interactive, just to highlight first we are not yet planning any changes today in the Liberty Interactive tracking stock and they are not impacted. Liberty Interactive's tracking stock is not impacted by any of the creation of the two new tracking stocks at Liberty Capital.
On an operating basis, clearly, we are disappointed with the continued soft QVC. QVC US had weak performance across many product categories in a difficult market. QVC International had good performance then UK, quite strong quarter. But, weaker performance in Germany and Japan, which continue to encounter difficulties.
Mike George will talk about those business in far more detail in a moment. While we are disappointed with those operations, we remained quite appreciative of the free cash flow generation capabilities in that Q. During the quarter, driven primarily by that, we repurchased about $500 million of equity since Q2 ended at Liberty Interactive.
Today we estimate that excluding the public stakes that are in Liberty Interactive and taking those stakes at market, Q is trading at above 8 times expected 2008 EBITDA and this doesn't take account of obviously its larger free cash flow generation capabilities which are very positive, relative with EBITDA stream.
Since we issued those tracking stocks, the initial set back in May of '06, we bought back more than 14% of the common stock at Liberty Interactive. And recently our Board authorized a purchase of up to an additional $1 billion. We still have under 4 times leverage on a net debt, both trailing and on pro forma at Liberty Interactive. So, we are enthused about the opportunity to potentially shrink more equity.
We also at Liberty Interactive had saw the operating growth year-to-date at Provide, Backcountry and BUYSEASONS, our three e-commerce businesses.
And lastly to talk about a development at Liberty Interactive, I think we are quite pleased with Barry Diller's plan split up of IEC. I think first that highlights the value of the components there, which we don't think had been fully recognized in the marketplace, and I think it will allow us to begin a dialogue with IC about how we are going to work together in the next phase of our relationship, not sure where that's going to turn out, but expect it will be positive.
So, with those comments, let me turn it over to Chris to talk more about the operations.
Thanks, Greg. Let's start by taking a look at Liberty Interactive. This quick snapshot of the third quarter revenue and OCF performance, indicates that Liberty Interactive's attributed businesses continued at a slower pace of revenue growth and experienced a decline in operating cash flow during the third quarter.
QVC is the principal driver performance among Liberty Interactive's attributed assets and its performance was sluggish. This was primarily driven by the continuation of difficult market conditions, challenging comparisons to last year's strong results from the same period and continuing operational challenges at QVC's international businesses, most notably in Japan and Germany. I'll talk a bit more about this shortly.
Looking more closely at Liberty Interactive, overall, LINTA's businesses achieved 4% revenue growth and experienced a 1% decline in operating cash flow. As I will discuss in a bit more detail in a moment. The pace of revenue growth remains slow at QVC and operating cash flow declined during the third quarter. Provide Commerce and BUYSEASONS which were acquired in 2006, experienced modest year-over-year revenue growth during the period had shown solid year-to-date revenue in operating cash flow gains. Backcountry which was acquired in June and is included in the third quarter result, doubled it's revenue during the quarter, I guess as compared to it's pre-acquisition prior year quarter and has experienced strong year-to-date gains in revenue and operating cash flow.
As Greg mentioned earlier, we continue to repurchase Atlanta shares during the quarter we bought back 14.9 million shares for $289 million. This coupled with our repurchases in October brings our total repurchases for the year to more than 46 million shares and over $1 billion. Since inception of the Atlanta share repurchase program, we have now reacquired over 14% of the outstanding shares.
We continue to believe in share repurchase as a solid means of enhancing shareholder value and will continue to evaluate opportunity to cost effectively shrink Atlanta equity. To that end, our Board recently approved the repurchase of an additional $1 billion Liberty Interactive stock buyback announcement.
Taking a closer look at the quarterly performance of QVC. QVC experienced consolidated revenue growth of 2% to $1.69 billion during the quarter and 1% decline in the OCF to $364 million. Domestic revenue grew 2% in the second quarter to $1.17 billion. The slower growth reflects softness across most major product categories. Total unit shift increased 1% for the quarter to $28 million while the average selling price grew 1% to $45.89. Domestic OCF increased 2% for the quarter to $278 million, while the OCF margin was largely unchanged at 23.7%.
Dot-com sales continue to grow as a percentage of overall domestic sales, rising from 19% in the third quarter last year to 21% this year. International revenue increased 2% to $512 million for the quarter, while OCF declined 8% to $86 million. The revenue growth was due to favorable foreign currency exchange rates in the UK and Germany, partially offset by lower average selling prices in all the QVC internationals markets. Operational challenges in Germany and the ongoing affect of changes in the enforcement of Japan's regulation of the marketing of health and beauty aids in that country.
The operating cash flow decline, was due to lower gross margins that were the result of higher product distribution costs and higher operating costs in the areas of commissions, customer service and SG&A expenses. Excluding the affect of exchange rates international revenue declined 3%, while OCF declined 10%.
QVC Germany and Japan as expected continue to experience challenges. The German business was affected by productivity challenges across most categories. Those contributed to a modest decline in the ASP, average selling price and a reduction in unit's shift that resulted in an 11% local currency revenue decline. QVC Germany also experienced a lower gross margin and higher operating cost percentage. Lower gross margin percentage was due to a lower initial product margin and higher product distribution costs.
QVC Japan experienced a 3.2% local currency revenue reduction as lower ASPs were partially offset by unit increases. QVC Japan management continue to ship product away from the health and beauty category to the apparel and accessories categories; home and jewelry, and experienced productivity gains in each of these categories to which it receive ship the product.
On more positive note we continue to experience improved results in the UK where QVC produced 9.3% local currency revenue growth and even larger gains in operating cash flow.
Before I walk through the Liberty Interactive liquidity picture I am going to turn the call over to QVC's President and CEO Mike George who will discuss QVCs operation in more detail and talk a bit about some of the new initiatives the company launched in the third quarter. Mike?
Thanks Chris. As Chris mentioned I'll provide a little additional background on the Q3 result and then give you a brief update on some of the growth initiatives that we've been driving. In the US as Chris described we saw continuation of the soft business trend that began in late April. With most merchandised categories underperforming our expectations. However, while the sales results were clearly sub par consistent with our long-term approach to the business, we avoided turning the pricing or promotions to artificially inflate the top line. As a result we were able to keep gross margin rates relatively flat for last year, contain expenses and grow EBITDA consistent with sales. And even if this soft business trend continues we are committed to sustain out of the promotional fray in the holiday season and believe we can maintain stable gross margin rates in this environment.
With the weak retail environment in the US clearly impacting our result, we need to raise our game to outperform. We are focused on that, we are focused on continuing to enhance our assortments and brands, creating engaging programming and dot-com experiences, and most importantly, ensuring strong day-to-day execution of the business fundamentals. And of course, we will continue to focus on tight expense and inventory management to avoid any significant fluctuations in our margin rates and profitability.
Turning to Germany. The results were poor on both the top-line and the bottom-line. Sales were hurt by our efforts to reduce reliance on a small number of core brands that have been over rotated. And ASPs and margins were impacted by some markdowns we needed to take to clear up underperforming inventory, especially in the apparel zone.
In Germany, as we have discussed on prior calls, we are focused on the fundamentals of cleaning up the inventory, diversifying the product and programming mix, we had been overly dependent on a few categories in the past, and moving our business away from promotional price points. And we remain confident that we will make progress against those goals over the next several months. However, as I mentioned in our last call, I don't want to try to predict the timings of a turnaround until we know we can deliver on it. So, we'll stay focused on key milestones and just moving the business towards a healthier long-term model for the business.
The Japan story remains largely the same as the last two quarters. We are focused on replacing the businesses that have come under increased regulatory scrutiny. When I first shared the regulatory challenges with you in our Q1 call, I told you that I probably would anniversary of the issue by next March, which is when the regulatory impact first hit us. However, over the course of the summer, several additional products came under regulatory scrutiny. As a result, we continue to withdraw from key product lines in our health and exercise categories over the course of Q2 and Q3.
We believe that as of the end of October, we have addressed all known regulatory issues. Although, we can't rule out the possibility of further impacts down the road, but we don't think they are likely.
As a result of these actions, we did see continued sales erosion in both Q2 and in Q3, and again, we won't fully anniversary the impact of having pulled out these products, until Q4 of '08. So, we do need to get past October to be completely anniversaried of all these known impacts.
Now having said that, I am actually encouraged by Japan. We are making more progress than we anticipated, growing our apparel, accessories, and jewelry lines at accelerated rates to compensate for the significant reduction in the help and exercise business.
So, those businesses are growing faster. On the flip side, the regulatory challenges were even greater than we anticipated when we last talked. So, while we are not seeing it on the top-line yet, we believe this business is fundamentally healthy and will show strong results once we anniversary these regulatory issues.
Finally, as Chris mentioned, the UK was a bright spot in the quarter with solid revenue growth and very strong EBITDA results.
Looking forward, we will remain focused on the core initiatives we have been discussing over the last year. For example, we will continue to add top-tier destination brands and innovative key items into our assortments. Our recent launches of Samsung, Garmin, Acer, Sharp, Oplus blackened in the US home category, as one example, have exceeded our expectations.
As you know, we launched the new QVC logo and branding in late September to very good reviews and positive customer feedback. We believe this is a strong step forward in updating our image and broadening our appeal and we'll provide important benefits over the long-term.
We have been migrating our customers to the new QVC.com site over the course of October. We now have all customers on the new QVC.com and while there is always some short-term negative impact when you convert customers from a site that they new well to a new site, we are very excited about the new QVC.com. We think it provides a strong foundation for future growth and we will be launching many new features early next year, and including more integrated video applications to continue to bring the value of our video skills to the internet.
Finally, we also announced this morning that we will be simulcasting our US program in high definition by Q2 of next year, and we are currently talking with all of our major distribution partners about carrying a second QVC channel in the HD tier. Now, we believe this will broaden the range of customers we reach.
And with that, I'll hand it back to Chris.
Thanks Mike. Let's take a quick look at the LINTA liquidity picture. We continue to maintain a strong capital structure with good liquidity the business has attributed to Liberty Interactive. Has attributed cash and public investments of $5.2 billion and has $7.1 billion in attributed debt. The increase in the debt balance during the quarter was primarily the result of ongoing Liberty Interactive share repurchases during the quarter.
Excluding the value of the investment positions in Expedia and IAC, Liberty Interactive's quarter ending attributed net debt of just under $6.4 billion equates to a multiple of approximately 3.7 times annual operating cash flow. As previously stated, we will be comfortable sustaining net debt levels 4 to 5 times OCF. As a result the Liberty Interactive businesses had significant liquidity to grow organically and through acquisition and to continue to shrink net equity as appropriate.
Now lets move on to Liberty Capital businesses. As Greg mentioned earlier late last month we received shareholder approval to -- upon completion of the News Corp exchange to reclassify our Liberty Capital tracking stock in to two separate series of tracking stocks, one called Liberty Entertainment, the other Liberty Capital. We believe this will produce reduced complexity, greater focus of assets, stronger currencies for financial flexibility, an increased concentration of our remaining non-core assets.
Overall during the quarter Liberty Capital reported a 52% revenue gain while OCF increased by robust 438% primarily as a result of some new businesses that we acquired. LCAPA's largest attributed operating assets Starz Entertainment which does not include Starz Media is continuing to strengthen its cash flow. During the quarter its revenue grew more than 11% to 282 million while it experience a 96% OCF growth to $88 million. I'll take about this more shortly.
Now let's take a closer look at Liberty Capital events during the second quarter. As I mentioned LCAPA's attributed revenue grew 52% in the quarter while OCF more than a tuple. Revenue growth resulted from strong revenue growth at Starz and the inclusion of Starz Media and the Atlanta Braves partially offset by lower GAAP revenue at true position which has been required to differ revenue recognition until its delivered all the software features required pursuant to one of its major contract.
The sharp increase in OCF is principally driven by strong growth at Starz also and the inclusion again of the Braves offset by a decrease in OCF at true position and operating cash flow deficit at Starz’s Media.
As we continued our efforts to complete the News Corp exchange during the quarter, we do not use any of the significant capital resources attributed to Liberty Capital to repurchase its common stock.
Since the issuance of the LCAPA attractive stock we have repurchased approximately 8.2% of the LCAPA shares outstanding. We continue to hold large cash reserves attributed to LCAPA and a final issuance of the new tracking stocks will continue to evaluate share repurchases as a means of enhancing shareholder value as our liquidity position warrants.
As I mentioned a moment ago, we continue to work on the completion of the News Corp exchange and hope to close that transaction during the fourth quarter. We are also evaluating numerous other transactions and report on those as they arise.
Now let’s take a quick look at Starz. Starz continued to experience solid subscriber growth in the first quarter, as Starz average subs increased 7% while Encore's grew 9%. For the quarter, this subscriber growth along with a higher effective rate due to the retroactive recognition of revenue related to the short-term expense of our DirecTV contract combined to drive an 11% overall revenue growth.
We had a couple of revenue growth mitigating items during the quarter including changes in the rate at which certain customers are paying under expired contracts that are under negotiation for renewal, and the shift of former Adelphia subscribers to the lower rate Comcast and Time Warner contracts.
Starz’s operating expenses declined 7% from the quarter largely as the result of a decline in programming expense and the reversal on the accrual for moving copy right fees. The reduction in programming cost resulted from lower effective rates for the movie shown in the quarter partially offset by increased costs from a higher ratio of first-run movie exhibitions versus library product expenses. Starz's SG&A expense was largely unchanged for the quarter.
Now, we've going to have Bob Clasen to say a few words about Starz Entertainment and Starz Media.
Thanks, Chris. Once again, we are pleased to report that subscriptions to Starz and Encore continue to grow in the fourth quarter, for the third quarter for the fourth quarter in a row reaching 16 million for Stars and seeing Encore past 13 million homes. These gains coupled with higher effective rates and a continued decline in programming costs serve to drive significant operating cash flow gains.
However, we have several expired affiliate agreements, the completion of negotiations of new mutually beneficial carriage agreements that will allow our business to continue to grow, remain a top year jump priority. I am also pleased to report that we are nearing the launch of the first original series ever shown on the Starz channels. These two half hour comedies at Kayson Hollywood residential will begin airing in January, so be sure to tune in.
Starz Media revenue increased again this quarter versus the same quarter a year ago. The company has began production on eight live action made for TV movies and four television series for first-run on basic cable programming networks and it continues to do animation works for the Simpson's and King of the Hill.
During the quarter, our Toronto Animation Studio began work for hire on two major CG theatrical films after completing the VeggieTales pirate movie that Universal will release in the first quarter of 2008.
Our Overture Films unit continues to add to its slate with the acquisition of the Visitor, winner at the Rome Film Festival and announced that it's first film Mad Money staring Queen Latifa, Katie Holmes and Diane Keaton, will premiere in theatres nationwide on January 18th. I'd be remiss not to make a quick statement on the writers strike. As most of you know the Writers Guild of America initiated a work stoppage this past weekend. Our current movies and series are fully scripted and either in production or set for production, so for the near-term its business as usual at Starz. Should the work stoppage be protracted, we will make adjustments as necessary, but the impact, certainly on the fourth quarter appears to be minimal.
Now, I'll turn it back over to Chris.
Thanks Bob. Taking a quick look at Liberty Capital's liquidity situation. The LCAPA business has remained in a position of financial strength. At quarter end, and including our News Corp. stake, LCAPA was attributed with approximately $16.9 billion of public investments and derivatives. This is largely unchanged from the second quarter.
In addition to our public holding, Liberty Capital has attributed cash and liquid investments of just over $2.7 billion at quarter end. Total cash and public holdings approximate $19.6 billion and are only partially offset by $5.3 billion base amount of attributed debt. This provides Liberty Capital with significant flexibility to grow its businesses and will play an important role in the strategic direction of these assets going forward.
Now, with all that said I'll turn the call back over to Greg, who's going to quickly recap the third quarter and talk about what's ahead for us in the remainder of the year.
So, thanks Chris and thank you, Mike and Bob for the updates on your businesses. So, as you can see it was another busy quarter. At Liberty Capital, we had strong operating performance in Starz and most of the other affiliates. We talked about the approval received for the issuance of our new trackers, and we are working to close the news exchange agreement.
At Liberty Interactive, we were disappointed with the growth. We believe management has got a firm handle on it and we remain optimistic about the long-term performance of the business. And we were fairly pleased with the performance of other internet affiliates. And as you know, we continue to buyback stock, having brought back almost or more than 14% of the stock since we issued this trackers.
Looking ahead, I think as you know we are first going to move to close that news deal. We are going to look to issue those trackers and we are not continuing to think about ways to optimize our non-strategic assets over the Liberty Capital. And put together synergistic operating businesses at Liberty Interactive and Liberty Entertainment. Create as much financial flexibility as possible to think about consolidating various assets, and above all, focus on trying to grow shareholder value.
So with that let me turn it over to the operator and open it for questions.
Absolutely. (Operator Instructions). And we'll go first to Robert Peck with Bear Stearns.
Robert Peck - Bear Stearns
Hi I have two quick questions. The first, Greg, is for you. Could you give us little more color around the IAC spend and what the implications are for Liberty. Are there any sort of tax implication that was going to stop any deal being done for a swap for HSN? And could you also talk about how your voting rights would be applied to be various businesses? Then I have a follow up for Mike.
Thank you Robert. I think to a large degree many of the answer to those questions are all no. I don't believe there are any tax implications from the spin itself. A question of how we redeemed or traded our stock for positions in one or the other of operating businesses including potentially HSN, it could be more attractive. We can't really do that before a spin. You can come up lots of scenarios. But, we know we played our hand and had our dialog with Barry about potential transactions prior to the spin and haven't reached provision. So, we'll continue that dialog heading into the spin and see where we end up.
As far as where our super vote goes and where Barry's proxy goes, it's complicated. It's somewhat related to where Barry is still CEO and what we negotiate with him. So, I have to tell you that I think we are going to a negotiation phase, and where we come at the other side, I can't predict which businesses will be ultimately owned, consolidated, held at all by Liberty or frankly by CREs.
So, I think the fact that it's happening will create opportunities, but I don't know exactly where they are going to go in from the relationship. Mostly, I think it's going to show and continue to increase the value at IAC and that's a positive for us. John, you want to add anything on that.
No, I think it's terrific for us. Each one of these businesses will now have clear dependant management for the most part and whether we increase, decrease or what relationship Liberty has with each one of these units will be determined, I would guess, over the next six months. But, I think it represents great opportunity for Liberty and frankly for IAC shareholders generally to focus their investment and their interests in the areas that they think closer than the most. It also creates the possibility of capital structures in each one of these businesses to take advantage of their particular cash flow and tax faster.
So, I think it goes a long way towards resolving much long time than the mild disagreement between Mr. Diller and myself about the appropriate use of leverage in each of these businesses.
Some of these clearly will have superior economic returns based upon leveraged balance sheet.
Robert Peck - Bear Stearns
Okay, great. So just to be clear than post spin with HSM, with any HSM deal therefore then be taxable?
Well, I don't think so. Other way to look at it would be to say that there would be more trust issues related to a change in either involving or equity ownership in excess of 50% from the existing shareholder group, since we already have 56% I believe as above.
Take it now 58 but it is something like that, yes.
We can't violate more stress by changing our voting relationship. We might be to some degree limited for some period of time and how much of the equity we could own in a cash transaction, but who knows that it depends on the capital structure with which this business is ultimately expand.
Robert Peck - Bear Stearns
Shifting gears for Mike then, Mike in HSN actually had a pretty good quarter up about 5% or so, could you talk a little about the differences that QVC is seeing and do you think you can start from emulating sum of that growth rate you are sensing?
Compare with HSN I asked, we don't know any more details than you all know in terms of what’s behind that. We also had a very strong record of growth for number of years and we had a very different place in terms of our profitability rate which is roughly four times HSN. So have chosen our path that we think is the most positive for the shareholders which is to maintain our margins and avoid heavy promotional activity is attraction of HSNs and we think that’s best for the long-term.
When you are in a period of copy the number of year's of high growth and in a period where there is some skittishness in the economy and in retail spend as we saw with yesterdays announcements. Yes, it will have an impact on us. We haven't been able to rise above it, so we are just going to stay focused on our business. We think there are enormous growth opportunities we have in front of us in terms of product categories and then in terms of great day-to-day executions. So we rip apart the business everyday. We try to find ways to create more exciting experiences for the customer, bring in new brands. We think that's right for the long-term, but when the business is fundamentally healthy we don' think we need to go to the pricing lever, we'd rather just keep working on as a fundamentals of exciting that core customer with great product. And I think we will over the long run we are very comfortable that that will get us to growth that we need.
Yeah. Robert, I'd like to -- this is Greg. I'd like to comment on the some of the premises of the question frankly, because if you are -- and look we are big shareholder and I see I hope they could see it very well but the comparison of somebody who has had very weak comps for long period, invested heavily in a lot of promotional items, in a lot of promotional inventory and then when that bar is lower enough hurdles over it at least only in the revenue line but doesn't reach at anywhere nearly on the profitability or free cash flow line it’s a little bit of an unfair comparison to say wow homerun. So I think we would be very happy and are very happy with the relative long-term performance and continued cash flow generation capabilities at Q relative to H.
Robert Peck - Bear Stearns
And we'll go to Imran Khan with JP Morgan.
Bridget Wyshar - JP Morgan
Hi this is Bridget Wyshar in for Imran. Quick question about domestic QVC, given that weaken retail environment and your non-promotional stands have you seen any changes in your inventory levels there?
Yeah, Bridget I think we have been actually very pleased with our ability to manage our inventories. We are always challenging when the sales come in below your expectations but we have been able to keep inventory on plan and for the most part we feel very comfortable with [Technical Difficulty] inventories.
Bridget Wyshar - JP Morgan
Great. And then a question on Japan. Can you give us any insight into how much of the business is now under regulatory environment in terms of product percentage?
Yeah. Clearly the biggest impact is in the health category. Health category we will give feel for that. If you look at that combined, the combined health category fell from about 21% of our business a year ago to a little less than 9% this year. So what was, you know, not quite a quarter of the business that is reduced to less than half of its current size. There are some impacts in a few of the home categories, primarily in the exercise fitness area. And so that's having an impact, but it's a smaller impact.
Again, as I mentioned earlier, what's encouraging to us is we had 20%, 30%, 40% kinds of growth rates in apparel, accessories and jewelry, although it's a more airtime. So we feel good that those businesses are growing, but we've got about a quarter of the business that really is in a very challenged state.
Bridget Wyshar - JP Morgan
Great. Thanks a lot.
And we'll next go to Jessica Cohen of Merrill Lynch
Jessica Cohen - Merrill Lynch
Thanks and also QVC related question. I was just wondering back to HSN, if you could be more specific on the pros and cons of combining with HSN from both a revenue and a cost perspective, because we've heard previous QVC management have -- we've heard many views expressed on that? And then, also could you comment on how much jewelry is of the business right now and the impact with gold prices increasing?
Sure. On jewelry, of course, the jewelry is about a quarter of our business in the US. As we've mentioned on prior calls, the gold component of that business has continued to struggle. And unfortunately, we thought we might see some stabilization, but obviously, gold has reaccelerated and we don't see any end in sight.
So our gold business is in negative territory, and gold is roughly a quarter to a third of the total jewelry business. There are other parts of jewelry that are doing reasonably well, gemstone business is particular strong. So, while gold is a bit of an anchor in the business, the rate of decline has probably slowed and there are other things working in jewelry, so that we think over the long-term we can manage around that issue.
On HSN, I guess I'll make a couple of comments, and then Greg wants to add to it. What we've said in the past on HSN is, at the right value, we certainly think there is some benefit to ownership of the two companies, but we don't think the hard synergies are significant. By hard synergies I mean clear cost takeout. So you'd have to run to largely independent businesses and the real costs are around the product and the operation of the channel.
So I think you'd see fairly modest hard synergies and wildcard or kind of the softer benefits of being able to perhaps counter program the two channels, leverage, share vendors in the right way, or other approaches to sort of present a more unified phase to the customer. But those are fairly untested. So you certainly wouldn't want to pay a premium to get those benefits. So at some costs, we think there is value in HSN. But the hard synergies are just not that significant.
And our next question will come from Jason Bazinet with Citigroup.
Jason Bazinet - Citigroup
Thanks. Two quick questions. Can you just go back to the stated objectives with the new trackers of Liberty Capital? I'm still sort of hung up on this 551 exchangeable over at Liberty Entertainment, because it seems like there is a risk that it reduces the amount of Holco discount that will be reduced by sort of muddying up the story a bit. And so my question is, is that designed to give you the flexibility to convert to an asset-backed security at some point in the future? In other words, is that why you put that there at all?
And then my second question on Q and H, do you think there is an opportunity to sort of -- if you get control of the asset to go after a very different demographic at H as opposed to sort of going after the same demo, which I think you are broadly today? Thanks.
Well, Jason, I'll kind of the first one, and then let Mike handle the second. Obviously, we hope not to muddy the water, and given the amount of cash that we sent over with the exchangeable, I don't think that is an issue. There were some, I would say, relatively tax motivated reasons we thought that it would be better to leave the exchangeable within or rather put it in the new tracker.
I would actually say it's probably the reverse of what you're suggesting in terms of a hard spin, because while one doesn't know exactly how our hard spin would work if one did a hard spin, that 551 via comp exchangeable is an obligation of the parent, which really is old Liberty Capital and would likely either need to be transferred or attributed back or paid off depending on whatever set of circumstances you can imagine. So Liberty Entertainment is unlikely, if it ever were hard spun, ever end up with that debt per se.
Jason Bazinet - Citigroup
So I don't think that's the motivation. Hopefully, we'll be able to walk through and explain in clarity what the balance sheet of Liberty Entertainment, which is very underleveraged, theoretically, it looks like, given its got net cash of about almost $600 million, $550 million, hopefully, we would be able to walk through and explain that. Mike, you want to address the second?
Sure. That is a kind of a general statement. We've found that it's hard to be too targeted or too narrow in the demographic reach that we go after and get the kind of revenue level that you need to support a national channel. Our approach has always been to try to appeal to the broadest range of demographics that we can. And we do find even with in Q that the demographics for Bare Essentials beauty hour is wildly different as you might expect than a NASCAR hour to pick two extremes.
So, typically the way our business works, and I suspect H is the same way, it needed diversity of programming that appeals to a broad range of demographics. And then the demographics vary a lot throughout the course of the day or week or month. That said, there is some opportunity to more sharply differentiate the two formats on some dimensions. There might be, I can't honestly say that I have studied it carefully to give you a really thoughtful response. So, there certainly maybe some targeting opportunity. But as a general statement, you typically need to reach for fairly broad audience to drive the kind of revenue we need to make the format work.
Jason Bazinet - Citigroup
That's great. Thank you very much.
And we will go to Benjamin Swinburne with Morgan Stanley.
Benjamin Swinburne - Morgan Stanley
Hey, guys, its Ben Swinburne. How are you?
Benjamin Swinburne - Morgan Stanley
Hey. Couple of questions. Greg, you made a comment upfront. I just wanted a get a clarification on the LCAPA, you didn't buyback stock in LCAPA during the quarter. Was that due to a restriction? Or just by choice?
And then on the QVC business, Mike you talked about at the Analyst day or Investor Day about new markets. Any change or update there based on the performances in Germany and Japan on sort of where you are focused and what the timing might be?
And then maybe lastly for John and Greg, you guys could give us your completely unbiased view of the cable and satellite results this quarter, I would appreciate it.
Why don't we do the Q first, then I will go right into the LCAPA and SAT versus cable. Do you want to talk about Q international markets Mike?
Thanks Ben. No new news on international expansion. As we did talked at Investors Day we remain interested and are in active, I would characterize it as active discussions with potential partners in a few different markets. And as I mentioned, there is nothing imminent on the horizon. And to the point you called out, Ben, we would be cautious about taking on another market until we are confident that not only do we have the right opportunity, but we have the management depth to take it on.
Clearly, David Fry and our international leadership team are very focused on addressing the issues in Germany and Japan. We want that to be there overwhelming focus and we don't want to create a lot of distraction by trying to start another market. But having said that, we are in active discussions, and if the right opportunity presented itself to us and we were confident that was a good long-term opportunity, we would go after it. But, we will do it in a measured way and make sure that it doesn't distract from driving the kind of results we need to see in the three existing markets.
So, Ben, on the stock question. I don't think we call out what did or didn't usually did it, or drove rather our purchase or lack of purchase decisions.
I think we've been relatively consistent in saying Liberty Interactive has an enormous free cash flow generating assets in QVC. So, one would expect, all things being equal, systematic shrink is the most logical way for us to do that. To the degree we don't have opportunity that we see to add synergistic e-commerce and brand assets and brand businesses, which we've done some of, but typically we can't consume all that free cash flow. It's likely that we will continue to repurchase stock, and given especially, under leveraged really above, the fact that we are sub 4 and we believe four to five is achievable on a net debt basis and manageable. It's likely we'll continue to shrink systematically to get to that target and take advantage of that free cash flow.
Alright. Now at LCAPA we have done one big shrink in the form of a self tender, but our progress there has been what we call episodic. Meaning, if there is a transaction which generates capital and frankly in 2006 and in 2007 we had several of those including, the Time Warner exchange, the sale On Command, the sale of Court, we'll consider cash flow utilized or utilized in a cash rather from those transactions then repurchasing stocks, but there is no sort of episodic or rather there is no continuing shrink there. And frankly, there was nothing in the quarter that we did which generated significant cash at Liberty Capital. There was the free cash flow generation at Starz, but it is relative to the scale of what Q does and relative to the scale of Liberty Capital it's not the same.
So, that's where the logic and mentality of it. And frankly, until we know where we end post the subsequent trackers or new trackers, we are going to probably watch and see how those trade and we are going to watch and see the free cash flow generation capability that Direct has what our access to that capital is and how we utilize that probably before we make any dramatic moves.
As far as the progress of satellite versus cable, I think we are very gratified on several levels. We believed when we were looking at becoming shareholders in DirecTV that the market probably had overreacted to the power of the bundle that mentioned what clearly bundle has positives but much of what it could do and how it would hurt DirecTV, with already being absorbed and DirecTV had ways to go directly to customers and create bundles with telcos that will provide an effective means to get into customers.
And offsetting that we saw and we endorsed what management was doing with it's focus on HD. It's focused on going for the best customers in the marketplace for video or in the DVR segment as well. And it's focused on the TV experience and content. And I think we are gratified that they have executed very well in that plan. They continue to show upside and they appeared to have run rooms, satellite appears to have run room in the marketplace.
We believe that competing on that differentiated experience; better video, more choice in video, more choice in content, a great TV experience. All of those are very attractive and they're going to give us some run room here. Will it be forever? Who knows, but I think satellite has got several more quarters of good growth relative to the cable choices and we are gratified that it's working that way. John do you want to ad anything?
Yeah. I mean, just looking at quarterly results, the cable guys are still eating into the telcos and data telephony. The video side seems to be favoring satellite at the moment. I think primarily driven by more choice in high definition which is clearly an edge at the moment in virtually all markets, so DirecTV over any of its competitors and I think also Direct has done an excellent job of differentiating itself in the sports. So now if they have high-def sports but have -- they can -- its actually the high end, it's at the high road in differentiated sports, so whether its investment in Sunday ticket or what they do on NASCAR in terms of multiple channels, when the races are on. They have done an excellent job of exploiting differentiated content, Hi-Fi definition that’s given the public rather accelerating take up of high definition now on a larger screen its pretty clear. I use the analogy the other way, I have got a treadmill and my wife brought me a large screen TV that's three feet away from the treadmill and DirecTV which we have at home is currently offering most of their high-def channels back-to-back with their standard definition channels, so you can by clicking back and forward you can see the football game in high-def from standard def and its dramatic to the point where, if I could only watch at standard def I probably would be very unhappy and thus seek an alternate supplier. And I think that that is starting to impact the high end of the marketplace in favor of DirecTV and as Greg says, it's hard to project how long it will take cable to be able to come up with something equivalent.
But I don't believe that switch digital which is essentially the technological solutions that the cable industry is hanging their hat on will be adequate to close the gap and certainly not adequate on ubiquitous spaces. So that these opportunities to differentiate on high def wire power will persist for an extended period of time and at least part of the country and it's satellite will be able to exploit that and simply DirecTV.
So obviously, we are thrilled with current results and we think that they press which is pretty strong potential in the exploitation of video. I wouldn’t try for the cable, I mean they are doing extremely well, with higher margin of products that they are eating into the telcos.
And going forward, I guess going back, we had a period where we see cable had a big advantage because of bundle and they do. They, as John notes are generating lots of RGUs even at a perhaps with slow rate versus telcos, but they generate a lot of RGUs and taking telco share. During that time people were quite negative about DirecTV, many people and we saw and frankly followed what the management team there did. We are not going to claim credit, but we saw they were doing endorsers of it in terms of their bet on the video capabilities and the video experience, and we see that paying off. As John notes, how long that will go on, this is the constant game of innovation, and the key is to find niches where you can be the leader and be providing a differentiated experience. And we think Direct's got lots of room to do that. For now in HD, and I think down the road, in content and the TV experience, what they have planned could be very interesting and very powerful.
The last thing I'd note is the opportunity created by having a national business, the one offset that we appreciate. And I think if the Direct team, it's management team is smarter, we can help is way to think about exploring the fact that we have national business. The guys who are hurrying the most are the ones who ended buyer from the strongest telco product and where the telcos have been strong, and obviously, particularly where they have files, that is a tough product to compete against, particularly given the amount of marketing and dollars that is being invested by the telcos. And we're lucky to have a balanced business that can absorb, a), one of the areas where we were strongest, DirecTV; b) we have an ability to grow another market.
I think I would add to what Greg is saying about ubiquity. When you have a national business, your services are ubiquitously available. It gives you enormous opportunities in content that frankly TCI and cable never had because of the vulcanization of the cable footprint. So that is a very important ingredient long-term that favors the satellite footprint over the cable footprint; i.e. the ability to make a decision on content and have that content available ubiquitously across the whole country.
A cable operator, even one as big as Brian, I think you know, is still limited to a footprint that may be 35% of the country. And then, only if all of these facilities are equally capable of adding an incremental service as DirecTV, if they have room to add an incremental service, it automatically is incrementally available on a national scale. This is a huge advantage for satellite over cable. And really when I've been on the other side of the equation, I used to worry about that a great deal.
Cable has lots of advantages by being regional, and they are doing quite well. And the best case for everybody would probably be if people gravitate towards their respective strengths and to some degree that's happening. We'll see how it plays.
Benjamin Swinburne - Morgan Stanley
And we will move next to Jeff Shelton with Natexis.
Jeff Shelton - Natexis
Thanks. Just one quick IAC follow-up question. At this point do you guys have any hard blocking rights over the ultimate IAC spin-off structure?
That's a legal question.
Yeah. I think we would argue that there are restrictions on what IAC can do and not do, but we'll have some of that dialogue with IAC.
But as announced, the answer is yes.
Jeff Shelton - Natexis
Does there need to be another Board vote or not?
Yeah. There will have to be many Board deliberations at IAC before the actual spin-off can be implemented, and it will have to be a resolution of these open issues relative to the relationship between Barry and Liberty.
Jeff Shelton - Natexis
Maybe two more questions.
Okay. We'll go to April Horace with Janco Partner.
April Horace - Janco Partner
Hi. Thanks. Quick question on QVC. I was wondering are you guys exploring, moving to more of an interactive platform, similar to what HSN did with Dish, and do you think that would add incrementally to the revenue streams?
April, we do explore it. We had tested interactive applications a few years ago, and didn't see a lot of benefit at that time. As you may know, we have an interactive application in the UK, which we've had for over five years. So we can't pioneer that concept in our UK business. And so I think we know a fair amount about it from our learning's in the UK.
At a high level, we don't see it being much of a revenue driver. And certainly, our five years of experience in the UK as well as our testing that we did in the US, in neither of those experiences do we feel that it materially added to revenue. But it can save some expenses, depending on whether people use that application versus a live operator or an automated voice response unit or the internet. So depending on what ordering mechanism it substitutes for, there can be a modest cost saving.
So we remain interested in it, and as the technologies mature and as it becomes an easier experience for customers, I think it's probably likely that we will adopt interactive application. For us, the upside is to look down the road and to see whether beyond just simplifying new ordering mechanism, there are really value-added applications that create a superior experience for the customer, and I don't think that technology is quite there yet. But it will probably come.
We're going to be testing a number of really interesting applications in our UK business next year on this platform. That will basically give the customer a choice of watching the live show, or watching a video-on-demand channel, or watching shows that had aired earlier in the day, so that it gives the customer more choice and control over what she is watching on TV.
So, obviously that platform is different in the UK than what we have in the US market. So, long we are saying, we think it's interesting, we know quite a bit about it. At the right time in the US we'll probably do something. Do we see it as being a significant revenue adder? Maybe in the long-term if some of these value-added applications are merged. So, not yet, but potentially down the road.
I think one of the most interesting potential applications, as you know DVRs are exploding in terms of take up rate. The ability to push video into the DVR and make it randomly accessible by the consumer could well be the application that ultimately benefits QVC in terms of broadening its audience and giving better access to selected products or something of that nature.
So, I have longed been proponent of interactive television. If the opportunities are still there the technology has not quite matured on the video side, the way it has on the Internet side, when it finally does, I think the ability to sell products to mass audiences on an impulse basis will turn out to be huge. The only place that we've ever seen it demonstrated are what you call per inquiry type adds, which is actually a pretty big industry by the way of somewhat [sloppy] products and still generating some huge amount of revenue both for network owners, as well as for proprietors. And that's sort of a demonstration of the fire power if you can put an offer in front of the large audience. And the opportunity to do that which may not be QVC's specific as much as it is a benefit say to do DirecTV eventually or anybody who can network and preload make video-on-demand a reality on a real-time basis and then cross promote it. I think it still remains unexploited, but very large opportunity.
Great. Last question please.
And your last question will come from Doug Mitchelson with Deutsche Bank
Doug Mitchelson - Deutsche Bank
Yes, good morning. I wanted to know, if you could talk a little bit more about Starz Media. How big the feature film slate is going to be, the impact on OpEx and synergies other parts of Liberty?
Hey, Bob do you want to comment?
Sure. Overture Films is looking at 40 titles, a whole slate of films over the next five years, so eight to 10 each year. They've already announced the first eight films and we would expect that there will be about seven or eight released in 2008. And again, these films are typically in a negative cost range anywhere from $5 million to north of $50 million. Although, our focus is acquiring only US rights. And so as we've reported we are looking to have an average acquisition price or production price of only about $15 million. We are actually thrilled with their initial slate that includes Righteous Kill with Al Pacino and DeNiro, very highly anticipated, and just wrapped. We are just finishing an Emma Thompson, Dustin Hoffman film in London, and of course, the Mad Money story is almost everywhere from People Magazine to Oprah. So, there is an awful lot of excitement about that that will be released in January.
Our view of this, of course, as we have said before, is that Starz Entertainment acquires about a 110 new output titles each year to fuel our viewer ship on the Starz channels. And that buying eight or 10 of those a year from ourselves and our affiliate companies seem to make a lot of sense, and we think there are other synergies to our home entertainment business through Anchor Bay, that will distributing these domestically as they come to that market, also digitally.
We have a company now that division within Starz Media that sells to everyone from Netflix to AOL to Amazon and we will be very active, moving product to the new digital technology, so they become available. So, we think it works very well on an integrated basis, and will give us very high quality films to anchor our entertainment channels. And then of course go into our library after they have gone through their broadcast window and so on and they will be available for us over the next 10, 15, 20 years.
Doug Mitchelson - Deutsche Bank
Do your current suppliers feel any kind of competitive pressure from you at all?
Well, that's a great question. I remember for the first time meeting, with Universal a few years ago, and they actually took the other position at Universal and I think that Sony. We think differently, if you also produce product as opposed to just being a passive distributor, and our relationships, I think, with most of our major studio partners, and the Disney lawsuit aside, are very positive and there are a number of studios who are concerned, obviously, about status of their pay TV deals. And we have become over the last few year the largest acquirer of independent films because of all the channels we have to fill for the premium space and are looking to actually acquire even more rights for those for your home video and even for domestic television which will give us another spin anchored by our ability to put them on a pay television service. And I think that we are exploring with the number of the other studios, things that we might do together on a production basis that would give them some access to Starz pay business but also give us an opportunity to leverage their tremendous production capacity and creative environments. So, I think the synergies are kind of popping out all over the place frankly.
Well I think Overture and Starz Media open up a whole bunch of options. Bob has noted that I think we are just beginning to explore hopefully over the next couple of years we really be able to take advantage of.
Doug Mitchelson - Deutsche Bank
Hey. Great thank you.
Thank you, operator and everybody who listened in and asked questions and we look forward to talking to you at the end of Q4, if not before.
And that does conclude today's presentation. Thank you for your participation and have a great day.