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Time Warner Cable Inc. (NYSE:TWC)

Q1 2008 Earnings Call

April 30, 2008 8:30 am ET

Executives

Tom Robey - Senior Vice President, Investor Relations

Glenn A. Britt - President, Chief Executive Officer, Director

Robert D. Marcus - Chief Financial Officer, Senior Executive Vice President

Landel C. Hobbs - Chief Operating Officer

Analysts

Spencer Wang - Bear Stearns

Ben Swinburne - Morgan Stanley

Doug Mitchelson - Deutsche Bank

Vijay Jayant - Lehman Brothers

Rich Greenfield - Pali Capital

Jessica Reif-Cohen - Merrill Lynch

Craig Moffett - Sanford C. Bernstein

Jeffrey Wlodarczak - Wachovia

Jason Bazinet - Citigroup

Bryan Kraft - Credit Suisse

April Horace - Janco Partners

Jonathan Chaplin - J.P. Morgan

Operator

Hello and welcome to the Time Warner Cable first quarter 2008 earnings. (Operator Instructions) Now I will turn the call over to Mr. Tom Robey, Senior Vice President of Time Warner Cable Investor Relations. Thank you.

Tom Robey

Thanks, Tammy and good morning, everyone. Welcome to Time Warner Cable's 2008 first quarter earnings conference call. This morning we issued two press releases, one detailing our 2008 first quarter results and the other updating our 2008 business outlook.

Before we begin, there are several items I need to cover. First, we refer to certain non-GAAP measures. Schedules setting our reconciliations of these historical non-GAAP financial measures to the most directly comparable GAAP financial measures are included in our earnings release or our trending schedules. All of these reconciliations, as well as today’s releases, trending schedules, and the presentation slides are available on our company’s website at timewarnercable.com/investors.

A replay will be available beginning approximately two hours after the call has ended and will run through midnight Eastern Time May 2nd.

Second, today’s announcement includes certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, which are based on management’s current expectations and beliefs and are subject to uncertainty and changes in circumstances. Actual results may vary materially from those expressed or implied by the statements herein due to various factors. These factors are discussed in detail in Time Warner Cable's SEC filings, including its more recent annual report on Form 10-K and quarter report on Form 10-Q.

Time Warner Cable is under no obligation to, and in fact expressly disclaims any such obligation to update or alter its forward-looking statements, whether as a result of new information, future events, or otherwise.

With that covered, I’ll thank you and turn the call over to Glenn. Glenn.

Glenn A. Britt

Thanks, Tom and good morning, everybody. I am pleased to report that this was a very successful quarter for us, a quarter in which we accomplished what we set out to do. There are three key takeaways; first, we posted very strong RGU growth, despite a challenging economic and competitive environment. This reflects both the success of our intensified marketing efforts and the fundamental strength of our products and brands. Second, we remain on track to meet our previously announced full-year financial objectives, and we are increasing our full-year free cash flow outlook. And third, we continue to invest prudently to sustain growth.

I will go through each of these during the next few minutes.

We delivered very strong subscriber growth this quarter. We added a net 55,000 basic video subscribers. That’s our highest in two years and we grew RGUs by almost 900,000 net additions. Total customer relationships, which we believe is an important measure of our overall operating performance, grew by a net 96,000 in the quarter. In addition, we added a record number of triple play customers.

As a result of our strong performance, we have achieved several significant milestones in the quarter. In particular, 33 million total revenue generating units, 3 million residential digital phone subscribers, and 50% penetration of bundled services. And in April, we reached another milestone -- 8 million residential high-speed data subscribers. We think these metrics demonstrate that consumers trust us to deliver quality services and this trust has translated into considerable growth for the company.

Financially, we performed very well in the first quarter. We came in where we expected, with 8% revenue growth and 7% OIBDA compared to last year’s first quarter. We turned in this strong financial performance despite some challenges in the current economic environment. In particular, our high margin advertising business appears to have been impacted by the economy.

The effect of the economy on our subscription business appears minimal at this point, although we have seen some modest weakness in regions that have higher unemployment and foreclosure rates.

That said, we remain very comfortable with our ability to manage the business in this environment and this morning, we reiterated our full-year financial outlook for revenues, OIBDA, and earnings per share. And we increased our free cash flow outlook for 2008, largely reflecting the impact of the 2008 Economic Stimulus Act on cash taxes.

On our last earnings call, we said that we would increase our marketing spending to tell the Time Warner Cable story much more aggressively and in the first quarter, we followed through. I attribute our strong performance in part to our much more aggressive approach. We directed more money to broadcast advertising, a medium that allows us to reach non-subscribers. In addition, we introduced a new advertising campaign just this week, which is designed to promote our products and debunk competitor claims with humor and a little bit of an edge. I think you will enjoy the new spots.

In addition to competing aggressively, we continue to invest in the business to drive growth. We are investing in three key areas. First, we continue to enhance the video capacity of our hybrid fiber co-ax network by implementing switch digital video and in certain limited areas, we are going all digital. We also continue to enhance high-speed data capacity by a variety of [inaudible], such as splitting service groups and adding equipment. We believe these network investments will enable us to continue providing the services our customers demand in the future.

Second, we are investing in consumer premises equipment, especially high definition set-top boxes. This is an important component of our strategy to attract and retain high-end customers.

And third, we are investing capital to grow our commercial business. In the first quarter, our commercial service revenues grew twice as fast as residential revenues. We are determined to seize this commercial opportunity in the coming quarters.

In summary, we are doing what we said we would do at the outset of the year. We think this quarter’s results demonstrate that our marketing message is resonating and we are competing effectively, despite the challenging competitive and economic environment. We are running the business efficiently and we are investing to generate future growth.

Before turning over to Rob, I would like to take a minute to comment on our relationship with Time Warner. As you may have read in their earnings release this morning, Time Warner has decided that under the right circumstances, a complete structural separation is in the best interests of both companies’ shareholders. We at Time Warner Cable concur with respect to our shareholders.

As Jeff Bewkes indicated, we have been working hard on a possible agreement with Time Warner and have made good progress to date. However, we are not able to get into any specifics on this call.

Now I will turn it over to Rob who will give you additional insight into our financial performance. Rob.

Robert D. Marcus

Thanks, Glenn and good morning, everyone. I am pleased to report this morning on another terrific quarter for Time Warner Cable. Turning to the first slide, let me hit the highlights for the quarter.

We had excellent results across all key subscriber metrics. We added 896,000 RGUs in the quarter, bringing total RGUs to approximately 33 million. This represents the 12th consecutive quarter of RGU net additions exceeding 500,000.

Los Angeles and Dallas each had their best subscriber performance since we closed the Adelphia and Comcast transactions in July of 2006. The rest of our systems also performed well, adding 50% more RGUs than in the fourth quarter of last year. This growth was generated both from an increase in bundle penetration among existing customers as well as an increase in new customer relationships. In this quarter alone, we added 96,000 net customer relationships for a total of over 14.7 million.

We continued to drive our bundled offerings, ending the quarter with 7.4 million customers that take two or more of our primary services. That’s 50% of our total customer relationships. The growth in bundles was fueled by 247,000 triple play net additions. That’s an all-time record. Triple play penetration is now at almost 18%.

On the financial front, we had a strong quarter with revenue growth of 8% and OIBDA growth of 7%, both in line with our expectations.

Finally, we are increasing our full year free cash flow outlook for reaffirming our full-year outlook for revenues, OIBDA, and EPS.

Let’s turn to the next slide and I’ll focus on our first quarter subscriber metrics. We added 55,000 basic video subscribers during the quarter. That’s the best quarter we’ve had since the first quarter of 2006. Our digital video net additions of 261,000 marked the second best quarter in the last three years, and our digital video penetration now stands at over 62% of basic video subscribers.

We continue to see strong demand for both HD and DVRs from new and existing digital customers. HD capable subscribers increased by a record 418,000 to 3.4 million, or 41% of our digital subs. DVR subscribers increased by 242,000 to 3.6 million, or 44% of our digital subscribers.

We had another great quarter in residential high-speed data, adding 304,000 HSD subscribers in the quarter. That’s the third time in the last three years in which quarterly HSD net adds were over 300,000. Residential HSD penetration is now over 30% and in fact, at the end of the quarter, we had four divisions with residential HSD penetration of 40% or higher.

Also very encouraging is the fact that during the quarter, we added over 100,000 subscribers to our premium HSD product, Roadrunner Turbo. Turbo subscribers now exceed 5% of our residential HSD subscriber base.

Our residential digital phone net additions of 280,000 nearly matched our record performance in the fourth quarter of 2007. Finally, we began to gain momentum in our commercial digital phone business by adding 5,000 net commercial subscribers in the first quarter.

Much of the success that we saw on the subscriber side of this quarter can be attributed to our intensified marketing efforts. We began to put meaningful incremental marketing dollars to work in mid-January and we began to see the positive impacts on subscriber additions a few weeks later. In fact, approximately 85% of our first quarter RGU net adds were in the last two months in the quarter, as compared to approximately 75% in the last two months of the first quarter last year.

We do have to acknowledge that seasonality probably played a part in these subscriber results. The first quarter, as you know, typically has the strongest subscriber net additions of the year and we generally see summer seasonality reducing net additions from May through August. We have no reason to expect a different trend this year.

Moving to the financial results on the next slide, we had solid revenue growth in the first quarter with revenue of $4.2 billion, a $309 million or 8% increase over the first quarter of 2007. Revenue growth was driven by an 8% increase in subscription revenue and a 4% increase in ad revenue.

Looking first at ad revenues, the 4% ad revenue growth benefited from some changes which occurred during the quarter, including our taking over management of Charter’s local ad sales business in Los Angeles. Taking into account these changes, ad revenues were essentially flat versus the first quarter of last year. This is reflective of the overall economy and its impact on the local ad business. In particular, we’ve seen pockets of weakness in certain geographic regions, as well as in certain advertising categories, such as auto, furniture, and financial services. This weakness more than offset strength in political advertising.

We expect that this slow growth trend will continue into the second quarter with growth accelerating in the back half of the year as we approach the November elections.

On the subscription revenue side, the 8% growth was driven by an 8% year-over-year increase in RGUs, as monthly subscription revenue per RGU remains steady at about $41.

Broken down by product line, the 8% subscription revenue growth was driven by 4% revenue growth, 4% video revenue growth, 11% HSD revenue growth, and 39% voice revenue growth. On a dollar basis, revenue growth was split fairly evenly across video, HSD, and voice, with each contributing approximately $100 million of year-over-year increases.

On the commercial side, while we are still in the early stages of deploying our commercial voice service, total commercial revenues of approximately $180 million grew at more than twice the rate of our residential services. Commercial revenues continued to be roughly two-thirds HSD and one-third video, with a relatively small contribution from our new voice product.

Total ARPU increased 9% year over year to approximately $105, with subscription ARPU also up 9% to just under $100.

Turning on the next slide to OIBDA, first quarter OIBDA of $1.4 billion grew 7%, which reflects our 8% revenue growth and a 9% increase in operating expenses. The growth in operating expenses is in part attributable to a $29 million increase in equity-based compensation expense, primarily due to the timing of equity grants that were made in the first quarter of this year but in the second quarter last year. Additionally, we spent $35 million more in marketing in Q1 of this year than in Q1 of last year. Excluding these items, operating expenses grew 6% year over year.

As I mentioned earlier, we are very pleased with the subscriber growth generated by our incremental marketing spend and consequently, we expect marketing spend as a percentage of revenues to continue to be up year over year in the second quarter.

Due to multiple factors, including the higher marketing spend, as well as continued slow growth in advertising sales, higher pension and group insurance expenses, offset in part by lower equity compensation expense, we expect our second quarter OIBDA growth to be similar to the first quarter, with overall OIBDA growth accelerating in the back half of the year.

The first quarter OIBDA margin of approximately 34% was similar to what we saw in last year’s first quarter despite our increased marketing investment and the timing of equity grants. Keep in mind that the first quarter margins tend to be our lowest of the year, with margins expanding throughout the year.

Turning now to EPS, our basic and diluted earnings per share in the first quarter was $0.25, as compared to $0.28 per share in Q1 of last year. You should note that this quarter’s EPS included a penny per share after-tax gain on the sale of a small investment and last year’s first quarter EPS included an $0.08 per share gain, after-tax gain related to the unwind of the Texas/Kansas City cable partnership. If you exclude these gains, EPS grew 20% year over year.

Looking at free cash flow on the next slide, while we tend to focus on annual rather than quarterly free cash flow, we are very pleased with our first quarter performance. We generated a healthy $339 million in free cash flow in the quarter, 51% better than the first quarter of last year. Higher OIBDA, lower interest payments, and favorable working capital comparisons all contributed to the free cash flow growth. These items were offset in part by higher CapEx, which I will discuss in a minute. We converted 24.2% of OIBDA into free cash flow in the quarter, up from 17.1% in the first quarter of last year.

Let’s now turn to the next slide for a discussion of CapEx. Capital expenditures for the quarter were $846 million, an 18% increase over the prior year. 75% of our first quarter capital spending was variable, or success based, with CPE being the largest component of the spending. Customer premises equipment accounted for $107 million of the total $126 million of year-over-year CapEx increase in the first quarter.

The increase in CPE expenditure was driven primarily by two things. First, the increased demand for HD boxes and DVRs from both new and existing customer. As I mentioned earlier, HD subscriber net adds were a record 418,000 in the quarter. In addition, the average number of HD boxes per HD customer continued to increase during the quarter. As a result, we deployed over 0.5 million HD boxes during Q1 of this year, up about 75% over the first quarter of last year. We anticipate continued strong demand for HD boxes and expect that HD penetration will hit 50% by year-end, up from our current penetration of 41% of digital customers.

The second item affecting CPE growth was that we made a decision during the quarter to increase our set-top box inventory levels to ensure that we have sufficient supplies to meet the increased demand resulting from our intensified marketing efforts.

The other noteworthy item on capital expenditures is line extension spending, which was up 14% in the first quarter compared to last year. This was driven by increased commercial line extension spending, which now represents over 35% of the total line extension investment. Residential line extension spending was actually down year over year, which is consistent with the overall slowdown in housing growth.

Before leaving CapEx, I do want to reiterate that we continue to expect that our full year CapEx will be approximately $3.5 billion.

Turning now to net debt, at March 31st, our net debt and mandatorily redeemable preferred equity totaled $13.3 billion, a reduction of $345 million from where we ended 2007. That was driven by our strong free cash flow. That puts us at about 2.3 times, a 2.3 times ratio of net debt and preferred equity to trailing 12-months OIBDA.

And finally, let’s move to the last slide, where I will review our 2008 outlook. As a result of our financial performance in the first quarter, the benefits of the 2008 Economic Stimulus Act, which has the impact of lowering our anticipated full-year tax payments and lower interest rates, we are raising our full-year free cash flow outlook to at least 40% growth. In addition, we are reaffirming our full-year outlook for revenue, OIBDA, and EPS.

That concludes my remarks. Thank you and I will now turn it over to Landel.

Landel C. Hobbs

Thanks, Rob and good morning, everyone. I have two topics to cover this morning. First, Glenn outlined for you how we are competing aggressively and effectively. I want to give you several concrete examples of our proactive initiatives. Second, I will give you an update on some of the investments we’re making to provide for continuing growth.

I’ll start with our competitive position. Our efforts here have two primary components, more aggressive marketing and differentiated products. As Rob indicated, our increased spending, marketing spending achieved the desired result in the first quarter, driving more subscriber net additions. Of course, as you know there are a lot of drivers of net additions and we believe that seasonality benefited us in the first quarter. But after we increased our marketing spend starting in mid-January, our subscriber trends in February and March were higher than in the comparable months last year.

Our incremental marketing spend in the first quarter was focused in several areas. For example, certain key markets like New York City, we invested in broadcast advertising to reach those consumers who don’t subscribe to our video products. In addition, we increased our Hispanic marketing in L.A. We also have dramatically raised our profile in the retail channel. Earlier this month, we launched a program that enables customers to purchase our video, high-speed data, and digital phone services in nearly 700 Wal-Mart locations. Customers can sign up for services with the help of a Wal-Mart electronics associate available to guide them in selecting packages through equally accessible in-store kiosks.

On the product side, we’ve been equally aggressive. We are increasing our focus on Hispanic households, which we estimate comprise 21% of our homes passed. In early April, we introduced a new offering in L.A. called El Paquetazo, which translated is the package of all packages, which we designed to super-serve Hispanic households. We think it combines the best of Spanish language channels with highly rated English language channels of our networks and is priced at $34.95 a month.

The addition of 31 Spanish language channels give El Paquetazo customers access to the most Spanish language content from anyone in Los Angeles. The early results are promising. For the first three weeks of April, approximately two-thirds of El Paquetazo subscribers were new customers. More than a third of them took a double or triple play.

If this product proves to be as successful as we expect in L.A., we plan to introduce variations in other areas like Texas and New York City in addition to their existing Hispanic offerings.

In high definition television programming, we promised that we would get more aggressive and in the past several months, we have delivered. As of today, there are 50 HD channels available in large parts of New York City and we expect that when we complete the transition to all digital in the city later this year, we will have the ability to deliver more than 100 HD channels throughout the city.

And it’s not just New York City. For example, Albany had 52 HD channels at the end of the first quarter and five other service areas had at least 40. You can expect to see these numbers continue to increase throughout 2008.

We are also delivering features that we know will enhance the customer experience. Our caller ID on TV feature, which you’ve heard us talk about before, is now available in many of our service areas and we introduced this month in parts of New York City. We expect to complete the rollout in the city in the coming months. In addition to caller ID on TV, we plan to launch Start Over in New York City later this year.

Before I close, I want to share a few observations on the investments we are making to drive continuing growth. First, our switch digital video implementation remains on plan. As we indicated last quarter, we intend to have switching launched in most of the major cities we serve by the end of this year. At the end of the first quarter, switching was launched in 10 service areas and we are currently testing in several more.

Second, in New York City, our migration to an all-digital system is proceeding well. This month we completed the transition in Brooklyn and Queens and we expect to complete the transition in Manhattan by the end of this year.

And third, we are making investments to grow our commercial business in several areas. As we begin to operationalize this business, we think about it in three parts. First of these, which we have discussed on recent calls, is the small and medium business, or SMB space, which we previously served with just high-speed data and video services.

Our business class phone service is now available to SMB customers in the majority of our service areas and we ended the first quarter with 10,000 customers. As we get more established, we are seeing the average installed lines per subscriber grow and we are seeing very strong traction for bundles and multi-year contracts.

The second area is the enterprise space, which is also not new for us. In this area, as an example, we are currently providing dedicated Internet and metro ethernet connections.

And the third is the carrier business, in which we provide connectivity solutions for other service providers. Cell backhaul is a significant part of this opportunity. We currently have several hundred towers under contract and we see significant opportunity for expansion.

As we said on our last call, our 2008 plans include increased capital spending in the commercial areas to support this growth, and in the first quarter, our CapEx reflected an increase in line extensions primarily related to our SMB and carrier businesses.

So to summarize, we focused a tremendous amount of energy in the first quarter on improving our competitiveness and we believe we are beginning to see very positive results, and we are continuing to deploy our capital in a prudent fashion to enable growth.

Thank you and with that, I will turn it over to Tom for the question-and-answer portion of the call.

Tom Robey

Thanks, Landel. Tammy, we are ready to begin the Q&A portion of the conference call. We would ask each call to ask a single question so that we can accommodate as many callers as time permits, and please remember that we won’t be able to address the specifics regarding a possible structural separation from Time Warner in the Q&A. Tammy, first question, please.

Question-and-Answer Session

Operator

Mr. Wang, your line is open.

Spencer Wang - Bear Stearns

Thanks. Good morning. I just have one question related to your basic sub-growth, a 55,000 increase, and I guess this question is probably for Rob; Rob, can you give us a little bit more color in terms of how those basic net adds broke out between the acquired systems and the legacy systems? And if you could talk a little bit about the L.A. market and Dallas specifically, that would be great. Thank you.

Robert D. Marcus

Sure, Spencer. A couple of things; first, as you I’m sure noticed, we did not report this quarter on the acquired and the legacies as separate groups of systems. That said, the basic subscriber growth was pretty broad-based across all of our properties. Both L.A. and Dallas did improve in terms of subscriber -- basic subscriber net adds. The other -- you know, to the extent that there is additional color to be added, that wasn’t in our proactive remarks. You know, the 55,000 basic net add increase was actually made up of 66,000 net adds on CPST and a 12,000 sub decline on BST, so in addition to the broad-based growth in basics, we are continuing to see that improvement in the mix of the basic subs.

Spencer Wang - Bear Stearns

Okay, so -- sorry, just to clarify -- so basic subs grew in L.A. and Dallas, is that what you were saying, Rob?

Robert D. Marcus

No, I said that L.A. and Dallas improved. They both still had modest basic sub losses but both are showing improvement trends.

Spencer Wang - Bear Stearns

Great. Thank you.

Operator

Thank you. Our next question comes from Ben Swinburne with Morgan Stanley. Your line is open.

Ben Swinburne - Morgan Stanley

I wanted to ask a question about your HD expansion plans and maybe start off and ask if Rob or Landel, have you seen different churn rates and subscriber trends on the basic front? Just trying to look at video market share where you have HD channels that have moved into the 50-plus range, where you have switch digital out there versus markets where you are still in that 25 or below. Just trying to gauge, as much as we talk about this a lot, how much this is actually impacting video market share in the marketplace. And any lessons learned operationally in New York as you have moved to all digital would be really interesting, any push-back from people who don’t like having boxes on every television set, although that might not be a big issue in New York. I think you’ve already encrypted a lot of your analog. Any logistical stuff would be helpful as well.

Robert D. Marcus

Maybe I’ll take the first part of that; Landel, maybe you’ll take the second. The first part is that the positive results we saw on the video side this quarter were, as I said, very broad-based, as was the demand for HD. So I would tell you that it is hard to discern whether or not there is a direct translation between improvements in the HD product, HD demand, and overall video demand. I mean, the results are pretty solid across the board.

Landel C. Hobbs

I’ll add a couple of things. When you think about churn, churn is down in all product categories. A lot of that is due to slower move rates because of what is going on in the economy but we do believe [pieces] that are due to continue to improve the products but it is hard to tell exactly how much of the reduction in churn is caused by just product versus economic conditions.

In New York City, you are right -- most everyone had a box, so we’ve seen no push-back at all with regard to going all digital in the city.

Ben Swinburne - Morgan Stanley

Thank you very much.

Operator

Thank you. Our next question comes from Doug Mitchelson. Your line is open.

Doug Mitchelson - Deutsche Bank

Glenn or Landel, I was just hoping you could talk about two aspects of that deal, thinking about it in two buckets, right -- the Dallas/L.A. bucket and then the rest. First in Dallas/L.A., you’ve had a lot of execution issues. You mentioned that it’s improving, those are the best results yet. You moved Barry from L.A. to Texas and I know it was a promotion but does this mean that L.A. is in great shape now because you were able to get Barry out of there, or does it mean that Texas has enough issues that you’d rather have him there?

And then the other bucket, the overlap that you had in Ohio, New York, the Carolinas, you mentioned a while ago that those margins in those markets have gotten up to Time Warner Cable levels but given this is some of the best local geographic concentration we’ve seen in cable, shouldn’t margins continue to move above historical Time Warner Cable levels? So margins and the moving Barry. Thanks.

Glenn A. Britt

Good morning, good to hear from you. A couple of things; on the Dallas and L.A., continue to be very happy with the progress and you are right, we’ve seen the RGU trends in both markets improve. So with regard to then how that impacts what happened, Barry did a great job out there but listen, we’ve got very deep bench strength when it comes to management and the person we had in New York City as well as L.A. were ready to step up for responsibility at the same time Wayne Knight, who’s been with us for a long time, was deciding to retire. So I think the timing worked out great in that we had two people moving up in those cities. We feel very comfortable with how they are performing and now we’ve got a very experienced person who is basically done in some of the most competitive markets or operated in some of the most competitive markets we have moving to Texas. So I am very happy about that.

Listen, Texas, a couple of things on it -- from an economic standpoint, even though very marginally impacts -- that is one of the heaviest impacted places that we have, Texas. Also, it’s hyper-competitive, so we are glad to have Barry there and yes, we do think there can be some performance in the state of Texas and with Barry’s expertise, he’s the guy to do it.

On Ohio and some of the other areas with regard to some of the acquired properties, we said those were -- had moved up basically to historic Time Warner Cable margins. We continue to see improvements in those markets. They are -- because of their low penetrations, all the things we talked about early on in the acquisition, Buffalo and the Ohio, those acquired markets continue to perform well because they are low penetration in terms of triple play, in terms of bundled sell-in. So we are very happy with where they are going. I’m not sure there the margin is going to end yet but they are performing like we expected them to when we acquired them.

Doug Mitchelson - Deutsche Bank

Just to be clear, the margin upside in the overlap markets like Ohio and New York, is really being driven by upside in penetration, not necessarily because structurally that amount of local geographic concentration should give you better overhead leverage?

Glenn A. Britt

I would say it leans more towards the increase in penetration than the latter.

Doug Mitchelson - Deutsche Bank

All right. Thank you.

Operator

Thank you. Our next question comes from Vijay Jayant with Lehman Brothers.

Vijay Jayant - Lehman Brothers

Thanks. I have a clarification; Rob, your comment on second quarter OIBDA growth to look similar to the first quarter, that’s about 7.5%. If you exclude the $28 million stock compensation, that implies about a 5%-plus OIBDA growth. Is that correct?

And also another clarification on Landel’s comment -- when you said churn has improved, is that sequential or year over year?

And if I can ask my question, which is really in this kind of environment, how much can you really borrow today at a reasonable cost? Because there has obviously been some talk about there may be a dividend or some structure as part of the separation from Time Warner but I just want to understand your borrowing capacity in this environment. Thank you.

Robert D. Marcus

Okay. I have a feeling I’ll end up taking all three of those. I’ll clarify the comment Landel made first, which is that churn is down both year over year and sequentially on all RGU categories.

The question about Q2, you are absolutely right, Vijay, that you do have a reversal of the effects of the equity compensation effect resulting from the timing of equity grants. The reality is though that only partially offsets some other things that are going into what Q2 is shaping up to look like. As we said, advertising growth continues to be slow and we are expecting that to accelerate in the back half of the year. We do expect that we are going to continue to spend more marketing in Q2 of this year versus Q2 of last year. We also have a couple of expense items that are up year over year, in particular our pension expense and our group insurance expenses are up. So those things are more than offsetting, or put another way, the equity compensation reversal is only partially offsetting the impact of those items. So that’s what’s going on in Q2.

As for borrowing capacity, again I don’t want to preview any elements of the possible transaction separating Time Warner Cable from Time Warner, but suffice it to say, we committed to -- we continue to be committed to maintaining a solid investment grade rating and anything we do is going to be consistent with that and obviously any transactions will factor in availability and cost of additional borrowing.

Vijay Jayant - Lehman Brothers

Thank you.

Operator

Thank you. Our next question comes from Rich Greenfield with Pali Capital.

Rich Greenfield - Pali Capital

-- New York market, obviously --

Robert D. Marcus

Rich, we can’t hear you.

Glenn A. Britt

Yeah, you are cutting out.

Operator

One moment. Sir, I’m sorry, your line is open.

Rich Greenfield - Pali Capital

Can you hear me?

Robert D. Marcus

Yes.

Rich Greenfield - Pali Capital

Sorry, I don’t know what that was -- a question on the New York Market; Verizon is supposed to have approval some time later this year. They seem to be moving through their process rather swiftly in New York. I’m wondering how this affects your marketing spend and any type of specific plans to deal with it, especially in a market like Staten Island, where Verizon supposedly has FIOS-wired the entire market just waiting for a video franchise. Just related to Rob’s comment about the timing of your marketing spends or the increase year over year, do we see another bump up towards the end of the year surrounding this move?

And then just a quick question on the commercial phone business -- what is your ARPU that you realize on that business compared to the residential business on average? Thanks.

Glenn A. Britt

Let me take the Verizon question at some generality and maybe look to Landel too. New York gets a lot of headlines but we’ve been competing with Verizon elsewhere with FIOS, both broadband and video, and other operators in the business have too, so I think we can pretty much see what is going to happen -- namely that when they enter a market with video, they will certainly get some video customers from both us and satellite, so that shouldn’t surprise anyone.

But we also see that broadly we continue to take a very large number of voice customers from both them and AT&T, so I think we will see patterns similar to elsewhere. It will probably get more headlines because it is New York City, but I don’t expect it to be different.

Landel, do you want to comment?

Landel C. Hobbs

The only thing I’ll add, Rich, is you’re right -- no one knows exactly the timing on their franchise approval and we’ve been waiting for quite some time. During the waiting period, we haven’t been sitting still. We talked about the HD channels in the city going all digital, we’ve launched price lock guarantee, so we are trying to move as quickly ahead of them in this opportunity before they actually launch.

In regard to marketing, we have increased our marketing in the city in the first quarter and yes, it will follow of course seasonality trends, but we are trying to increase it in all cases to be more aggressive in the city. So you are going to see all of those things leading up to the time whenever they launch.

Glenn A. Britt

I think you asked about commercial ARPU also, so --

Robert D. Marcus

Rich, commercial voice ARPU, you know, not all customers are created equal but it is probably in the $125 per customer plus zone.

Rich Greenfield - Pali Capital

Thanks so much.

Operator

Thank you. Our next question comes from Jessica Reif-Cohen with Merrill Lynch.

Jessica Reif-Cohen - Merrill Lynch

Thank you. I was wondering if you could give us an update on your wireless strategy, why a partnership might make sense. And separate from that, could you just discuss the transition to digital broadcasting in February of ’09, maybe size the opportunities there? Thanks.

Glenn A. Britt

Let me take both of those -- our wireless strategy really hasn’t changed for some time now, but let me repeat it. I look at the wireless business as today’s business and then separately what may come in the future. Today, the wireless business is largely about cellular telephones and texting, and some of us have Blackberries but not that many. And the question around that for us and for the cable industry has been is it natural for consumers to buy the so-called quadruple play. And you all know about our pivot venture with Sprint, and that’s being discontinued. We have not seen big demand for the quadruple play to date. We continue to study that and if that changes, we’ll figure out what to do about it. So I view that as maybe largely defensive.

More interesting to me is the notion of a broadband wireless and how that might related to wireline networks, because I think in the future there may be a robust broadband wireless offering but it will be in the form of hybrid networks that are wireless and wireline, not two separate things, per se.

And we continue to talk to all sorts of potential people about whether there is a good opportunity to participate in that. It’s very formative, the technologies are still being created, the products are still being created. So early in that but we continue to look at it.

On the digital transition, I assume everybody on the call knows that February 17th of ’09 the broadcast industry is being required to broadcast only in digital after that date, and that means people who are over the air only homes, which seems to be 10% to 15% of the homes, the number is hard to get, those people will have to do something. They will either have to get a set-top converter or a new TV or hook up to cable or satellite or phone video where that’s available.

So we and all the industries involved are engaged in a big public education effort because there is concern that those people who are still over-the-air viewers may be very hard to reach to get this message to.

If you are already a cable customer and your sets are hooked to cable, you don’t have to do anything. We will provide all kinds of sizes and shaped signals to get to your sets.

I think specifically, Jessica, you were wondering if we might pick up some customers out of this, because it could be a juncture for people who are now over-the-air viewers to finally buy cable. And we do think that we will modestly pick up some customers from it but we don’t think it’s a huge thing because quite frankly, multi-channel video is a very mature, longstanding product at this point. There is probably nobody in America who hasn’t been offered it multiple times, so these folks have chosen not to buy it, not because they don’t know about it but they’ve chosen not to buy it.

So we think we are going to get some but it’s not a big deal.

Jessica Reif-Cohen - Merrill Lynch

Thank you.

Operator

Thank you. Our next question comes from Craig Moffett with Sanford Bernstein.

Craig Moffett - Sanford C. Bernstein

Good morning. Landel, this quarter you had about 41,000 non-video subscriber additions. That’s been consistently running at about that same level. I’m wondering -- I know Comcast had talked about making a much more serious initiative to try to capture a larger percentage of those customers with broadband only and broadband and phone types of offerings. Have you been doing the same thing and have you seen any early success in your marketing efforts with the broadband single and broadband double play packages among non-subscribers?

Landel C. Hobbs

Craig, a couple of things on that topic; we have tested all of those segments quite extensively over the last couple of years. On combo high speed data and phone, we’ve seen no traction and it is a fairly nascent portion of our overall population. What seems to resonate more is high speed data onlys and where we have seen traction is use of our light product, and so we are using that. Now, that’s one avenue we take. We still though primarily focus on bundles and so again, what we are not seeing traction is in the high speed data and phone. We’ve tried a number of different angles. That doesn’t seem to resonate with customers. We are seeing much more traction with our high-speed lights and going after high-speed onlys and then trying to up-sell them later.

Craig Moffett - Sanford C. Bernstein

And is it your sense that most of those are satellite subscribers today for video?

Landel C. Hobbs

Yes.

Craig Moffett - Sanford C. Bernstein

Thank you.

Operator

Thank you. Our next question comes from Jeffrey Wlodarczak of Wachovia.

Jeffrey Wlodarczak - Wachovia

Good morning. On your more aggressive Q1 marketing effort, was there a discount attached to the amortizing or was it mainly branding? And then I guess given the success you’ve had with your promotional activity, how is the competition responding generally? Thanks.

Glenn A. Britt

Let me take that and then Landel may have something to add to it; our more aggressive marketing was largely intended to get the word out about our products. The observation was we have great products, consumers think we have great products but that we weren’t being aggressive enough about telling our story, so people didn’t know about all the good things we had. So that’s been our focus. There are always offers in the market from time to time in any quarter and it is different in different places, so that hasn’t changed particularly. That was not a part of this effort. This was more about getting the word out.

Landel, do you --

Landel C. Hobbs

The only thing I’ll add to that is for those of you -- you will see our new ad campaign in the market. The first quarter it was, as Glenn indicated, much more targeted, much more aggressive and as you watch our ads moving into the marketplace now, even more poignant, a more -- much more clear with regard to product differences between us and our competitors, so going -- on the branding question, we are just now beginning to look at branding in a much heavier way, so you will begin to see that out of us towards the latter part of the year but right now, it is primarily acquisition focused.

Jeffrey Wlodarczak - Wachovia

Thanks.

Operator

Thank you. Our next question comes from Jason Bazinet of Citigroup.

Jason Bazinet - Citigroup

Thanks so much. I just had a longer term capacity question; you know, AT&T using copper and I guess IPTV and switch video is out in the market claiming they have sufficient capacity to offer everything they need to for data and video. And when you talk about your investments, it’s switch digital, you mentioned all digital, and I think in some markets going to 1-gigahertz. And the question that we get from clients, there’s three ways to interpret this -- either AT&T has sort of leapfrogged the cable industry using new technology to provide sufficient capacity at lower cost. Option two would be AT&T actually does not have enough capacity, and option three would be that you have alternative strategic objectives with the spending that you are embarking upon, either to get more data capacity or get high-end set-top boxes into consumers’ homes for DVR and HD.

I was just wondering if you could just sort of reconcile those two technology paths and sort of weigh in on which one of the options you think is most likely. Thanks.

Glenn A. Britt

Sure. Let me see if I can clarify what is going on there -- when you look at cable, the physical plant, there’s two things going on. There’s the historic broadcast of TV signals to every home getting the same signal, and that has historically driven the need for capacity, so there is 750-megahertz, 1-gigahertz, whatever. So that still continues and it is the biggest use of capacity that we have in our plant today.

But our newer plant and the capability we built in the mid-90s was designed around this notion of switching, and that is subdividing the plant into small neighborhood groups which can receive different signals from each other.

So our broadband plant works on that basis, video-on-demand, voice, and what we are doing with video switches is now starting to make video work in that switched subdivided way, which will allow us over time to move away from a broadcast all the signals to everybody. So that’s what we are doing to evolve our plant and to ensure there’s a lot of capacity.

So within that, yes, we are adding switches and we, you know, the high speed data plant, you add CMTSs and divide service groups and there is a whole litany of things we do to increase that capacity as it is being used.

We are by and large not going to expand the overall capacity from 750 to 1-gigahertz. Some operators are doing that. There are a couple of selective locations where we’ve done that. Those are ones where there are a huge number of off-air signals but it’s pretty rare in our case. We are focused on moving to the switch fabric, so we a big believer in that.

So back over to AT&T, yes, AT&T is using a form of switching, so in that they resemble us. But the reality is their last mile was twisted air copper and that is less capable then the coaxial cable we have. So yes, they are working on ways to do everything they think the consumers want but at the end of the day, it doesn’t have the same capacity.

I would also point out that they are -- that only exists in a relatively few places now, so hybrid fiber co-ax exists in most of the country. AT&T’s rebuild exists only in a few places, so they have a long way to go before they turn their whole plant into that, and a lot more money.

Jason Bazinet - Citigroup

So I guess the follow-up question then is it sounds like switching is the future, and I guess my question is then why in some markets are you going all digital?

Glenn A. Britt

They are not really separate things. All digital is another way to increase capacity and recognizing that most of what is happening in the world is digital these days, the drawback of all digital is that everybody has to have a set-top box, which one of the earlier people were questioning about that. So there are places like New York City where virtually everybody has a box already, where actually going all digital was easy and probably an easier way to create capacity than adding switching, which by the way we are not doing in New York for video.

But most of our markets where you’ve got 60% of the people with boxes and the rest without, they are not going to go all digital for some lengthy period of time.

Jason Bazinet - Citigroup

Okay. Thank you very much.

Operator

Our next question comes from Bryan Kraft with Credit Suisse.

Bryan Kraft - Credit Suisse

Thank you. Given that Verizon is close to receiving a franchise in New York, the question is how difficult and time-consuming do you think it is going to be for them to gain building access for MDUs? Is this going to be a major obstacle for them or is this going to be a process that is relatively uncomplicated? And then just secondly, what percentage of your subs company wide are MDU subscribers? Thanks.

Glenn A. Britt

First of all, difficult doing business in New York. I believe, unless one of the lawyers sitting in the room here corrects me, that in New York State, everybody has by law access so I don’t think that’s a particular issue in this state. And there’s federal rules about this too.

I think the real difficulty, and you are sort of thinking about Manhattan, not necessarily all of New York City, it’s really time-consuming and expensive to get into all these high-rise buildings and actually wire them and do it in a way that doesn’t mar the hallways and that sort of thing.

So it’s certainly a much more complicated longer build than it is in a more suburban area, but I would remind you that most of New York City doesn’t look like Manhattan and it’s much more single family dwelling or two family houses. It may not look like New Jersey, although Staten Island looks more like New Jersey, but Manhattan is the exception, not the rule.

Bryan Kraft - Credit Suisse

Okay, thanks. And can you comment on the overall percentage of your sub base that is MDU?

Landel C. Hobbs

On MDUs, it’s roughly in the low 20%.

Bryan Kraft - Credit Suisse

Great. Thanks.

Operator

Thank you. Our next question comes from April Horace of Janco Partners.

April Horace - Janco Partners

Thanks for taking the question. I was wondering if you could give us the customer response to your price lock guarantee program and then also, going to 100 HD channels in Manhattan, can you also do that in other markets where you are switching, and if so, what those markets might be?

Glenn A. Britt

Let me take the HD question and Landel can handle price lock guarantee. On the HD, once we have switching we can essentially add all the HD channels we can get our hands on. And so the gaiting factor is how many HD channels are really available as opposed to various marketing hype. Are they really available in a way that we can give them to customers? Then we have to have contracts for them and then launch them. So I think you should assume capacity is not the constraint -- it’s getting channels and signing contracts.

There are some number of HD channels that we may decide are not terribly attractive to consumers because generally in our programming, we are not going just for bulk or hours or whatever. We are going for programming that we think consumers want.

So since we are not trying to market by bragging about the number of channels, we’re going for quality, you may see a difference in our advertising versus some other competitors. But rest assured we are going to have everything that people really want.

Landel C. Hobbs

On price lock guarantee, the customer response has been quite positive. We are in the majority of our divisions now, which we’ve turned up primarily towards the -- in the fourth quarter. We’ll be in all divisions some time in the second quarter here.

What we’ve seen is a pretty dramatic ramp once we get it launched. In the divisions where we launch it, typically we are seeing somewhere in the high 30% sell-in from a bundle perspective. Another important thing to note is that what we have seen in some of the markets where we’ve been the longest is we’ve seen a 40% reduction in churn where we’ve launched the price lock guarantee. And also, we are still pulling quite good ARPUs out on these price lock guarantees, so it appears to be working and consumer response is strong.

Tom Robey

Tammy, if there is one more caller, we have time for probably one more question.

Operator

Our next question comes from Jonathan Chaplin of J.P. Morgan.

Jonathan Chaplin - J.P. Morgan

Thank you. I’m wondering if I could just get a little bit more color on EBITDA trends in the back half of the year. It seems if I’m doing this correctly, to get to your full-year EBITDA guidance given the guidance you’ve given for the second quarter, costs would effectively half to stay almost flat or actually come down a little for the second half of the year versus the first half of the year. But to get the revenue guidance, we are looking at about a $400 million increase in revenue in the second half from the first half. So is this all marketing expense going away in the second half or what are the other drivers on the cost side that help margins spike that much? Thank you.

Glenn A. Britt

That sounds like a good question for Rob.

Robert D. Marcus

Jonathan, I’m not going to do the math with you on the fly but suffice it to say that implicit in our reaffirming our OIBDA guidance, the back half of the year does drive the OIBDA growth. We are going to pick it up after the second quarter. In terms of the individual assumptions, we clearly get the benefit of our increased subscribers for the back half of the year, which we don’t necessarily get as we are ramping them up in the first quarter. And on marketing in particular, I don’t want you to jump to the conclusion that we are going to keep marketing higher in the second quarter and then drop it off thereafter. We are going to be very smart about the marketing that we implement and we are going to try to tailor it to when we think we can have the greatest impact.

So I think it’s fair to say that marketing is going to be up relative to last year throughout the year but we are going to tactically deploy that as we think it’s going to be most efficient.

Jonathan Chaplin - J.P. Morgan

Is there another bucket of costs that comes down?

Robert D. Marcus

As I sit here, there’s nothing that jumps out at me but we can go through that in greater detail with you. The other thing I mentioned during my remarks that I want to point out is we do have ad sales, which is a high margin business and has a meaningful impact on OIBDA, which is going to ramp in the back half of the year as well.

Jonathan Chaplin - J.P. Morgan

Great. Thank you very much.

Tom Robey

Thank you all for joining us.

Operator

Thank you. That concludes today’s conference. Thank you for your participation.

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