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The DIRECTV Group, Inc. (NASDAQ:DTV)

Q4 2007 Earnings Call

February 13, 2008 2:00 pm ET

Executives

Jonathan Rubin - Investor Relations

Chase Carey - President, Chief Executive Officer, Director

Patrick T. Doyle - Chief Financial Officer

Bruce B. Churchill - Executive Vice President; President, DIRECTV Latin America

Analysts

Doug Mitchelson - Deutsche Bank

Craig Moffett - Sanford C. Bernstein

Ingrid Chung - Goldman Sachs

Bryan Kraft - Credit Suisse

James Rockcliffe - Lehman Brothers

Jeff Wlodarczak - Wachovia

Tuna Amobi - Standard & Poor’s

Ben Swinburne - Morgan Stanley

Jessica Reif Cohen - Merrill Lynch

Spencer Wang - Bear Stearns

Tom Watts - Cowen & Company

Jonathan Chaplan - JP Morgan

Operator

Good day, ladies and gentlemen. My name is Tom and I will be your conference operator today. At this time, I would like to welcome everyone to the DIRECTV Group’s fourth quarter 2007 earnings conference call. (Operator Instructions) It is now my pleasure to turn the call over to your host, Mr. Jonathan Rubin, Senior Vice President of Investor Relations and Financial Planning. Please go ahead, sir.

Jonathan Rubin

Thank you and thank you, everyone, for joining us for our fourth quarter 2007 financial results and outlook conference call. With me on the call today are Chase Carey, our President and CEO; Pat Doyle, CFO; Bruce Churchill, President of DIRECTV Latin America; and Larry Hunter, our group General Counsel.

In a moment, I’ll hand the call over to Chase and Pat for some introductory remarks but first I am obligated to read to you the following: on this call, we make statements that may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve known and unknown risks, uncertainties, and other factors that could cause actual results to be materially different from those expressed or implied by the relevant forward-looking statements.

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

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

With that, I am pleased to introduce Chase.

Chase Carey

Thanks, Jon and good afternoon and welcome, everybody. I believe our fourth quarter results are a clear indication that DIRECTV's strategy of focusing on delivering the best television experience to the highest quality and most valued subscribers is truly working well for us. Our leadership and content service and the key technologies that are dominating the television industry, essentially HD and DVR, which I clearly think are at the forefront of what is driving our business today, drove our fourth quarter results to an eight-year low in monthly churn of 1.42%, 275,000 net subscriber additions, and an ARPU growth exceeding 8%. Our brand has never been stronger and we are making good progress and tackling some of our key challenges.

Pat will take you through the quarterly results in more detail in a couple of minutes so I just want to spend a few moments highlighting a couple of things. First, our quarterly subscriber growth was about more than just strength in a challenging and competitive marketplace. We grew with quality subscribers. Clearly one of the key factors driving the quality subscriber growth was demand for HD and DVRs which represented comfortably over 50% of our gross, Q4 gross adds versus about a third of our gross adds a year ago.

Another increasingly important factor was our direct sales force, which has really become better and better at targeting the right customers and the right local market opportunities. This direct sales channel generated well above 40% of our Q4 sales and is quickly moving towards generating half of our new subscribers.

Our eight-year low in churn was a particularly noteworthy accomplishment. Our focus on advanced products and quality subscribers was again certainly important to our churn reduction. However, equally important were our initiatives to limit risky customers through stricter policies. We do recognize these policies cost us some subscribers but it’s a trade-off we’re more than willing to make.

On the cost side of the business, I want to spend a minute on SAC and upgrade spending. SAC is obviously increased. One of the forces driving SAC is the demand for advanced product overall and more specifically, the HD DVR within the category. It should be noted that up-front revenue we receive to offset the cost of an HD DVR goes to revenue, not as an offset to SAC so I do think in some ways if you look at SAC on a net basis, it would present a different picture.

The second factor in our increase in SAC is higher sales costs that have come with our goal of targeting the right customers. Sales tools we use to target customers have a higher customer cost but they more than pay off in the quality of customers generated.

We will continue to exploit opportunities to manage these pressures on SAC through hardware cost reductions and other efficiency moves but the bottom line is that we feel our SAC is in the right place and we are investing intelligently in the right customer, as I think our ARPU and churn numbers show.

Regarding upgrade spending, we have seen upgrade spending exceed our expectations for quite a few prior quarters, largely to demand for advanced product and once again within that category, in particular demand for HD DVRs.

Demand for advanced products continued in Q4 although for the first time in a while, we began to see these costs stabilize. Q4 spending was below Q307 which has really not been the case, at least since I got here in ’04. And furthermore, if you offset upgrade costs with up-front revenue we receive at the time of upgrade, our 2007 Q4 upgrade spending was below our 2006 Q4 upgrade spend.

We do continue to view upgrade spending as primarily a revenue generating investment quality subscribers but we also believe we are beginning to get on top of the amount we’re spending here.

Other key costs were largely in line with expectations, essentially headed in the right direction though not necessarily where we want them to be yet.

The final area I want to highlight is Latin America where we had another really strong quarter. Net subscriber additions more than doubled from a year ago to about 200,000, while maintaining an excellent 1.35% monthly churn. ARPU grew 18% with revenue up over 40%. Equally important to the financial result is that success is not just a one country story of Brazil emerging from the merger but really across-the-board strength in countries like Argentina, Colombia, and Venezuela.

I might also add that these results in Latin America do not include our 41% ownership in Mexico, which we do not consolidate, where we continue to generate solid growth in subs revenue and [inaudible].

With that, I’ll turn it over to Pat and then come back to make a few comments before closing out for questions.

Patrick T. Doyle

Thanks, Chase. As you saw in our release, the rapid growth in consumer demand for HD and DVR services is having a material impact on both our top line and bottom line results. Consistent with our results from recent quarters, we’re attaining favorable financial benefits from customers purchasing advanced services, and this translates into better subscriber growth, ARPU, margin, and churn.

Looking first at the top line, DIRECTV U.S. revenues were up 14% to $4.4 billion in the quarter. Much of this increase was due to our second consecutive quarter of ARPU growth over 8%, bringing ARPU to $87.40 in the fourth quarter.

In addition to the benefit we get from annual price increases, we’re continuing to see strong growth in HD and DVR equipment and service revenues. As we saw in the third quarter, we again added over 600,000 new HD and/or DVR subscribers, bringing our total advanced service penetration to over 40% compared to just under 30% a year ago.

If you recall, last quarter we mentioned that we started booking revenues on an older satellite that is being leased to Telesat. Excluding those revenues in the fourth quarter, ARPU growth would have been a little bit under 8%.

Turning to subscribers, the highlight in the quarter was the eight-year low churn rate. We are particularly pleased with this number, considering the increasingly competitive marketplace and slowing economy.

Most of the churn improvement was due to lower involuntary churn and this is attributable to our continued focus on higher quality subscribers. The fourth quarter was the first full quarter where we saw the impact from two recent changes designed to further improve the credit quality of new subscribers, namely mandatory credit cards and the increase in minimum commitment for new customers from 12 months to 18 months.

It’s clear that these changes impacted gross additions, which were slightly lower than the prior year but as you heard Chase say, this is a trade-off we’re happy to make as we prioritize quality over quantity.

Another indication that these changes are working is that the percentage of higher quality gross additions was at an all-time high in the fourth quarter, as the average income levels for new customers continued to rise.

It’s also worth mentioning that our direct sales channel again posted extremely strong results, reaching a record in the mid 40% range of our total gross adds, or 15% more subscriber additions than a year ago. And since this channel generally attains higher quality subscribers, this helps explain why new customers purchasing HD and/or DVR services jumped from a little over 30% of gross additions last year to well over 50% this year.

Moving on, operating profit before depreciation and amortization was up 14% to approximately $1 billion. OPBDA margin of about 23% was flat versus the prior year and significant margin gains in subscriber services and G&A were offset by the increased cost related to both new and existing subscribers purchasing HD and DVR services.

In terms of our subscriber and G&A costs, we are pleased to see that we are starting to capture some of the efficiencies that we have previously targeted. Our SAC and upgrade costs increased in the quarter mostly due to higher installation and dish costs related to the increase in advanced subscribers, as well as higher direct marketing expenses for new subscribers and SAC.

However, perhaps the most important trend to highlight is that our capitalized set-top box costs were actually lower both sequentially and compared to the prior year. This is particularly impressive when you consider that we activated nearly 50% more advanced boxes compared to a year ago, including more than twice as many HD DVR boxes. Obviously we’ve been successful in driving down the set-top box costs, including a large step-down in costs in the fourth quarter on many of our advanced boxes.

As a point of reference, we reduced the cost of our HD and HD DVR boxes last year by roughly 30% and we are targeting another 30% or so this year. With these cost reductions, we will continue to aggressively pursue HD and DVR customers while generating financial returns that are generally twice those of a basic subscriber.

Also in the quarter, we had higher upgrade costs of $60 million for MPEG 2-4 swaps compared to only $33 million a year ago.

Before moving on to our balance sheet, I would like to quickly mention that our programming margin in the quarter was relatively flat, which is consistent with our expectations going forward.

We’ve been working hard to control programming costs and reverse the margin erosion we’ve seen in recent years. We believe the fourth quarter marks the beginning of a trend toward more stable programming margins.

In terms of our cash and balance sheet, the DIRECTV Group generated a bit over $500 million in cash before interest and taxes in the quarter, bringing the full year total to $1.48 billion, or 13% more than in the prior year. We also purchased about 19 million shares in the quarter for $479 million. Since we began our share repurchase programs about two years ago, we have purchased about 270 million shares for roughly $5 billion, while reducing our shares outstanding by about 19%.

As a reminder, our board authorized another $1 billion buy-back program last month, so we have just begun purchasing shares through this program.

Mostly due to share repurchases, we ended the year with net debt at the corporate level of about $2.3 billion, up from $900 million a year ago.

With that, I would like to turn the call back to Chase for some closing remarks.

Chase Carey

Thanks, Pat. Before turning to questions, I thought I’d spend a minute recapping 2007 and looking forward to 2008. At the beginning of 2007, we outlined our objectives for the year and while it’s clear we didn’t bat a thousand, I do believe we did pretty well. We said the core of our strategy was to provide the best television experience, defined by leadership and content technology and service. From a content perspective, I think we’ve never been stronger. We’re a clear leader in HD, our sports content added depth and breadth, and we continued to bring new features, channels, and choices to our customers. And our content is only going to get richer in coming months as we add or expand new dimensions to content like our VOD offering.

Technology wise, our advanced products continue to drive our business and stand out from our competitors. We’re adding new capabilities like remote booking and are making real progress in developing a true whole home solution for our customers.

Service side of our business took real strides forward in 2007 but frankly it’s an area we still have a ways to go in 2008. We clearly improved in 2007 and continue to lead our industry but this is a case of more to come.

2007 was also about moving forward in an array of other key ways. We wanted to continue to build our brand and I believe our marketing truly distinguished this year probably more than ever. The key theme for sales was to become both more targeted and opportunistic and we achieved both. We got on top of third-party programming costs and began to bring them into line with our targets outlined a few years ago without compromising our position as the leader in program choice and quality.

We built new tools like our website to improve the quality of our customer experience and are more efficient vehicles for sales and service.

With regard to the ten-thousand-dollar-question about competing with the bundle, we feel we’re positioned pretty well. All along we said our goal was to ensure the customer had broadband and telephony choices compatible with DIRECTV. It’s clear from our growth that customers are finding these choices.

We also said broadband was a tough space, with risks of commoditization and price competition, which also seemed true, that we want to be careful and that has seemed equally prudent. Our options are as plentiful as ever and we will continue to focus on helping customers find the right solutions without making a difficult investment unless there is a really good case for it.

From a financial perspective, we laid out a view of 2007 that we met or beat on most levels. Our growth metrics like revenue subscribers and ARPU all exceeded expectations. Churn was another area whereas we said before, we made real progress. We achieved our goals in key cost areas like programming and overhead, as well as CapEx. Two factors we did not fully anticipate were the demand for advanced product and the sales cost associated with targeting subscribers, which to SAC exceeding our $650 to $700 range by year-end, and upgrade spending, as I said earlier, above our expectations.

Nonetheless, OPBDA was at the high end of our 15% to 20% growth range. Although cash before interest and taxes was up in 2007, we did not quite get to our targets, again because of the advanced product demand. But overall, we feel pretty good about our year in 2007.

And with that being said, in many ways we feel even better in terms of positioning for 2008. We have some areas that we have real strength and momentum, like content in HD, where we’ll continue to build on that strength and some other areas like service, where we are on track for real improvements in both quality and efficiency.

I’m not going to say too much about 2008 right now as we have our investor day in two weeks, but I do want to highlight a few themes that will be at the top of the page for us in the coming year, or in this year.

First, this will be a year where we expect major improvements in our margin and key costs, enabling us to take our cash flow before taxes and interest to a whole new level.

Second, we’ll continue to have strong top line growth with double-digit revenue growth. This will be attributable to both ARPU and sub growth, although we expect sub growth to be down a bit in 2008, particularly with the transition from BellSouth.

Third, advanced product will continue to be strong. This will lead to SAC that may be a bit above our historical target range. On the other hand, we continue to generate great reduction in box cost to keep SAC around the $700-and-change level. For example, our HD DVR will cost in the low $200 range by late 2008 versus well over $400 a year ago. At the same time, we expect our 2008 upgrade spending to be below 2007 as we benefit from efficiencies and our leasing program kicks in.

Fourth, CapEx excluding boxes will be down a couple-hundred-million dollars, although we are still finishing off satellites and HD ground infrastructure in 2008.

And fifth, Latin America will continue to build the success you’ve seen this year.

Finally, as has been already publicly disclosed, we expect the Liberty transaction to close in the next couple of weeks. There’s not a whole lot more I could say about that transaction or related items, like our balance sheet, but the close of that transaction will enable us to properly address them in the short-term.

We are very excited about 2008 and look forward to giving you a better sense of our plans in a few weeks. With that, I’ll turn it back to Jon.

Jonathan Rubin

Thanks. Before moving to Q&A, investors should note that we have members of the media on this call in a listen-only mode. I would like to remind the media they are not authorized to quote any participants on this call, either directly or in substance, other than representatives of the DIRECTV Group. In addition, we are webcasting this call live on the Internet and an archived copy will be kept on our website. Finally, I would like to ask callers to limit your questions to one or two until everyone has had a chance to ask their questions.

Operator, we’re ready for the first question.

Question-and-Answer Session

Operator

(Operator Instructions) We’ll go first to Doug Mitchelson with Deutsche Bank.

Doug Mitchelson - Deutsche Bank

Thank you very much. I guess two questions but I’ll make one real quick -- on the balance sheet, have you explored at all the tax implications of a one-time dividend? Not that you would commit to one, but have you explored it at all?

And then secondly, since you just mentioned BellSouth, there remains a pretty persistent investor concern regarding that shift where you lose co-marketing starting in the second quarter. Can you talk more about what you see as the impact of losing that co-marketing starting in the second quarter? Thanks.

Chase Carey

Sure. In terms of the balance sheet and -- I guess the specific question is about tax implications of one-time dividend -- I guess what I’d really say about all of it, and I really probably -- I think we’ve tried to say in the past, I mean, we certainly have evaluated and looked at the array of options that exist. We are really not moving to a place until we get the transaction closed and have the long-term ownership structure in place. Our longer term board in place to make those decisions, so certainly in terms of doing the groundwork and the leg work to be prepared to move forward, we have done that. In terms of taking this -- taking these decisions to a board to discuss it, there are still things that we will do, you know, in the short-term once we close the Liberty transaction.

In terms of BellSouth, I mean, I think again, as we said before, I mean, if you -- BellSouth I think in the fourth quarter was about 7% of our gross adds or so, so that’s -- and again, clearly some of it is incremental, some of it is not. We’ll take steps to mitigate for it.

Probably the most complicated point -- I think we’ll be okay. We’ve done a lot of planning for it. We think we’re ready for it. We’ll have some resources to redeploy because we invest resources into the BellSouth relationship to it today. There will obviously be a transition window in sort of end of March, April to get through it but we think it will have a -- I think I’ve said before on the service, we’d look at it and say it will have an impact on subs. We don’t think it will be a meaningful or dramatic overall impact. Again, if you take the 7% and assume we can mitigate a -- recapture assume half of it -- some percentage of it is incremental and we can recapture some part of the ones that aren’t incremental, you know, it will hit us but I think -- and there’s no scientific -- there’s no perfect science to it. It’s a number on an annual basis that probably is a $50,000 to $100,000 -- 50,000 to 100,000 sub type number. And we’ll see how effective we can be at closing that gap and finding other tools and venues to recapture that.

There will probably be a little more friction right at the moment where we transition through it but we feel very good about 2008. We feel good about sub growth. It’s an issue that we have to deal with but I think we are taking steps to deal with, though I again there will be some impact to our sub growth on a -- and those numbers I gave were an annualized number, not a quarterly number.

Doug Mitchelson - Deutsche Bank

Thank you very much.

Operator

We’ll take our next question from Craig Moffett with Sanford C. Bernstein.

Craig Moffett - Sanford C. Bernstein

A couple of quick questions, if I could; first, the pattern that you got here of a very low churn and maybe slightly lower gross adds would look to be consistent with just the broader slowdown in the housing market and slower housing velocity. I’m wondering if you are seeing the same thing with the movers program. Are you just seeing reduced activity? And if so, would that suggest a tailwind for margins in ’08?

A second question is about Massachusetts specifically, because the Department of Cable and Telecommunications in Massachusetts just released some interesting data about FiOS. It’s hard to square the circle with what happened in the puts and takes of subscriber losses and I’m just wondering if you can share any specific color about that market and what your experience was in the FiOS markets in Massachusetts.

Chase Carey

I’ll I guess touch on the first, which I had a couple of -- I guess it sounded like the question, I mean, there’s a comment in the question, I guess. I guess on the -- is there an economic -- do you read something into the dynamics between gross adds and churn that relates to the economy. I don’t think so. I mean, I -- again, I guess I’d reiterate what I said before. I really don’t -- I think we continue to really not see an impact on our business from any broader economic sub-prime issues. I’m not saying there are none but certainly not an impact and again, I think our -- we’re down a touch on gross adds. Again, I think that is by and large focusing in discipline and the trade-off as we said. We’re going after the customers we want and in some ways creating higher hurdles for the customers we don’t want and we think it’s the right place to be and we feel good about it and I think the churn is a result of those efforts and initiatives, as well as the quality of our underlying sub base and the array of things that go with that.

So I don’t think there’s an economic issue in terms of -- in terms of movers, likewise. I think movers is down a touch but I’m not sure -- but it’s probably within the -- you know, it’s never a number that has sort of got a very tight consistency quarter to quarter. It ebbs and flows a little bit and I’d say it’s within the range. I mean, I think it is down a bit but I’m not sure it’s outside the range of the ebb and flowing quarterly that I would have seen over the last couple of years.

In terms of FiOS, I’m not sure -- kind of the Massachusetts specific. I probably can give you -- I can probably on FiOS a little more generally. I think where FiOS exists, and I guess Verizon’s number was that they rolled it out to cover about 6 million homes, will add another three. I think where FiOS exists, it has been there, it adds a competitive dynamic to the market and I think that’s true. Having a third player there that really they are competing as a cable company as a competitor in the market, I think we’re doing okay. Each market varies a little bit. Massachusetts actually wouldn’t have been, sort of I was going to look at the various FiOS markets, we track each of them, Massachusetts actually would have been one that again, wherever FiOS is, there’s a bit of an impact but it certainly would not have been in the top couple of markets where I’d say there’s a particularly dynamic competition.

In many ways, the competition is half as much how did the cable guy respond to the phone guy, or to Verizon’s FiOS. So there is not just FiOS going in. In many ways, it’s how does the -- what does the cable guy do back and then how do we play. And to some degree again, we’re not approaching this as a one size fits all. We’re competing in different FiOS markets in different ways and in different ways in each market, trying to be smart about how do we approach it.

But Massachusetts, certainly they are in there with a bit of FiOS, but I wouldn’t have picked that as a market where I’d say there’s particularly meaningful FiOS impact, although there is some. Again, any place FiOS goes in has some impact on the market.

Operator

We’ll take our next question from Ingrid Chung with Goldman Sachs.

Ingrid Chung - Goldman Sachs

Good afternoon. Thanks for taking the question. I have two quick questions. First of all, I think you had talked about in the past of achieving a churn rate in any given year of 1.5%. Given the fairly large reductions you’ve been able to do over the last two quarters, do you have a new goal in terms of churn?

And then my second question is about the NFL Sunday Ticket exclusivity. I think that exclusivity comes up in 2010. How important is that to you to keep that exclusivity and what kind of weapons do you have in your arsenal to prevent one of the telcos from taking it away?

Chase Carey

In terms of churn, we do -- I’m probably not going to say a whole lot because it’s sort of looking forward and again, I think we’re trying to -- you know, we have a day set aside to talk about 2008 and beyond in a couple of weeks, though we still expect improvement in churn. And I expect -- I think we made real strides in 2007. I think we talked in the past about being frustrated with the churn not getting to where it is and I think we pursued an array of initiatives and finally made the type of headway we expected to make. Though that being said, I expect churn to be down a bit on ’08 from ’07. So we still think churn is an area we expect improvement.

In terms of Sunday Ticket, you’re a bit -- it’s awful early and it really is the ’11 season is the first one we’re not licensed, so you are practically three-and-a-half years out, so you are pretty far ahead of the curve.

Look, Sunday Ticket’s been a great property for us and there’s no two ways about it -- it comes at a big price. I’m not going to pre-negotiate where you get to it. I think probably in many ways it is -- what are our greatest strengths? I think we’ve done a great job with it. I think the NFL values what we’ve done with it. I think the NFL has made a decision that the way they distribute Sunday Ticket goes hand in hand with being unique in the sports world of keeping their major events predominantly on broadcast television and not having it emerge into the pay-per-view VOD and keep it somewhat of a more limited distribution product that maintains that event status of broadcast television on Sunday afternoon and Sunday nights and Monday nights for every American household. And I think that’s a mix that works well for them but there are a lot of dynamics between now and 2011 when it’s available and I think we’ll have to see where those come out and -- would we like to keep it? Yes. Is there a price at which it doesn’t work? You know, yes, but I think we have a very good relationship with the NFL. I think they tremendously value and respect what we have done with the franchise, adding the Super Fan package, continue to enhance it, the HD components. I think we have -- you know, I think we’ve really been and I think they’d second it, very much a part of making the NFL clearly unique in the television sports world and a power inside that and we will continue to do so and we’ll deal with the issues that come up and -- look, we had a great year in Sunday Ticket. We hit our targets and we had great growth and I think continued to build that franchise, so we are very proud of it and -- but we’ll make those judgments as -- and we’ll work with the NFL as the years go along and it gets closer.

Ingrid Chung - Goldman Sachs

Okay, great. Thank you.

Operator

We’ll take our next question from Bryan Kraft with Credit Suisse.

Bryan Kraft - Credit Suisse

Thank you. Chase, do you see acquiring content as a potential direction that you would take DIRECTV in the future? I mean, is there a rationale for DIRECTV actually owning content and do you think, under any circumstances, you might advocate moving more in that direction over the next couple of years?

Chase Carey

Yeah, I think it’s probably -- I do believe -- and I’m not going to get too far into hypotheticals. I do think content and distribution still have a synergistic value between them and the ability that one enhances the other and the back and forth, but I think it’s got to be the right -- you’ve got to have the right content and there isn’t a lot out there.

I think we feel very good about DIRECTV as a business. It certainly does not need to add anything to it. I think we believe we’ve got a lot of room to grow the business, a lot of room to expand the business. I think that being said, we’ll always sort of try and make sure we look at the world with an open mind and are in touch with whatever’s out there. And if there are opportunities, to make sure to evaluate them.

But our core focus is truly to grow this business and grow this business to everything it can be and we’ve got a lot of room left to expand and build the business. But you know, [regarding] content, I do think content and distribution have a -- you know, there’s a value that comes from having -- being able to work together with it and obviously content players value us. We’ve gotten some -- you know, they haven’t been operating. We’ve gotten some channels in the last couple of years, equity positions in some of the emerging content players and I think that reflects the value we bring to it and clearly content is a part of our mix.

But bottom line is our focus is on building and driving DIRECTV.

Operator

We’ll take our next question from Vijay Jayant from Lehman Brothers.

James Rockcliffe - Lehman Brothers

It’s James Rockcliffe for Vijay. Two questions; first of all, on customer quality, how do you measure that from a demographic perspective? Can you give us some idea of what the average customer looks like in terms of income, education, and so on versus the U.S. population? And also, what portion of customers are under contract versus month to month?

And secondly, regarding the Latin American operations, any thoughts regarding the two that aren’t wholly-owned, Mexico and Brazil, of either consolidating this in or potentially divesting your stake in Mexico?

Chase Carey

In terms of customer quality, yeah -- I mean, there are an array of tools. Certainly one of the ones you look at is income. It’s not the only but that would probably be near the top of the list, but you get age, home ownership, education, an array of dynamics, of metrics we use to evaluate those customers and that I think would probably be -- I’m not going to -- we ultimately have a model to value them. We’ve gotten -- we developed in the last couple of years a much more sophisticated customer segmentation set of tools that are unique to us, so I’m probably not going to put them out there but it enabled us to take our customers and based on an array of these dynamics, to categorize them into, to put them into various segments so we can value them and determine what’s the appropriate resources to deploy, whether it’s going after them or other decisions we make in sort of managing that customer relationship.

But I think that it’s probably the metrics you’d expect to be there, that most people would have in terms of demographic measures and other types of measures you have in that basis.

In terms of -- what was the second question? Latin America -- I wouldn’t -- I mean, at the end of the day, we’ve got partners there. I mean, I guess we -- I don’t think it would be -- I don’t think I’d be assuming, particularly in Mexico that Televisa would be -- we have a very good relationship with Televisa. We’re very happy with the relationships with Televisa. I think they the relationship with us, so I guess I’d be -- if somebody wanted to change, we’d be happy to talk. I don’t have any indications that that’s something there.

Globo has from where they were a few years ago gone down to a smaller position. Again, the business is going well and I think Globo would end up in the same way, being pleased with the progress we’ve made in Brazil. But I think in some ways, it would -- I think both partners are pretty happy where they are but if they wanted to talk, we’d talk. We like both businesses but there are no indications there is anything that either one would be open to engaging on and again, they are healthy businesses going well, so our focus is on building them.

Operator

We’ll take our next question from Jeff Wlodarczak, Wachovia.

Jeff Wlodarczak - Wachovia

Chase, your thoughts on potentially being able to win back that AT&T relationship in the fall, and then how much of the ultra low churn that you all are seeing on advanced set-top boxes can be attributed to the fact that you are often requiring consumers to pay for the box? And is there any concern as you drop the price of that box, people have less skin in the game and be more prone to churn? Thanks.

Chase Carey

In terms of AT&T, I’m not sure a lot more color than what they said. I mean, after they -- I think they said it’s a decision they’ll make and I guess they have the opportunity to make in the fall. I think we continue to talk to them, as I’m sure EchoStar does, and I think they recognize there are an array of unique things we bring to them in terms of our content, a lot of things I guess I talked early on in the earlier part of the call here, you know, that distinguish us.

I think on the EchoStar side, probably first and foremost, they have a relationship that’s up and working and so I think we have assets and virtues and values that we bring to them that distinguish us from EchoStar, but I think there are obviously things they have and I think it’s tough to tell where it measures out.

And it’s also tough to tell whose -- how aggressive either one of us are pursuing. Again, I think we value the telco relationships, particularly the good relationships and the right relationships, but we can compete okay without them. That’s not saying we wouldn’t -- that we don’t -- we wouldn’t look to have the right relationship with a telco like AT&T. We have good relationships. We had one with BellSouth. We have one with Verizon and Quest today but there are ways we can effectively compete, as we do and have done in the last few years in the AT&T region, that we compete quite effectively when we don’t have a telco relationship.

So I think there are a lot of dynamics around and I think as with any negotiation of a -- I’ll call it a deal -- you’ll have to see how much EchoStar values it, how much we value it, and how AT&T measures the various dynamics here. And I can’t -- I couldn’t handicap it other than I think they are seriously engaged with both of us and I think both of us are seriously engaged with them but we’ll see where it goes.

In terms of the --

Unidentified Participant

The relationship to up-front fees on products and churn.

Chase Carey

I think it’s a factor. I don’t think it’s a huge -- I mean, I think -- you know, look, it always help to have skin in the game. Would you rather have skin in the game and does it help? Sure, though I think as you go along in time, I think that probably becomes sort of a -- goes from a front-of-mind to a back-of-the-mind issue as you go along a year or two years or three years. So I think it’s more economic than skin in the game. I think particularly we have contracts, the advanced products that are two-year contracts, so by the time to get out to two-year contract and if somebody is there with an alternative box that is -- that they don’t have any charge for, that they don’t have an up-front charge for, I don’t think the fact that you paid us something a couple years earlier is a -- it’s a help but I don’t think it’s a huge deterrent.

So I actually think as we go down, I’d rather keep it. I’d rather -- we live in a competitive world. We’d rather be able to continue to charge something up front but I think the reality of where the marketplace has moved with all these products I think is fairly clear. But I think it’s more of an economic decision, though again I wouldn’t -- I’m not saying there isn’t value in having a customer have skin in the game and having taken our box but I don’t think it’s a huge factor in driving the churn.

Operator

We’ll take our next question from Tuna Amobi with Standard & Poor’s Equity.

Tuna Amobi - Standard & Poor’s

Great. Thank you very much. The first question, Chase, is on the 700-megahertz auction. Can you perhaps provide some thoughts on that and is your decision not to participate related to perhaps the issue of the Liberty deal? And related to that, how does this affect your wireless strategy?

Separately, on Wild Blue, given Liberty Media’s controlling interest in that, Wild Blue, should the deal with Liberty close, do you expect Wild Blue to feature prominently in your strategy going forward? And how does your current relationship with Wild Blue change or not change as a result of Liberty’s current stake?

Chase Carey

On the 700-megahertz, I guess obviously, as you said, we’re not in it and the reason has nothing to do with Liberty. I think our view, and I guess a little bit of what I said about broadband earlier, I think it’s a tough place. Clearly going in and building an entirely new technology, we’ve continued to kick around WiMAX and these technologies for a long time. Look, it’s a tough go. This spectrum was going to go for a lot of money and we knew it and right now, I think we feel we’re positioned -- we were never sort of -- we were saying, our goal was to get into the broadband business. Our goal is to find, make sure there are ways a consumer can find broadband and telephony options that are compatible with us -- continuing to find it, people are continuing to build it. In many ways, I’d rather have others build it and us be a partner that can align with them and provide distribution muscle. And the type of relationships we have with an array of parties today to build it out.

I think the practical -- you know, the belief that we’re going to go in and go toe-to-toe with existing broadband guys with billions spent on spectrum and then billions spent to build it out is just a -- you know, that’s tough going in a business like broadband that I think is one that is going to continue to be challenged, the commoditization and price competition.

So it had nothing to do with Liberty. I think it had to do with A, the price of the spectrum and what we thought that was going to go for, and that leads into B, the price that it was going to cost on top of it to ultimately build this out on top of the risks of building out a new broadband entry.

We’d like to see it happen if we can be helpful in it happening, but we are going to be prudent and smart. We’re not going to -- we’re not going to sort of just jump into this fray with the type of costs and the like that exists, particularly when our business is continuing to grow and we’re finding solutions don’t require us to take those things on.

Wild Blue, again, Wild Blue -- I don’t think Liberty’s ownership of Wild Blue or position in Wild Blue would have any -- we have a good relationship with Wild Blue today, you know, in the early stages. I think Wild Blue is -- you know, look, Wild Blue I think is -- satellite broadband is largely a rural product where others don’t exist. We think it’s a good option to have for consumers who don’t have the wired, the cable or telephony broadband options. But we really think it’s more of a niche product for those markets. That’s a reasonable size and it means Wild Blue could be a nice business but -- and we’re going to move forward with Wild Blue to find ways we can work with Wild Blue to provide an option to those customers that don’t have those options. But really that’s the approach we’d be taking with or without Liberty’s ownership, so I think Wild Blue is largely -- you know, I guess you’d call it a rural product for the customers who don’t have the telephony or cable broadband options.

Tuna Amobi - Standard & Poor’s

Okay, this is very helpful. I have some numbers questions. I’ll follow-up offline. Thank you.

Operator

We’ll take our next question from Ben Swinburne with Morgan Stanley.

Ben Swinburne - Morgan Stanley

Thanks. Good afternoon, guys. Maybe just a question on the satellite fleet and the free cash flow ramp from here, Chase. At least my numbers, it’s roughly doubling in ’08 versus ’07. Some of that has to do with capital on the satellite launches and infrastructure declining, which you referenced in your opening remarks. I know you have D11 to go up this year. I think you are spending some money on D12 but I don’t know if you’ve officially announced whether you are going to launch that and if so, when.

What is the average life, remaining life on the fleet after that is all done? I’m trying to get a sense for when replacement birds, spending on replacement satellites would kick in. And does Kevin Martin’s suggestion of HD must-carry, or digital must-carry for satellite change that outlook?

And then just a quick question for Pat on the taxes -- you guys are still it looks like paying about half your provision out in cash taxes in ’07. Does that -- any guidance when that rolls off? Is it all over the next couple of years?

Chase Carey

In terms of we are -- we do have D11 and D12 spending. Again, it’s true with the CapEx -- and CapEx is sort of continuing to extend out longer than we initially planned. I think we had talked about a window and it has taken longer, so we have D11 and D12. We haven’t really made a final decision on the D12 launch plans so we don’t have those finalized yet.

In terms of the age of satellites, once those of done I think the average life is over 10 years. I mean, I think it’s 10 or 11 years and I think actually the short one, and it is still way up there, I mean, it’s probably not a whole lot under 10, so it’s a pretty fresh fleet. And again, who knows what comes?

And clearly the HD must-carry and stuff really just came out the last few days. It sort of came out -- came a bit out of the blue. How come we didn’t know -- it sort of generally was out there but all of a sudden be put out there in a more formal way, you know, came up pretty quickly. And clearly it’s an issue for us. HD must-carry or those things have [inaudible] to satellite.

Again, I think we haven’t seen enough. It sort of came out quite quickly and trying to understand all the things around it, I think it would be premature at this point with it having just come up. But certainly it’s an issue for us and we -- we’ll have to look at it and talk to them about what are the specifics underneath it.

I think probably at this point, it’s probably premature to say what is it, what are the -- what does it mean and what do we do. I do think we’ve got a robust HD fleet. I mean, we have invested significantly in it. We’ve got multiple birds up there, the space way birds that give us flexibility but flexibility is not infinite, so I think we’ll have to see where this -- where this more specific thing comes out and we’re working with the FCC to try to get a better handle and a better understanding of where this should be.

Patrick T. Doyle

And then on taxes, yes, we’ve clearly come out of the period where we’ve used up our net operating losses and tax credit carry-forwards, so 2008, we’ll be a full taxpayer. Having said that, we still have some advantages of the accelerated depreciation on our CapEx, so we expect it to be below our provision for 2008 but it will be higher than the 2007 tax payment.

Ben Swinburne - Morgan Stanley

Thanks, guys.

Operator

We’ll take our next question from Jessica Reif Cohen with Merrill Lynch.

Jessica Reif Cohen - Merrill Lynch

I have three questions --

Chase Carey

Jessica, you have to speak up.

Jessica Reif Cohen - Merrill Lynch

Okay. I have three questions -- Chase, you said in the earnings release that you were going to generate significant free cash flow in ’08, and I think we all have that in our models, and you’re clearly under-leveraged. So I was just wondering if you could update us on your current comfort level with leverage. And can you go back -- can you give us your bias in terms of dividends, continued buy-backs?

And on the acquisition question that was already asked on programming, is there anything else that you would consider -- like, for example, other international assets?

The second question is could you talk about your marketing plans for the digital transition in February of ’09?

And then the final one is what was advertising revenue in the quarter and how much did it grow year over year?

Chase Carey

Let’s see -- I’m not sure. The free -- I’ve got to go back to the top. Free cash flow -- what was the question related to free cash flow?

Jessica Reif Cohen - Merrill Lynch

Use of free cash flow, your comfort level with leverage.

Chase Carey

With leverage -- you know, again realistically we have not, as I said -- I guess in the question on -- I can’t remember what was the question related to. We’ve not gone actively -- we’re under-leveraged and there’s no two ways about it. I know historically what the view would have been from the credit markets. We have not really engaged with them intensively enough to sort of determine where -- what would be the guidance today. Historically we had gotten sort of again that 3.5 turns and sort of said if that was the -- sort of with our credit rating where you could get to on EBITDA, you wouldn’t go to the max but 2.5 would leave you room.

I think what we will do, again as this Liberty transaction finally comes to a close, we’d obviously be -- as we lay out all these options, so they’d include the balance sheet, we’re get a more refined view of what the markets will be telling us and what we think is prudent. And I think as what I’d say with dividends and buy-backs, I’m not going to get in front of a discussion with the board. Haven’t had those discussions. These are things that we prepare to have. It’s difficult to keep getting prepared. I mean, I thought this deal was going to close in June, so we could have got prepared to have the discussion in June and then have a the discussion in September and then have the discussion in November, now we’re going to have a discussion in February. So at some point, we can -- you know, we’ll drive ourselves nuts trying to continually be ready to deal with it.

So I think we know the right questions, we know the right options, and I think we can quickly bring them to the forefront once we get to a place where we’ve got an ownership, a long-term ownership and board in place to make those decisions. And I guess the same answer would apply to dividends, buy-backs.

And I guess in terms of acquisitions, again I think that it’s -- you know, at it’s core our focus continues to be build DIRECTV. That being said, I think you always want to be opportunistic. I don’t think there is a per se sort of -- certainly there’s not a weakness or a need we have. Are there opportunities that one would want to look at? I think that, as is always the case, will be what’s there and when.

And I probably again likewise, you know, falls into the category of trying to get through this transition place to have an intelligent and thoughtful, longer looking view at that business. But at it’s core, I think our focus will continue to be and where we have tremendous opportunity first and foremost is really taking DIRECTV to the next level.

And as you said, we think a lot of that you’ll see -- you’ll see it over time but we expect a lot of it you’ll see in ’08.

In terms of the digital, we are going to -- I’m not sure there’s any magic to it. I think we have the benefit -- clearly one of the benefits we and I guess we and EchoStar have is having a national reach and therefore there -- I think there are ways we’ll go at it. I’m not sure I put up all the math because some of it is competitive but there are clearly segments that have been well-identified that people would say were probably disproportionately be represented here and elderly and therefore there are vehicles and ways you can sort of contact an elderly population, an ethnic population. Again, there are probably ways and vehicles that are more better equipped to go after an ethnic population. We have our own subscribers, to the degree they may in their house have still a third or fourth set that’s an antenna-based set. Make sure we educate our own but we are moving forward. We actually have plans. We’re going, they’ll be out in the coming couple of months. We’ll start to go out and engage with both ours and outside customers through various vehicles to go after it.

Patrick T. Doyle

And then on ad sales, the ad sales for the fourth quarter was a little bit north of $100 million and it was about -- it was a little bit better than 30% increase from the fourth quarter of ’06.

Jessica Reif Cohen - Merrill Lynch

Thank you.

Operator

We’ll go next to Spencer Wang with Bear Stearns.

Spencer Wang - Bear Stearns

Thanks for taking the question. I just have one question. I wanted to go back to ARPU growth, Chase, which has been pretty strong in the last two quarters and I know the advanced services have been dropping some of that, so I was just wondering if you could talk a little bit about how sustainable you think this level of ARPU growth is, given that penetration of events, as this is getting pretty high? And if you could maybe talk a little bit about where you think penetration of these services can go maybe over the next 12 months or what you think the long run penetration opportunity is, that would be great. Thanks.

Chase Carey

Yeah, I mean -- I would not necessarily -- we had -- what was the year, 7, close to 7%, a touch under? Or 8%? I think our ARPU start-up growth will be healthy. I’m not certainly sitting here saying we expect that growth in ’08. I think our growth -- you know, I expect our growth to be -- and again, I don’t want to get too far in front of things we’ll talk about in a couple of weeks. I expect to have healthy ARPU growth, certainly north of 5% ARPU growth but we’ll probably get a bit better picture.

But I think we are continuing to see very significant growth and penetration of those devices and good growth in an array of areas in ARPU, so certainly we see some continued growth and would expect to see good healthy continued growth in that in ’08.

In terms of advanced products, generally again what we sort of talked through is an overall sort of 10% a year penetration. I think we beat that I think probably would end up saying it is continuing to seem to grow a bit ahead of what expectations were.

And as you get out in time, so certainly if you look out over the next 12 months, I think you’ll -- you know, we’ve talked about 10% a year and I think it’s probably continuing to trend, if anything, a bit above that.

Longer term, where does it go? I mean look, I’m a big believer that these -- particularly the DVR and HD have a momentum behind them that are making them sort of mainstream products to American households in the way that over time, DVDs and VCRs and other various things became. I think the DVR is ahead of HD on that curve but they’ve both got a lot of momentum. Trying to put timeframes to that, I don’t have probably a good enough crystal ball. We have our own assumptions but to date, it’s probably running at what would have been my expectations. Certainly for us it’s running ahead of -- a bit ahead of what would have been my expectations. But I think there is a lot of room, because I do think these are -- I don’t think these are products that are sort of maturing out at 40% or 50% of American households. I think they are ones that will become much more mainstream foundations in the television experience.

Spencer Wang - Bear Stearns

Thank you very much.

Operator

We’ll take Tom Watts with Cowen & Company.

Tom Watts - Cowen & Company

Good morning, Chase, or afternoon. In terms of advanced services, clearly the HD and DVR have made a lot of progress. Can you give us any indications of other things we might be seeing coming and particularly opportunities for integrating IP video into many offerings, particularly given since you’re broadband agnostic?

Chase Carey

It is again, you’re probably into some of the things that we are going to talk more about in a couple of weeks, but I think VOD will clearly be something we have -- we’ve launched to customers. We’ll continue to roll it out. It’s really more sort of launched in a limited basis now and we’ll roll out. I don’t think VOD to date has gotten -- clearly HD and DVR are the driving forces. VOD is there. VOD I think will though continue to be a part of the experience so I think from us, that will be there. I touched on the whole home and I think the ability to have consumers share things around the home on multiple sets, [inaudible] use, I think will a part of the experience that you want to bring to people and will open up stuff.

And clearly broadband connectivity -- you know, clearly we’ve had complications with it but it’s something we’ll very much engage in. How do we tie in in the right way on the right basis the content available on broadband into the experience on the television? But we have to be smart about that. I think somebody said it the other day, that there are a lot of things on broadband and we want to make sure we are not opening up ways to find, to people to -- to trade down to other ways to access products that are not as attractive to us or not additive to our experience.

So I think we need to find ways that we are continuing to enrich that experience, provide solutions to the customer, but do it in an intelligent way that builds on top of the business we have with them.

I think we have an opportunity to be a real leader here but I think we have to be smart about how we deal with content from broadband -- broadband-based content.

Tom Watts - Cowen & Company

Thanks.

Operator

We have time for one final question today; it comes from Jonathan Chaplan with JP Morgan.

Jonathan Chaplan - JP Morgan

Thanks for taking the question. I’m wondering if you can give us a little bit of color on how much of the increase in ARPU came from price increases? And then just with ARPU being where it is and the market getting more competitive, how easy it’s going to be to continue pushing price increases into the market?

And then I’m wondering if I could follow-up with just asking for a little bit of color on how you are expecting to be able to control programming costs, where the stabilization of programming margins is going to come from more specifically? Thanks.

Chase Carey

In terms of price increases, I mean obviously in this quarter, it would have been the price increase we put through in the beginning of the year. I think that was sort of overall a 3.5% to 4% price increase, generally. Now probably offsetting a price increase, I would say and I think we’ve talked about it before, you do see a level of competition already in the market and I think it shows up more in offers. So while you have a stated price increase, probably what we are putting into consumer offers into the market is offset to some degree that 4% price increase, so I don’t know that you’d end up saying the 4% is part of that because against the 4, you really have a structural increase -- you know, it’s not 4% but offset a bit by more aggressive consumer offers.

And I think we said before, that’s really where you see the price competition today manifesting itself. I think most people are still, and we’re going through the cycle now, most of us cable ourselves, put through the price increases in the early part of the calendar year. Most are putting them through, so I don’t think you are seeing -- I think you’re seeing those price increases continue to be put into the market place. The place you are seeing price competition emerge is probably more the offer side of it, so -- I do think that dynamic is there.

But again, we’re pretty well into it for ’08. Is there a risk of price competition? Look, it’s always there. Right now, it has not certainly -- I think most of the major players have announced their price increases for the next 12 months and a couple of them did it in a little bit more of a -- probably confusing way to try to hide the price increase but I think the reality is everybody put through a degree of price increases in the last 12 months. So I think by and large, what you’ve seen, what you are going to see for ’08 is largely what you saw for ’07, with probably a bit of an increase on the -- you know, a bit of an increase on the offer side.

Probably the only dynamic that I think we have to keep an eye on is clearly a number of players have struggled a bit and are sort of that’s the perception and to what degree do they -- do they increase the offers sort of as a way to compete? And I think we will have to continue to be savvy. We feel pretty good about where we are today but the competitive marketplace is fluid and we’ll continue to monitor that. But I guess in terms of pricing power, again I’d say as you look at it, you can look right now into ’08 to a degree at least on the stated price increases, it’s okay.

But it’s a fluid marketplace and we’ll have to continue to see -- do people react by using price more aggressively than they have? Although I think if they did, it would be mostly on the offer side.

Operator

Ladies and gentlemen, thank you. This does conclude today’s DIRECTV Group’s fourth quarter 2007 earnings conference call. You may now disconnect your lines and have a pleasant afternoon.

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