Charter Communications Q4 2007 Earnings Call Transcript

Charter Communications (CHTR)

Q4 2007 Earnings Call

February 27, 2008 9:00 am ET

Executives

Mary Jo Moehle - Investor Relations

Neil Smit - President and Chief Executive Officer

Jeffrey T. Fisher - Executive Vice President and Chief Financial Officer

Michael J. Lovett - Executive Vice President and Chief Operating Officer

Eloise E. Schmitz – Senior Vice President, Strategic Planning

Analysts

Michael Pace - JPMorgan

James Ratcliffe - Lehman Brothers

Jason Bazinet - Citi

David Goldberg - Morgan Stanley

Rich Greenfield - Pali Capital

Bryan Kraft - Credit Suisse

[Joe Stein] - Deutsche Bank

Ethan Lacy - Merrill Lynch

Tuna Amobi - Standard & Poor’s

Benjamin Swinburne - Morgan Stanley

David Hamburger – Citi

[Anton Anderson] - Morgan Stanley

Lance Vitanza - Concordia

Presentation

Operator

I’d like to welcome everyone to the Charter Communications fourth quarter and full year 2007 results conference call. (Operator Instructions) I’d now like to turn the call over to Ms. Mary Jo Moehle.

Mary Jo Moehle

Thank you and good morning. Welcome to Charter Communications’ fourth quarter 2007 conference call. The results we’re reporting this morning are included in the news release we issued over Business Wire at 8:00 am Eastern Time and posted to our website, charter.com. We also posted a presentation there covering our fourth quarter and full year results.

This morning’s call will contain certain forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ from historical or anticipated results.

Certain factors that could affect actual results are set forth as risk factors described in Charter’s SEC reports and filings, including our annual report on Form 10-K for the year ended December 31, 2007, which was filed with the SEC earlier this morning.

During the course of this call, we’ll be referring to non-GAAP measures as defined and reconciled in this morning’s earnings release. These non-GAAP measures as defined by Charter may not be comparable to measures with similar titles used by other companies.

In today’s earnings release, we reported results in accordance with GAAP as well as pro forma results for the fourth quarters and full years of 2006 and 2007. The pro forma results reflect sales and acquisitions of certain assets in 2006 and 2007 as if they had occurred on January 1, 2006. During this morning’s call, we’ll be referring to pro forma growth and results for the fourth quarters and full years of 2006 and 2007 with the exception of capital expenditures, which are in accordance with GAAP.

With that introduction, I’ll now turn the call over to Charter’s President and CEO, Neil Smit.

Neil Smit

Good morning and thank you for joining us today. Since my first day at Charter, I’ve stressed the importance of consistent performance. And today I’m pleased to announce double-digit year-over-year revenue and adjusted EBITDA growth for the fifth consecutive quarter.

During the fourth quarter, we generated strong RGU growth, continued to increase bundled customer relationships, and accelerated the sales of advanced services to our customers. This combination enabled us to improve total ARPU at a very healthy rate and to improve margin.

Phone and the bundle continue to fuel growth with bundle penetration rising to 47%, up from 40% a year ago. Our strategies are working and we’re properly focused. For the fourth quarter, we reported 10.6% revenue growth and 12.6% adjusted EBITDA growth.

I’m also pleased to announce we delivered the highest quarterly phone net gain in Charter history. In fact, in a separate press release this morning, we announced the installation of our one-millionth telephone customer late in January.

Our success in telephone drove higher bundle penetration, which fueled a 70-basis-point improvement in fourth quarter margin and the nearly 13% increase in total ARPU year-over-year. The pull-through effect of telephone is evident in both video and high-speed customers, and the benefit of phone is reflected in operating margin as well.

While we lost 66,000 analog customers during the fourth quarter, we’re encouraged by the performance in markets more highly penetrated with telephone, as both video and high-speed benefit from the value inherent to the bundle. The simplicity and value of the bundle have become well understood, and that plays well with today’s consumer.

As we’ve said in the past, we believe our markets reach a turning point when they achieve double-digit telephone penetration, and about half our phone footprint has attained or surpassed that threshold.

Our double-digit phone markets have better video and high-speed internet performance, accounting for only about one quarter of the full year 2007 loss in analog customers and generating more than two-thirds of our high-speed internet customer net gain. And margin in those markets is about three points higher than company average. With about half our telephone footprint yet to reach double-digit penetration, we believe there is significant opportunity for all three products.

As we gained experience in the telephone business, we became more effective in our market launches. Take for example, Michigan, where we launched phone just over a year ago. We reached double-digit phone penetration faster there than any other Charter market, with the 2007 telephone penetration rate almost double the company average.

And in one of our most highly penetrated markets, we’ve reached 18% penetration. We’ve created strong customer awareness and we’re seeing a shift in market share, as now we’re receiving the dominant share of new wireline connects in that market. Our marketing strategy has been to drive product growth by emphasizing the value of the bundle and targeting the right customers with the right offers.

We measure not only campaign response rates with a lifetime value of our customers to evaluate the effectiveness of our marketing tactics. Our average response rate to direct mail efforts has improved significantly, and we’re increasing the use of cost-efficient sales channels including online.

We continued to build on data-driven marketing capabilities targeted to deliver improvements in both cost efficiency and campaign targeting. In 2008 we expect to increase the amount we spent on targeted marketing, with the overall spend to remain consistent as a percent of revenues.

I’ve always stressed the importance of providing a superior end-to-end customer experience, and in an increasingly competitive environment, I’m even more convinced of its importance. We’re making things more convenient for our customers. We’ve narrowed appointment windows, improved average time-to-repair, have online, self-help, and chat capabilities.

And our Care Center service levels in 2007 improved considerably compared to 2006. Improving the customer experience will continue to be a major focus of this company in 2008.

This business has clearly evolved from providing one service just a few years ago to providing multiple services over one advanced network, diversifying the revenue stream and providing an opportunity to expand margins. Each of our product offers a distinct competitive advantage. Phone, a low-cost, higher-margin product for us is also our fastest growing. And as the business has scaled, we’ve cut direct cost per customer in half over the past year.

Our internet service offers a speed and reliability advantage over other providers. We offer up to 16-meg speeds in a number of markets now, we’re launching it in all of our KMAs in 2008, and we plan to test next-generation DOCSIS 3.0 in the second half of this year.

With an ever-increasing on demand capability, our customers can watch more of what they want, when they want. And with our HD OnDemand service in any given time, we offer our customers more HD choices than they can get from any other provider.

We’ve been in the commercial business for over five years and we built a $340 million business. We generated 14% year-over-year revenue growth in 2007, primarily through video and high-speed services. We see further growth potential there, as well as significant opportunity in the telecom area and now that commercial phone is available across the residential telephone footprint.

And finally, advanced advertising capabilities are evolving, which we believe will enhance revenue streams and provide more effective advertising for our customers.

The right strategies are generating the desired results. We will continue to improve customer service. And we will continue to bundle our products. And we will remain disciplined with our investments.

Capital expenditures are expected to remain essentially flat with 2007, but will decline as a percent of revenue. The business has demonstrated growth, and all our efforts are targeted at maintaining momentum. I’m proud of the efforts of our dedicated employees in 2007, and I look forward to working with them to grow this company in 2008 and beyond.

Now I’ll turn the call over to J.T. for a discussion of our financial results in greater detail.

Jeffrey T. Fisher

For the fourth quarter of 2007, total revenue was $1.548 billion, an increase of 10.6% over the fourth quarter of 2006. We grew RGUs by $199,000 in the fourth quarter and $836,000 for the year. We achieved a 12.9% increase in fourth quarter total ARPU, as customers continue to respond favorably to the value-added advanced services we are offering and purchased additional services in either two or three product bundles.

As a result of the continuing deployment of telephone service and strong take rates for the triple-play bundle, telephone revenues were the company’s largest revenue growth driver during the fourth quarter. We added $58 million year-over-year as telephone revenues grew from $49 million in last year’s fourth quarter to $107 million this quarter.

High-speed internet revenues increased, by $49 million or 17.7%, to $326 million for the quarter. Video revenues in the fourth quarter rose by $28 million or 3.4% to $846 million, benefiting from digital growth, price adjustments, and repackaging and up-selling of digital tiers.

Ad sales revenues for the fourth quarter decreased by $9 million or about 10% year-over-year primarily due to 2007 being an off-cycle political year, as well as lower demand in the automotive and furniture categories. Our commercial business revenues continued double-digit year-over-year growth up $12 million or 15.4% to $90 million for the quarter.

We translated the 10.6% increase in total revenue growth into adjusted EBITDA growth of $63 million or 12.6% year-over-year for the fourth quarter.

Pro forma operating expenses, which include programming, service, and advertising sales costs increased 10% year-over-year, reflecting annual programming rate increases and the growth of our telephone business and other advanced services.

Selling general and administrative expenses increased by 8.3% compared to the year-ago quarter. Increased SG&A expenses reflect continued improvement in the customer experience and increases in marketing expenditures targeted at RGU acquisition and customer retention. Marketing expenses increased to about 4% of revenue compared to about 3% in the year-ago quarter.

We continued to allocate approximately three quarters of our capital expense dollars to success-based initiatives, including further telephone and advanced video services growth. Total CapEx in the fourth quarter was $354 million, and for the full year 2007 we spent $1.244 billion. We expect to spend approximately $1.2 billion in CapEx in 2008, approximately three quarters of which is once again expected to be directed towards success-based initiatives.

As of December 31, 2007 availability under our revolving credit facility totaled approximately $1 billion, none of which was limited by covenant restrictions. We expect that cash-on-hand, cash flows from operating activities, and the amounts available under our credit facilities will be adequate to meet our projected cash needs through the second or third quarter of 2009, and thereafter will not be sufficient to fund such needs. We will need to obtain additional sources of liquidity by early 2009.

I’ll now turn the call over to Mike Lovett for a discussion of our operations.

Michael J. Lovett

Our fourth quarter results reflect consistency in our strategic priorities and in our focus on the bundle, as well as our ability to quickly respond to changing market conditions. We’ve enhanced our products. 16-meg internet speed is available in a number of markets, and we’ll continue to roll it out in each of our KMAs this year, with even greater speeds of DOCSIS 3.0 and the horizon. And Wireless Home Networking is proving to be a popular enhancement.

Now with over a 150 high-definition viewing options at any given time, we offer our customers more HD choices than any of our competitors. Our OnDemand platform and DVR offering provide the convenience and choice customers want. We’re constantly adding content to our OnDemand library, and in fact as of today our monthly OnDemand orders are up approximately 40% compared to a year ago.

HD and DVR customer growth accelerated this year resulting in an increase of about 60% in advanced video subscriptions year-over-year.

We’ve also diversified our sales channels. Online connects in the fourth quarter more than doubled compared to a year ago, and retail and front counter sales continue to climb.

The value of the bundle is our key marketing message. Approximately 47% of customers are in a bundle, with nearly a third of those taking the triple play of video, high-speed, and phone. We have grown our non-video customer relationships 14% year-over-year. And with over 6.5 million unserved households in our footprint, we see a lot of opportunity for any mix of products in those homes, including non-video single and double play.

Our ability to modify, monitor, and measure the effectiveness of our campaigns contributes significantly to our success. And importantly, we continue to improve service. As Neil indicated, we’re seeing improvement in several key service metrics, and I believe that is making a difference to our customers.

Based on these actions, we had a net increase of nearly 200,000 RGUs in the fourth quarter, up almost 20% from the prior year fourth quarter to end the year with 11.8 million RGUs.

The acceleration in RGU growth was primarily driven by telephone, with net adds of 155,000 in the quarter, a 46% increase over a year-ago quarterly adds. This is the highest telephone net gain in our history, and we reported an annualized penetration rate of over 7.5%. With 959,000 customers, we ended the year with 10.6% telephone penetration.

Our phone business is among the fastest growing business in the U.S., and as Neil announced, we’ve reached the million-phone customer milestone late in January. Telephone is now available to over 9 million homes. And given that we have reached critical mass in our phone deployment, the majority of our efforts are concentrated on driving penetration and efficiencies. We plan to end this year with telephone available to approximately 85% of our footprint.

High-speed penetration has reached 24%, and we’re seeing the pull-through benefit of the bundle. We added 51,000 high-speed customers during the quarter compared to 59,000 in the fourth quarter of 2006. We recorded a 4.8% increase in ARPU year-over-year as a result of speed migration and content enhancements, including home networking. Continued product enhancements support the value proposition and present further ARPU in customer growth opportunities.

During the fourth quarter, we added 60,000 digital RGUs and lost 66,000 analog RGUs. As Neil mentioned, we saw improved performance of video in our markets that have reached double-digit phone penetration, reinforcing the power of the bundle. And we’ll continue to reinforce the bundle’s value to our customers.

Moving on to annual results, throughout 2007, we balanced rate and volume effectively. We added 836,000 RGUs, 15% more net adds than in 2006. And we grew 2007 total ARPU about 13% primarily through bundling, speed migrations, and advanced video services.

We’re particularly pleased with our phone and high-speed performances for the year. While phone started the year as a relatively small new business, it accounted for 35% of our total revenue growth this year. We added over 0.5 million phone customers, which is 65% higher than a year-ago adds.

We added 289,000 high-speed customers for 12% year-over-year customer growth, relatively in line with the 306,000 net adds in 2006. High-speed accounted for 36% of total revenue growth.

On the commercial side, we see significant opportunity for continued growth now that commercial phone and the Charter business bundle are available in all residential phone markets. We heightened our focus internally to leverage residential operations to gain cost efficiencies and accelerate commercial growth.

Charter business represents a significant growth opportunity in 2008 and beyond. As Neil said, we believe we’re properly focused. The bundle is a powerful tool in this competitive and economic environment, and we believe we have the people, products, and platform to be successful.

With that, I’d like to turn the call over to the operator and open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Michael Pace - JPMorgan.

Michael Pace - JPMorgan

Neil, I know that you haven’t given much guidance in the past, and understand and respect that, not asking for that. But also in the past you have given us some indication that you expect Charter to be able to perform similarly to your top tier peers. I’m wondering if you could add some color on that thought, and then I have a quick couple of follow-ups.

Neil Smit

I think we’ve demonstrated that we can perform at peer levels both in Q4 and on the year in ‘07. As we continue to drive and deeper penetration of phone and the bundle, we expect to see continued benefits in volume rate and margin. There’s nothing about our markets that leads us to believe that we can’t achieve 20% to 25% phone penetration going forward.

Michael Pace - JPMorgan

CapEx guidance for 2008, some of your peers are actually increasing the dollar amount of CapEx. Can you remind us, were there any onetime items in ‘07 or where are you spending more in ‘08 and where are you spending less in ‘08 to kind of get to the net-net flat roughly?

Neil Smit

I think as I mentioned, we’ll be flat CapEx on the year at $1.2 billion mark, which should be a reduction as a percentage of revenue. I think in terms of spending categories, as we rolled out telephone, we spent more in enabling and launching the product. Going forward, we’ll be spending more on CPE and installs.

The other category where we feel we’ll be launching initiatives are in bandwidth capacity such as SDV and other capabilities like that. So those would be the categories, some of which are down and others of which are up.

Michael Pace - JPMorgan

Almost $7 billion of debt outstanding on your credit facilities, can you just remind us how much of that is floating so we can get a sense of how LIBOR might benefit your interest expense? And then of the fixed amount, can you give us some general color on the timing of those swaps and when you might be able to realize some benefits on that as well?

Jeffrey T. Fisher

Michael, our total debt mix right now is about 85% fixed, so we’re about 15% variable rate overall. The swaps are generally five to six years in duration.

Operator

Your next question comes from the line of James Ratcliffe - Lehman Brothers.

James Ratcliffe - Lehman Brothers

Can you give us an idea where your overlap with both DISH and DIRECTV local HD stands at this point? And secondly talking about analog customer losses a bit, what portion of the customers you’re losing are Broadcast Basic/Lifeline subscribers, and what portion of the existing subscriber base are those kind of customers?

Neil Smit

Concerning basic losses, we don’t track according to which categories they’re in. I think on the Basic side, subs fell short of expectations. But as I mentioned, where we’re double-digit penetrated, which is about 52% of our footprint, that accounted for only about 27% of our basic sub losses in ‘07. So we clearly see the benefits of bundling. And once we reach double-digit penetration, the markets perform differently.

Michael J. Lovett

Yes, I think the best way to get to your question James, I think, is to go back to what I shared earlier on in our statements. With 150 viewing choices at any given time, we have more viewing choices in HD than any of our satellite competitors today.

James Ratcliffe - Lehman Brothers

On phone, you said 85% by the end of the year. Should we be expecting that it sort of levels out there, or should we be moving on final numbers towards 100% of the footprint?

Michael J. Lovett

We’re looking at options for the remaining 15%, but it really ties to the economic situation associated with deploying phone in those markets. So the 85% is our current target. We’ll continue to explore options to pursue technical alternatives in the remaining 15%, but as Neil mentioned, our primary focus is on driving efficiency and deeper penetration.

Operator

Your next question comes from Jason Bazinet - Citi.

Jason Bazinet - Citi

On the number of phone-only or data-only or phone-data customers in a bundle, it seems like on a year-over-year basis there is maybe more modest growth in that particular bundle than I would have thought you would have driven from a marketing perspective, just given that it’s lower CapEx and higher contribution margin.

Can you just provide a little of bit color on is that a function of it not being a priority for Charter, or is it a function of it just getting less receptivity on the part of your customers?

Neil Smit

We don’t turn customers away, Jason. However, I think our primary focus is on driving multiple products, since we find that’s a better hook. And when we get the difference in churn between a single play and a triple play, is it drops over 40%. So we clearly see the benefit of that.

That being said, if there are customers who are on a single product such as data or phone, we pursue different strategies to bundle them up or up-sell them within their current product offering. I think HSI is a good example where we were able to drive both strong customer growth 12%, as well as strong ARPU growth at 5% on the year by up-selling them within the speed tiers.

Michael J. Lovett

And, Jason, to your point about the priority, obviously on the early phases of launching phone, the priority was driving triple play success. And we feel like we’ve done that quite well with just under 80% of our telephone customers in a triple play.

Now we’re shifting our focus, and we talked about this in the latter part of Q3. We shifted our focus to those non-video packages. And we think there’s opportunity there. And again we look at the 6.5 million households that we don’t have a relationship with today, and we’ll be pursuing any opportunity to get allied into those house, be it a single product non-video offer or a double play.

Operator

Your next question comes from the line of David Goldberg - Morgan Stanley.

David Goldberg - Morgan Stanley

On your digital home program, how has that been coming along? What percentage of the sub adds in 4Q are in that type of a program as opposed to kind of the standard digital package? And first of all, what kind of box are you using there? Is it a cheap digital converter or is it just a standard set-top box? And also how long do you think that it’ll be until that starts to free up some capacity for incremental HD channel, things like that?

Michael J. Lovett

From a percentage and mix standpoint, we don’t disclose that regarding our digital performance by product mix or tier. But I will say that we have been very pleased with the deployment of that campaign. And it really does set the stage for not only digital transition downstream, but it sets the stage for opportunity to, in a very economic fashion, upgrade customers into digital tiers as well as other services associated with that platform.

And the feedback we’re getting from the customers, they really enjoy the interactive program guide and then access to OnDemand. So it’s something that we will continue to focus on. To your question about bandwidth, it obviously gets us closer to freeing up analog capacity. As we drive deeper penetration, it puts us in a position to migrate markets more effectively.

David Goldberg - Morgan Stanley

And are you using a standard set-top box for that program?

Michael J. Lovett

Yes, we are using a low-cost standard set-top.

David Goldberg - Morgan Stanley

On the SME market, is there any update on voice and if you have been able use to multi-line MTAs yet, or are you still kind of stacking traditional MTAs?

Neil Smit

We’re currently stacking traditional, but there is an opportunity for us early in ‘08 to move to multi-line.

Operator

Your next question comes from the line of Rich Greenfield - Pali Capital.

Rich Greenfield - Pali Capital

When you look at your comment that you made regarding maturities or liquidity in 2009, wondering if you could discuss first, whether this relates to maturities in 2009 or your just ongoing free cash flow deficit caused by kind of core operations.

And just basically if you could give us anything to quantify based on your current projections how wide the gap is or how much the shortfall is, and then discuss potential options in terms of is your only option to seek other financing? Could you cut back CapEx to squeeze your way through the gap, etc? Just wondering how to think about the comment that you made on the call as well as in your press release.

Eloise E. Schmitz

The maturities in 2009 are about $300 million. So they are having some impact on the liquidity needs obviously. But in prior years the maturities have been much more significant. And we have I think demonstrated over time that we are continually addressing both our liquidity needs, as well as our near-term maturities, and we will continue to do so.

I think that the actions that we will take around the liquidity needs in 2009 will be consistent with what we’ve done in the past, and looking to the market to enhance the liquidity, as opposed to changing any of our operating strategies for the business. So those will be the actions that we will be looking to take over the next year.

Rich Greenfield - Pali Capital

And given the current state of the financial market, especially the high-yield markets, is it possible that you’re going to have to think about alternative sources such as [inaudible] or outside funding? Or do you think you can get something done even given where we are today in the credit markets and not assuming an improvement because I don’t know how to project an improvement?

Eloise E. Schmitz

I don’t know how to project the market either. I think one of the relatively odd benefits of our capital structure is we have several financing options that we can utilize in accessing the market through the different layers of the capital structure as well as secured or unsecured facilities. I agree the market is certainly not as deep as it has been in the past. Some transactions are clearing the market. We’re going to continue to watch that.

But we have never been opposed to looking at various either traditional or nontraditional options that may be presented. So we’ll continue to explore all the options and make sure we’re keeping an eye on keeping the balance sheet out of distracting any of the operating strategies of the business.

Rich Greenfield - Pali Capital

From the standpoint of asset sales, did they become any more interesting given the current liquidity issues?

Neil Smit

No, I think as Eloise said, we don’t necessarily make business decisions or dictate our M&A strategy based on liquidity. A point of consideration, I think our strategy around M&A has been to improve our clustering. I think we’ve been successful at that and tightening up our footprint over the last year. And while I never discard any alternatives, the liquidity situation is not the driving force behind our M&A decisions.

Operator

Your next question comes from Bryan Kraft - Credit Suisse.

Bryan Kraft - Credit Suisse

Can you tell us roughly what percentage of your base or your homes passed are within areas where Verizon and AT&T have deployed fiber? Secondly, I just wanted to find out what your status is on switched digital and how extensively you plan to roll it out this year, and what is therefore on the CapEx guidance?

And then also can you talk about how business is trending now in terms of gross adds and churn? Is it consistent with the fourth quarter? Have you seen any improvement and maybe whether the fourth quarter was weighted more toward the front or the back-end in terms of performance or if was fairly consistent?

Neil Smit

In terms of competitive, Verizon and FiOS overlap right now. It’s about 5% to 6% of our markets. Switch digital video we’ve tested a rollout in LA. We expect to extend it significantly over the course of ‘08.

And in terms of Q4 we built momentum as the quarter went on. As you recall Q3, we did not have a strong volume quarter, and we built momentum as we came out of the tail end of Q3 and throughout Q4.

Bryan Kraft - Credit Suisse

On the switched digital piece of it, is it safe to assume that you’ll complete the switched digital rollout across the footprint by the end ‘09 then? Is that a good assumption? Just asking the question from the perspective of when you would have an even more robust HD offering than you have today.

Neil Smit

Yes, I think it’s fair to assume we would complete the SDV across the majority of our footprint by the end of ‘09.

Operator

Your next question comes from [Joe Stein] - Deutsche Bank.

[Joe Stein] - Deutsche Bank

In your presentation you said that you had liquidity until the second quarter or the third quarter of 2009. And I believe, Eloise, you said that that included the upcoming maturities between now and then, as if you would have to take them out effectively with cash. And I was wondering if that included tapping your incremental term loan as allowed in the credit facilities, or if that was excluded from that estimate?

Eloise E. Schmitz

Yes, that liquidity statement reflects only what is currently committed. We certainly have the billion dollar incremental facility that is provided for in the credit facility, but it is not currently committed to.

So the liquidity statements that we have reflect what we have currently committed and the maturities as they mature in that same time period. So the majority of the debt maturities are frankly in the fourth quarter of 2009, but there are some modest maturities in the front half of 2009.

Operator

Your next question comes from the line of Ethan Lacy - Merrill Lynch.

Ethan Lacy - Merrill Lynch

On voice, can you sort of give me a sense of what you feel really drove the improvement in the fourth quarter versus through 3Q07? Then your weekly add rate jumped up to roughly 11,000 per week, and I think it’s probably one of our largest numbers we’ve seen. And do you expect that kind of growth to continue, or do you think it sort of falls back down more to the 8,000, sort of 9,000-type range where it had been sort of in previous quarters?

Michael J. Lovett

Yes, we put that obviously when we talked about coming out of Q3, we put a keen focus on an internal campaign to drive the passion of our employees. We saw that carry forward into the quarter. We also leveraged some of our marketing capabilities focusing on specific segments with specific offers.

Obviously we’re very pleased with 7.5% annualized penetration rate for the quarter. As Neil mentioned, we don’t see any reason why we can’t reach 20% to 25% penetration over the next years. I think that may ebb and flow by quarter. A lot of that’s tied to seasonality, and the seasonality of the video business more than telephone. But we don’t see any reason why we can’t get to that 20% to 25% penetration over the next several years.

Ethan Lacy - Merrill Lynch

Is there any correlation as well when you look on a year-over-year basis and there’s always sort of a lag for adoption in voice. But looking at your homes passed in the year-ago period that had telephony offered to them, I think you had a fairly aggressive launch in the third quarter and the fourth quarter, roughly 1.2 million homes in 3Q06 and about 900,000 homes in 4Q06.

Does some of that play into it as well? So when we’re trying to model quarterly voice adds going forward, should we be paying attention to that?

Michael J. Lovett

Yes, I think it does and I think Neil referenced one of our markets where we have highest penetration and the fact that we’re getting a greater share. There’s obviously the benefit of awareness. As your end market and you become more mature, there’s awareness in the market that you’re a phone provider.

And we’ve talked about our shift from a marketing standpoint, from one of up-selling our existing base to now focusing on new customer relationships. And that builds one’s awareness is in the market.

Ethan Lacy - Merrill Lynch

And so if I just kind of look out maybe here to the next couple of quarters I think your incremental telephony homes passed in 1Q07 and 2Q07 were a little bit smaller. So should we be thinking that maybe that weekly add rate drops down a little bit, just given the size of new markets that were rolled out in the first half of ‘07?

Michael J. Lovett

Yes, I don’t know that I would look at specific quarter year-over-year. I think it has more to do with the base that we’re marketing to and the maturity of that base.

Ethan Lacy - Merrill Lynch

The 66,000 Basic sub loss, who do you feel you’re losing your subs to? Do you think it’s DBS or is it FiOS? And who do you view as a greater competitive threat to your business model currently?

Neil Smit

I mean, I think DBS is the main competitor across the majority of our footprint. FiOS and U-Verse represent an estimated 5% to 6% of our footprint. We continue to enhance our video products promoting the advanced services in OnDemand, which I believe can give us a competitive advantage over satellite.

And I do think it’s more than just the video product we’re marketing. It’s not just about video. We’re in five different businesses if you count commercial. And we’re going to continue to promote our value proposition through the bundle. It’s not just about the single product, and we believe we’re well positioned to compete.

Ethan Lacy - Merrill Lynch

And as pay TV gets more competitive, are you seeing, Neil, the pricing environment remain rational, or are you seeing increased promotional activity recently?

Neil Smit

Thus far it’s remained pretty rational, as we’ve seen by some of the recent price increases by some of our competitors.

Operator

Your next question comes from the line of Tuna Amobi - Standard & Poor’s.

Tuna Amobi - Standard & Poor’s

Neil, I was looking for your thoughts on wideband, what the tests you might be running on that and any timeframe that you share with us, any kind of plan that you’ve made currently in terms of strategy for that product and how that might be fit into different data tiers right now, how that might result in any possible changes to your data offering.

Neil Smit

Well, we’ll be testing DOCSIS 3.0 as we move through the year. We think we’re very encouraged by the technology and the ability to offer much higher speeds to our consumers. We’ve migrated customers successfully through the different speed tiers. The majority of our customers are now on 5-meg or higher.

We have 16-meg launched in a number of our markets and intend to roll that out across all our different markets during the year. As we see opportunities and more customer demand for higher speeds, we’ll be exploring, either via DOCSIS 3.0 or other initiatives, means of providing that increased speed to them.

Tuna Amobi - Standard & Poor’s

So it’s fair to say that it’s not going to happen this year, maybe 2009?

Neil Smit

As I mentioned, DOCSIS 3.0 we’ll be testing this year and wider deployment will be in 2009.

Tuna Amobi - Standard & Poor’s

In terms of marketing spend; is it okay to assume that it’s probably going to peak this year? And if you can provide some color on what percent of marketing spend that you’re targeting for this year that would be helpful.

Neil Smit

In this year, we expect to maintain marketing spend as a percentage of revenue at about the same level or 4%, which will be an increase in absolute spend. Concerning going forward, as I’ve said in the past, if we see opportunity in Demand, we’ll find ways of funding increased marketing. If the returns are there and it makes sense for the business, we’ll figure out a way to do it.

Tuna Amobi - Standard & Poor’s

On the channels, I know you provided some color in the prepared remarks. I think that was Mike Lovett actually who provided some detail about the online channel in the retail. It seems like you’re getting a lot of traction now in online channels.

So I’m just kind of wondering in terms of the order of magnitude that we can expect from the channels, how do you see the composition of your different channels normalizing? What percent do you think online can settle down as well as the retail? I’m just trying to get a sense on how the different channels could perform over the longer term.

Michael J. Lovett

Yes, Tuna, we’re certainly making enhancements to increase as we did this year, the online channel specifically. But I think a lot of it is going to be dictated by consumer behavior. So I think it’s early to say what that will look like or whether it stabilizes in 2008. And, it’s really based on, as Neil mentioned, all of our marketing efforts are based on the return on investment. So if we find a channel that we can drive a greater return, we’ll accelerate our efforts there.

Tuna Amobi - Standard & Poor’s

I understand that you can’t comment on a pending litigation, but I guess my question is on the Verizon in the patent lawsuit, which they filed against you. And I’m aware also the same lawsuit against Cox Communications earlier this month. Were you surprised about the patent lawsuit on the digital phone?

And it’s my understanding that some of those patents that have been disputed were all the same patents that Verizon had claimed against Vonage. So I guess kind of a general question on what your thoughts are on this litigation, any potential merit and what implications this might have for your fund deployment.

Neil Smit

Well, Verizon alleges that our telephone service infringes on patents owned by various Verizon entities. Four were the Verizon and four are new. We believe our phone product is sound and intend to vigorously defend against Verizon’s lawsuit.

Operator

Your next question comes from the line of Benjamin Swinburne - Morgan Stanley.

Benjamin Swinburne - Morgan Stanley

I want to go back on the double play, which is something you have been pushing for awhile. And I think there’s just a lot of; I don’t know if confusion’s the right word, but a lot of interest among investors and analysts on the opportunity here.

Any color, Mike, you can give us on what the customer perception is of taking a voice and data product along with the satellite television offering, or I guess in some rare cases that Telco TV offering? Because it would seem like giving the speed advantages and what we think at least as the perception that cable modem is a faster period product to DSL that this is a relatively low hanging fruit for the industry.

And maybe we’re being overly, us in the financial community, overly optimistic about it and we’re missing just the real nuts and bolts of marketing and sort of customer behavior. Any light you can shed there would be helpful.

Michael J. Lovett

Yes, Ben, a couple of things. We really haven’t been at this all that long. We started, as I mentioned, trialing different offers in Q3. So it’s still relatively early in the game. But we don’t disagree with your view on the opportunity.

We initially put this on the roadmap when we started thinking about satellite households that were under contract, and was a way to crack the code to get into that household, and then ultimately ideally up-sell them into a triple play once they roll off contract. That’s still our view. And we view the speed, particularly as we migrate 16-meg across our KMAs this year we view the speed advantage in the same fashion that you view it.

I think it’s important to note, too, that they’re not just targeting double play; that would be an ideal offering with the voice product. But that we’re also looking at any type of penetration on the single play as well.

Benjamin Swinburne - Morgan Stanley

Are the marginal economics as attractive as we think from a CapEx perspective? Can you add voice or data, or voice and data doubles without a truck roll in a lot of cases?

Michael J. Lovett

To a new household, it requires a truck roll where we don’t have an active relationship because the line isn’t active.

Benjamin Swinburne - Morgan Stanley

You can’t just ship them a modem, an E-MTA, and let them self-install?

Michael J. Lovett

No, because the line into the household is not active.

Operator

Your next question comes from line of David Hamburger - Citi.

David Hamburger - Citi

You mentioned in the third quarter that about 8% of your subscriber base, that being LA and Dallas/Fort Worth, accounted for 29% of your analog sub losses. I was wondering if you can give an update on those markets, maybe talk a little bit about the trends in Basic sub losses in general in the fourth quarter.

Neil Smit

Well, as we mentioned in the third quarter, those markets are not double-digit and have not yet reached that level of double-digit phone penetration. Therefore they don’t perform as well as higher penetrated markets. We have seen modest improvement in those markets, and once again I think it’s not just about the video product.

We offer a number of different products. And we think as those markets become penetrated at a higher level with phone that we will continue to see improvement in their performance.

David Hamburger - Citi

Have you given any indication as to when you expect those markets to hit those double-digit penetration?

Neil Smit

No, we haven’t.

Operator

Your next question comes from the line of Javier De Busturia - Morgan Stanley.

[Anton Anderson] - Morgan Stanley

[Anton Anderson] on Javier’s line; on receivables aging, I know it’s not a large percentage of your total sub base, but I couldn’t help but notice that number of accounts that were at least 60 days past due was up roughly 50% both sequentially and year-over-year. So I’m curious if you think there is a macroeconomic effect we’re starting to see there or if there are some other factors at play.

Jeffrey Fisher

No, actually our trend on number of accounts over 30 and 60 days are actually trending positively. But the amounts go up as our bundling takes more effect. So you see two things going on right there. There’s nothing further to it than that.

[Anton Anderson] - Morgan Stanley

You obviously got the exemption from the FCC last year on the separable security card. I think that was a 12-month exemption. So I’m curious if the $1.2 billion of CapEx guidance assumes that sometime in the second half of this year you end up spending more on the set-top boxes with a separable security, or you think it’s just such a small number it’s a rounding error.

Neil Smit

Yes. We did get the waver on the low-cost set-top box. It expires in July and that fact is incorporated into the CapEx spend.

[Anton Anderson] - Morgan Stanley

And you think the year-over-year increase on CPE spends, is that a meaningful number to call out, or it’s not really worth talking about?

Neil Smit

No, I don’t think it’s meaningful.

[Anton Anderson] - Morgan Stanley

The $2 billion, obviously a lot of questions on funding beyond early ’09, as you think about your options, obviously we’ve all talked about the billion-dollar incremental term loan. If that is kind of the obvious source of funding, however costly, would you still do it given that they would arguably make refi $2.2 billion over the CCH II notes only about a year or year-and-a-half later that much harder if you have now layered those bonds with more priority debt? What are your thoughts on that?

Eloise E. Schmitz

I guess my first response is as we think about enhancing liquidity, I think about it more in terms of the leveraged neutral transaction that’s basically replenishing the revolver as opposed to some sort of priming of the other bonds. And that is consistent with what we have done frankly for years, is replenishing the revolver with liquidity.

And the access for that liquidity could come in the form of tapping the incremental credit facility at CCO or the credit facility at CCOH or the various high-yield issues, secured or unsecured, at CCO or CCOH. So liquidity enhancing transactions should not have any impact on the decisions that we make around maturity extension.

[Anton Anderson] - Morgan Stanley

Yes, my point is if the only financing is available at the level structurally senior to your largest upcoming maturity, you’re arguably making your job that much tougher in September 2010, as opposed to hypothetically raising some junior capital and really making this either leverage-neutral or ideally de-levering. Is that a major consideration?

Eloise E. Schmitz

I guess part of the question that you’re asking is, should liquidity be raised as an equity-type issuance, or should it be raised as a debt-type issuance? And I would say that we continue to look and try to balance through all of the options that are available to us as it affects both near-term and long-term decisions. And we’re going to continue to look at those options and balance through the priorities and the strategies in the balance sheet. And this is the best answer I can give you right now.

Operator

Your next question comes from line of Lance Vitanza - Concordia.

Lance Vitanza - Concordia

On the cap structure for a second, you at one point alluded to having some various financing options based on the different levels of the cap structure. And could you kind of tick through what those are, taking into consideration the various debt incurrence restrictions and baskets and so forth in your credit agreements and bond indentures?

Eloise E. Schmitz

Relatively generically speaking, we have the billion-dollar incremental facility that’s permitted under our credit facility, and we have credit facility carve-out through the indentures in the capital structure. So we would have the ability to access credit facilities regardless of our leverage ratios.

Also any liquidity transaction would be leverage-neutral, as the proceeds would go to pay down the revolver. So the ability to incur that through the capital structure is limited, either at that box’s leverage ratio or through the credit facility carve-out or the any- purpose carve-out. But the transaction would be leverage-neutral.

Lance Vitanza - Concordia

To what extent can you raise debt at the CCOH level to take out the 10.25 of September 2010?

Eloise E. Schmitz

Well, that would be reliant upon our ability to incur the debt at CCOH, which is not as simple of an answer that I can articulate on the phone, other than to watch through the leverage ratios at each of the boxes that would impact our ability to make restricted payments.

Our ability to raise incremental debt, as I said, is limited either by the leverage ratios, the credit facility carve-outs, or the any-purpose basket. So there’s sort of a lot of different leverage you have to watch as you look at refinancing options, and those will be things that we’ll continue to look at. But they also change over time depending on what point in time you’re looking at analyzing.

Lance Vitanza - Concordia

Well, for example then, at the end of the year, I know in the CCOH bond indenture, it talks about a 4.5 times debt incurrence [inaudible]. What was your measured leverage ratio at that level at December ‘07?

Eloise E. Schmitz

December of ‘07 it was 4.4. And it may make more sense for us to go through this discussion offline.

Lance Vitanza - Concordia

You’ve obviously spent a lot of time talking about the bundle that you offer. And it’s been very successful. To what extent to you believe that you may need to offer a wireless in the bundle going forward? Is that something you think you could get away without having? Or do you feel as though you need have it and you’re working on a strategy to get it? How should I think about that?

Michael J. Lovett

Well, I think we’re monitoring the progress of the joint MSO and Sprint consortium and trying to glean understanding from that. We are in conversations with various wireless partners to see if there is an alternative there that may benefit us both. I think that going forward the bundle may include a wireless offering, but that all depends on whether it makes business sense for us. And we’ll continue to monitor that status.

Neil Smit

Well, I’d like to thank you all for joining us this morning and I look forward to speaking with you again soon. Thank you.

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