Welcome to Comcast’s second quarter 2008 earnings conference call. (Operator Instructions) I will now turn the call over to Senior Vice President Investor Relations, Marlene Dooner.
Marlene S. Dooner
Welcome everyone to our second quarter 2008 earnings call. Joining me on the call are Brian Roberts, Steve Burke and Michael Angelakis. Before we start, let me refer everybody to Slide Two which contains our Safe Harbor disclaimer and remind you that this conference call includes forward-looking statements subject to certain risks and uncertainties. In addition, in this call we will refer to certain non-GAAP financial measures. Please refer to our press release for the reconciliation of non-GAAP financial measures to GAAP.
Now, for opening remarks I’ll pass to Brian Roberts for his comments.
Brian L. Roberts
We’ve delivered solid results in the second quarter as we continue to focus on our financial priorities and to execute well in an environment that continues to be challenging with the economy and competition. Michael and Steve will provide lots of detail on the call but, let me go through some highlights. In the second quarter apples-to-apples, we delivered revenue and OCF growth of 8%. For the first half of the year we are executing according to our plan with revenue growth of 9% and OCF growth of 10%. As revenue and units are growing more slowly, we are appropriate continuing to focus on expenses. The second quarter results include slightly higher cable margins even as we invest in marketing through businesses like CBV and business services and improving customer service.
Earlier this year, I outlined our commitment to improving the customer experience end-to-end, as one of our core key initiatives for the company, and we’re working hard on every aspect. While it’s still early, we’re starting to see some real benefit from these efforts and today and on future calls we will continue to update you on our progress.
Our second quarter capital expenditures were 20% lower than last year and we remain focused on returns and growth. Our capital budget is on track, Steve Burke called it his fighter’s budget but as we continue to invest to recapture bandwidth and improve reliability and enhance our products and maintain our competitive advantage, while doing all of that we’re still able to bring in lower capital spending. Later in the year we will begin to deploy DOCSIS 3.0 and an all digital line up to the first 20% of our cable markets. As we do that, we continue to expect to meet all of our previous targets.
As a result of higher cash flow and lower capital expenditures, we delivered significant free cash flow in the second quarter of about $1.2 billion, more than triple last year’s amount. We also continued our program of repurchasing shares and we repurchased 48 million shares this quarter for around $1 billion. So, as I look at our position half way through the year, I’m pleased with where we are. Our businesses are fundamentally strong and yet resilient. I’m pleased with how we are executing. We have a strong balance sheet which is a real asset to this company particularly in this environment and we are striking the right balance to enhance shareholder value, investing in the business and new opportunities while being able to return a substantial amount of capital to shareholders.
With that, let me pass it to Mike Angelakis and Steve Burke to cover the numbers and to provide an update on operations.
Michael J. Angelakis
Please refer to Slide Four which highlights our second quarter consolidated results. The second quarter reflects solid operational results in our cable programming and interactive segments as well as the consolidation of the Insight cable systems. The company’s consolidated revenue increased 11% to $8.6 billion and consolidated operating cash flow grew 11% to $3.4 billion. On an apples-to-apples basis, our second quarter consolidated pro forma revenue growth was 8% and our consolidated pro forma OCF growth was 8%. Our consolidated pro forma margin for the second quarter was 39.2%, up slightly from last year.
Our reported net income for the second quarter was $632 million or $0.21 per share. Year-to-date, reported net income was $1.4 billion or $0.46 per share. Year-to-date net income for both this year and last year include gains from the dissolution of our Insight in Texas/Kansas City cable partnership. These are the only adjustments and when excluded, our adjusted EPS for the quarter increased 11% and for the six months of the year, our adjusted EPS increased 14% to $0.41 per share.
Free cash flow for the quarter increased 216% to $1.2 billion reflecting growth in operating cash flow and a reduction in capital expenditures from $1.6 billion in the second quarter of 07 to $1.3 billion in the second quarter of 08. Free cash flow per share increased 225% during the quarter from $0.12 in the second quarter of 07 to $0.39 in the second quarter of 08. It’s important to note that our free cash flow excludes any impact on the economic stimulus package. As described on page 8 of our second quarter press release, the economic stimulus package reduced our cash taxes by $315 million for the quarter. However, for normalized comparisons we have excluded that from our free cash flow. With year-to-date pro forma revenue growth of 9% and pro forma operating cash flow growth of 10%, our results are consistent with the full year target we provided at the beginning of the year. All despite an economic environment that remains challenging. As such, we remain comfortable with our full year guidance.
Let’s review our revenue results in more detail so please refer to Slide Five. Pro forma cable revenue for the second quarter increased 7.2% to $8.1 billion. Our video revenue growth of 3% reflects advanced services growth and rate adjustments offset by weak pay-per-view comparisons, continued promotional activity and the effect of a larger portion of our subscriber based in bundled plans. At the end of the second quarter of eight, one out of five of our customers took all three of our products. That compares to one out of nine in the second quarter of 2007. As I mentioned, this quarter’s video revenue growth was negatively impacted by pay-per-view as last year’s second quarter included two major events that generated $33 million in revenue.
Our high speed data revenue grew 10% in the quarter reflecting continued unit growth and relatively stable ARPU. We continued to gain market share and early indications continue to look favorable for our customer mix as new premium tier additions are outpacing those of our economy service by four to one. Our phone revenue increased 50% in the second quarter of 08 reflecting continued penetration of our market and growth in our CDV subscriber base. Consistent with each of the last eight quarters we added one percentage point of CDV penetration this quarter which now stands at 12.5% of homes [inaudible].
Our legacy circuit switched phone service continues to be a drag on revenue growth as phone revenue would have increased 77% year-on-year if we excluded the decline from our circuit switch business. Our business services group continues to experience healthy growth with second quarter 09 revenue of $138 million, an increase of 38% versus last year. Steven will spend more time discussing each of our services later in the call.
Unfortunately, cable advertising revenue decreased 2% in the second quarter of 08, highlighting that this business area continues to feel the impact of a softer economy, particularly our local business as well as the auto and housing related categories. We did recognize some political spend this quarter which accounted for approximately two percentage points of growth. While the advertising environment continues to look soft, we expect heavier political spending in the second half of the year.
As we review the programming division, this area continues to grow nicely with revenue increasing 10% to $366 million in the second quarter due to higher viewership, higher distribution and higher advertising revenue. The corporate and other category also saw strong revenue growth this quarter as we benefited from increased display and search advertising at our CIM property and incremental revenue from our Spectacor properties.
Please refer to Slide Six. The company’s consolidated pro forma operating cash flow increased to $3.35 billion, an increase of 8% for the second quarter. Pro forma operating cash flow for the cable division increased 7.6% to $3.36 billion. During the second quarter of 08, cable’s operating cash flow margin modestly increased to 41.5% from 41.3%. There are clearly some pluses and minuses impacting our overall cable margins and we are very focused on managing these leverages. For example, we continue to extract operating efficiencies in our CDV cost structure as we scaled to 5.6 million customers. Our direct cost per subscriber continued to see a meaningful decline of approximately 40% versus last year. Total direct costs related to our high speed Internet business, actual declined 5% on an absolute basis this quarter as we continue to migrate more traffic to our own network.
As we mentioned last quarter, we have been very focused on bad debt expense and this metric is back to levels similar to those in last year’s second quarter. We also had improvements in churn across all of our product categories compared to the prior year which we believe reflects improved retention and lower move activity in the marketplace. While we are benefitting from these efforts, we continue to invest in marketing by increasing our spend by 10% in the second quarter and 15% year-to-date and we expect to continue to do so throughout the year.
Another area of operational investment is in business services where expenses increased almost 70% this quarter driven by an increase in headcount, and acceleration in marketing as we continue to invest in the growth of these services. As the market evolves, we are very focused on pro-active management of our expenses and aggressively investing where appropriate. The programming division’s operating cash flow increased 17% from $75 million in the second quarter of 07 to $89 million in the second quarter of 08. Year-to-date programming operating cash flow has increased 44% from $140 million to $202 million. As we mentioned in the first quarter, we expect to see higher marketing and programming expenses in the second half of the year as we launch new programs in the fall and as such we do not expect this level of growth to remain throughout the year.
Please refer to Slide Seven. Total capital expenditures for the quarter were $1.3 billion down approximately 20% compared to pro forma capital expenditures of $1.6 billion for the second quarter of 07. On a year-to-date basis, consolidated CapEX has decreased 13% from $3.1 billion to $2.7 billion. Consolidated CapEX as a percentage of revenue decreased this quarter to 15.2% from 20.6% in the second quarter of 07 and year-to-date consolidated CapEX has decreased 16.1% of revenue from 20.1% last year. We remain disciplined with our capital expenditure program and consistent with historical trends, cable capital expenditures continue to be predominantly growth oriented and are directly tied to revenue generation.
As you can see on the Slide, growth CapEX was 76% of total cable CapEX for the first six months of the year. The most significant driver in this quarter’s CapEX decline was CPE. Given the significant number of set-top boxes deployed last year as part of our digital acceleration plan ahead of the July 1, 2007 regulatory deadline. During the second quarter we added 490,000 digital set-top boxes as compared to 2.1 million in the second quarter of 07. We are also being impacted by the economic slowdown related to the housing market as capital spent on new construction has declined 50% versus last year. These declines were somewhat offset by our continued investment in business services.
The timing of CapEX will vary from quarter-to-quarter and as expected, the bulk of our bandwidth and product enhancing investments such as all digital and DOCSIS 3.0 will begin in the second half of the year. Clearly, these investments are multiyear projects that will begin in the third and fourth quarter of this year and will likely extend in to 2010. While the strategic importance of transitioning in to all digital is obvious, our initial analysis indicate that converting a market to all digital can also generate attractive financial returns under relatively conservative operating assumptions. This is an area we hope to provide more granularity on later in the year. Just to confirm, these initiatives as well as a few others are all contemplated in this year’s plan. We remain comfortable with our full year guidance for capital expenditures as a percentage of revenue decline to approximately 18% of revenue for 2008 from 20% in 2007.
Please refer to Slide Eight. As we have said in the past, we have a disciplined financial strategy where we look to invest for growth and differentiation with a strong focus on returns on invested capital. Our strategy is supported by a sharp focus on free cash flow and giving the continued growth in our operating cash flow and lower capital expenditure we generated free cash flow of $1.2 billion this quarter. On a per share basis, we generated $0.39 of free cash flow in the quarter, an increase of 225% over the last year. Year-to-date we generated $1.9 billion of free cash flow versus $810 million last year or $0.62 per share, an increase of 138% from $0.26 per share during the first six months of last year. Remember, our definition of free cash flow remains unchanged and specifically eliminates any impact from the economic stimulus package. Free cash flow generation is a priority for the company and we are on track to achieve our full year target of at least 20% in free cash flow this year.
We have also maintained a disciplined investment and acquisition strategy that returns focus incented on extending our product leadership and gross platform features of our services. Recent investments in the regional sports network, [inaudible], Plaxo, [VX] and our proposed wireless investment are all consistent with this strategy to build long term shareholder value. At the same time, we are committed to returning capital to shareholders. In the second quarter of 2008, we repurchased $1 billion of our stock reducing our shares outstanding by nearly 2%. This, coupled with the payment of our dividend back in April equates to the company returning over 100% of free cash flow to shareholders. Over the last 12 months, we have repurchased approximately 3.9 billion of our stock reducing shares by approximately 6%. As of June 30th, we have 4.9 billion remaining in our current stock repurchase plan and our goal continues to be to complete this program by the end of 09.
Now, let me pas the call to Steve.
Stephen B. Burke
Half way through 2008, we are right about where we thought we would be, executing well on the plan we laid out for the year. We’re going to stick with the key elements of the plan including a balanced approach with aggressive marketing, continued high speed data and telephone growth, investment in new businesses like commercial and managing operating expenses and capital to generate strong operating cash flow and free cash flow.
At the beginning of the year, we said revenue growth would be in the 8% to 10% range. In the second quarter cable revenue gross was basically at the low end of that range due to difficult comps in pay-per-view, the unwinding of our circuit switch phone business and as Michael talked about, continued softness in the local advertising business. We managed expenses very well during the quarter. Now that our phone business is scaled, we’ve slowed down hiring and reduced contract labor which is actually down $80 million year-to-date. We’ve also put a number of tools in place to increase productivity. For example, we’ve given over 13,000 of our technicians handheld devices and have seen productivity in our technical workforce improve by 15%.
With over 5 million phone customers, our direct unit cost for providing phone service continues to decline; as Mike mentioned down approximately 40% versus last year. Capital costs are declining as well as result Tru2Way and the R&G program, our advanced set-top box costs are down over 25%. Thanks to DOCSIS 3.0 our downstream CMTS costs are 50% lower than a year ago. VOD costs are down 40% per stream.
Now, moving on to individual product areas in the next Slide, during the second quarter we traditionally have had a slow quarter for basic subscribers given our footprint. We loss slightly less video customers than we expected and keep adding digital subscribers during the quarter. Digital penetration is currently at 67% and we’re starting to convert markets to all digital in the fourth quarter of 2008. We think our digital conversion and the countries broadcast digital transition represent opportunities for us in 2009. Free up analog capacity will also make us more competitive as a high def platform as more people convert to high def television.
Moving on to high speed data, our high speed business continues to perform well with net adds equal to 82% of last year’s level, a comparable index to the first quarter. These results continue to suggest, as some have said, that DSL may be the new dial up. This quarter, approximately two thirds of our net adds came from DSL customers. Our ARPU has been stable as we balance premium and economy tiers. We’ve been testing a 50 megabyte service in the Twin City area and plan to launch this to 20% of our systems by the end of the year using DOCSIS 3.0.
Our phone business continues to do well and we’re on pace to add over $2 million new phone customers this year. We added less phone customers in the second quarter than the first but think this is probably due to seasonality and as you can see from the graph, we’re still in a very steep ramp. With phone penetration overall around 12.5% and some markets over 20%, we would anticipate many more quarters of growth ahead. Of note, we have now essentially unwound the remainder of the circuit switch business during the quarter. We inherited over $1.4 million circuit switch customers from the AT&T broadband deal and getting out of this business has been a drag on our results, we’re glad it’s behind us.
Our commercial business is now growing rapidly with revenues up 38% for the quarter. This is now a $500 million plus business, getting big quickly. We have 2,500 employees and are approaching full staffing levels. We’ve launched 8-line phone services across our footprint so we have the right set of products now to be fully competitive. This business is really starting to move. We’re also investing in reliability and service, improving the customer experience is a key priority for the company and we’re working on every aspect of it from call centers to technicians to network reliability. During the last few years we’ve integrated 4.5 million video subscribers and launched residential phone. Now that this work is behind us we look forward to optimizing the business and improving service. As we look to the second half of 2008, we’ll be launching two major initiatives that will position us for the future: going all digital; and DOCSIS 3.0. These initiatives will allow us to have more high def channels and faster data speeds in the future.
Moving to Slide 14, as we’ve grown each of our businesses and added new features, our ARPU has increased from $91 in the second quarter of 2006 to $110 in the second quarter of 2008. This Slide really reflects our approach to growth. Single digit growth in vide ARPU complimented by high speed data, CDV and new digital features such as DVRs and high def. Halfway through what is a difficult year for the economy and the country, we’re doing well and are right on plan. When you look at our results compared to our wireline competitors, I think it speaks volumes about the strength of the cable platform and our team’s ability to execute.
Marlene, let’s open it up for questions.
Marlene S. Dooner
Let’s open the call to Q&A.
(Operator Instructions) Our first question comes from Jessica Reif-Cohen – Merrill Lynch.
Jessica Reif-Cohen – Merrill Lynch
I was just wondering if you could comment on the outlook for program cost growth? We’ve heard from several companies who receive [inaudible] from you that they’re expecting double digit increases. We’ve heard some broadcasters talking about retransmission fees. I’m just wondering if you could comment on your own outlook giving the 3% video revenue growth.
Brian L. Roberts
Well, part of this is I think the revenue you have to look at is the combined package because the way we’re choosing to market, where we’re creating promotions for the consumer, which products work well in the bundle, so I personally am focused on the total $110 combined ARPU number myself. Year-over-year, that’s shown good growth and quarter-over-quarter good growth. Programming costs, are always each year a little different. There are definitely some things happening in the sports area that are creating some upward momentum on price as people create more networks with different teams, or different leagues, or different colleges. And generally, I think we are comfortable that there’s no create change that’s going to happen on the edges, there might be some increase distributors that are going to create an opportunity for programmers to try and increase rates and we’ve seen that trend in years gone by. Retransmission consent continues to be an area that there’s always a lot of tension around and it’s not my favorite public policy because I think it puts the consumer in the middle of free television and broadcast television. So, I think we’re going to have a pretty ability to manage that cost line. It may creep up a bit one year and creep down another year but so far this year we’re pretty on track.
Our next question comes from the line of Craig E. Moffitt – Sanford C. Bernstein & Co.
Craig E. Moffitt – Sanford C. Bernstein & Co.
Two questions, first Mike for you, you’ve described in the past a little bit a new capital budgeting process or sort of a new budgeting process with the regional business unit that pushes free cash flow responsibility out and sort of syndicates it out to the field. I wonder if you could just talk about what you’ve found so far in indicating that process and what your key learnings are? Then Steve, if you could comment on the company’s plans for the digital TV transition and what kind of initiatives and expectations you’ve got in place for next February?
Michael J. Angelakis
With regards to free cash flow and CapEX, we actually have from a budgeting standpoint we sort of categorize CapEX in to three areas: maintenance; growth; and discretionary, really driven that kind of mode in to the field so people are really understanding where they are spending dollars whether its on the maintenance side or the strategic or discretionary side, or on the growth side which really needs to have a pure revenue component. Clearly, CapEX has a very meaningful impact on free cash flow and I think people in the field or throughout the company understand that’s a primary focus of ours.
Stephen B. Burke
Craig, in terms of the countries digital transition, we think this is a real opportunity. It’s very, very difficult to precisely determine how big the opportunity is but just to give some range, we think that there’s between 6 to 8 million people that live in our footprint who currently get their television signals over the air and somewhere around 20% to 30% of those 6 to 8 million people will not be able to get digital signals over the year in our engineer’s estimation. So there’s a number, a million, 2 million people that live in our footprint that are going to have to get satellite or cable to have connectivity to their television. In addition, the other people who can get over the air signals, the evidence suggests right now that a lot of the coupons are not be redeemed. Once somebody redeems a coupon for the antennas, you’ve got to go home and set it up. So, we provide, I think, a very low cost alternative for somebody to reliably get service after the transition and we have a full comprehensive marketing campaign that we’re going to be launching in the not too distant future to go after the opportunity. But, the sort of $64,000 question here is how many units is it going to generate? The thing I will leave it at is it’s going to be a substantial number of new basic customers.
Our next question comes from Benjamin Swinburne – Morgan Stanley.
Benjamin Swinburne – Morgan Stanley
I wanted to ask about the digital to analog converter project and the all digital shift for 2009. I know you said you’ll be talking more about the sort of economic benefits later in the year. But, if you look at what Cablevision saw when they went through their digital transition, some of their systems they eliminated a lot of piracy and saw a nice basic sub lift. They also obviously saw a CapEX lift. I’m wondering on both of those ends, do you think there’s a chance you can see basic subscriber growth by attacking that piracy issue as you convert people over to a digital platform because you can encrypt better? And, within the context of your sort of long term view that CapEX decline as a percent of sales, does that change in 09 because of the move towards all digital or does that fit in to your broader long term view on capital intensity?
Brian L. Roberts
Right now only a very small percentage of the company has actually gone all digital, we’ve taken parts of Chicago all digital for example. The initial results indicate that a lot of good things happen once you go all digital; good things happen in terms of theft reduction, good things happen in terms of the elimination of truck roles when you disconnect a customer because you have the ability to do that on a remote basis so, the initial results would indicate that there are good solid economic returns in addition to the benefit of getting all that analog spectrum back. As Mike mentioned, we’ll be sharing those numbers with you but what we’d like to do is start to roll out more markets which we’ll be doing in the fourth quarter so that when we share the numbers, we have a bigger sample size. But, there’s no question in my mind, theft remains a real issue for cable companies, it always has been and the digital delivery mechanism has never been hacked. And, the fact that it’s never been hacked and by definition it’s going to be harder to try and steal our service would indicate that we should get a lift in basic subs.
I’ll take the capacity intensity side. It is still our goal that as a percentage of revenue the trend goes downward and we think we’re able to both this year and next year manage that appropriately.
Our next question comes from John Hodulik – UBS.
John Hodulik – UBS
A couple quick questions on the video competition, it looks like you guys were able to defy the typical seasonality that we see here in the second quarter. If you just talk about some of the promotions or what you guys are doing to really defend your share in the quarter and talk about any increase there or changes in the competitive levels that you’re seeing from pear Verizon in the quarter? Then lastly, with the new promotion with the Nintendo Wii if you could give us any detail on the economics there or what impact it might have on the margins.
Brian L. Roberts
Let me just start and then kick it over to Steve on the specifics of some of the marketing promotions. I think one of the things we said at the beginning of the year is that one of the goals of the company is to maintain superior products. How you communicate that to the consumer with our marketing and our messaging and different promotions is critical. I think in an age where more and more people want to use video over the Internet whether that’s YouTube or now just tons, and tons of streaming video – and we’ve always said video is friend of Comcast over the Internet. It is going to create more broadband demand and I think it’s going to help differentiate what it means to have faster, more reliable speed and I think that proved out in this quarter once again. The same goes for whether its our OnDemand platform and what Steve was just talking about in our all digital plan, we have all the specifics of how we’re going to do it and all the possible short term benefits but longer term, having a road map without needing a rebuild that is going to give us an ability to innovate and have more creative products both for video, on the data side and on the communications front and cross platform services, it is critical that we maintain our superiority and I think that’s what sort of showed through here when you compare our industry to some others.
Stephen B. Burke
In terms of the other product categories during the quarter, we’re spending more on marketing than we did last year and we’re trying to be aggressive in terms of the message that we’re bringing out to customers but, we’re also trying to be balance in terms of generating operating cash flow and free cash flow. If you look at basic subscribers, the second quarter we traditionally lost basic subscribers, we have a lot of college campuses in Florida, residents who disconnect because they go back North. But, just for reference, in 2005 we lost 95,000 subscribers in the second quarter 2006 91,000, 2007 101,000, 2008 138,000 so we think with all of the new competition on the basic subscriber front, that was pretty good performance. And, as I mentioned in the opening remarks, better than we had thought.
In terms of telephone, even though we added less phone customers in the second quarter than the first, 550,000 new phone customers is a lot of customers. We’re on a ramp to add over 2 million phone customers this year and that business is growing really rapidly so we feel good about that. In terms of the packaging and promotions, we launched a promotion where if you get a certain level of triple play service you get a Wii video game unit and we’re marketing that and we’re going to be pretty aggressive with that. And, we’re going to try to continually come up with new ways to talk to customers about our bundles and three product versus two product versus one product. I think it’s a very competitive world and we had a major promotion with the launch of batman that we were really proud of. So, I think what you’re seeing is we’re stepping up our game here and we want to do it in a balanced way and I think we need to be realistic that with more competition there will be quarters where basic subs do well and basic subs don’t do well. But, as a whole, I think we’re pretty pleased with our platform and pleased with the performance.
Our next question comes from Ingrid Chung – Goldman Sachs.
Ingrid Chung – Goldman Sachs
Two quick questions if I may, the first one on business services. I think you just reported revenue up 38% year-on-year. A very strong growth rate but a tad slower than the year ago growth rate for the full year. I am just wondering if you expect this growth rate to accelerate in the second half and do you think this soft economy is helping you or hurting you. Then secondly, I was wondering about net neutrality, would you ever go to a consumption based model for broadband?
Michael J. Angelakis
Let me start with business services, I think that business is really starting to ramp and you may be looking at since the business was so much smaller, if you look at the annual growth rates but I think the speed of the ramp now, I’m very pleased with. And, I mentioned on one of these calls a few quarters ago that I was getting impatient that the hiring was taking longer, everything else. We’re now, in my estimation on a very, very aggressive ramp that I’m very pleased with. Just to give you a range, we added close to 90,000 units in the second quarter of this year in the business space, we added 47,000 in the second quarter last year so that’s a pretty rapid ramp. What’s great about this business is we now have a lot of our sales people onboard, they’ve been trained and we have an 8-line phone product. Virtually, you pick what was in our footprint which was not the case just a few months. I think in my mind, the velocity of the ramp is speeding up not slowing down.
Brian L. Roberts
On the consumption based billing model for the net neutrality, as I think we’ve said before, we disagree with the FCC’s apparent finding by three commissioners. We believe our network management choices were reasonable, consistent with industry practices and we never blocked any websites or any applications as some of the articles have suggested. In fact, today’s Wall Street Journal had an interesting editorial on this raging debate that was whether this was the right path. That said, we’ve already said that we were going to adjust our network management techniques to go to a big more consumption based model for individual consumers. You have to manage your network to give everybody a great experience. I think almost universally, people are coming to that view from different perspectives, different network operators. I think we will continue along this road and find proper techniques that work that give many, many people a great experience and are in some ways less offensive to some for those who are offended.
I think it’s going to be an evolution, technology changes all the time. What people are doing on the Internet changes all the time, the vast amount of quantities they consume but, net-net I think people love our product, there’s a lot of trust in our product and I think that’s why you see it growing as well, as Steve might have said, better than the DSL.
Our next question comes from V.J. Giant – Lehman Brothers.
V.J. Giant – Lehman Brothers
If I could, two questions. First, for Steve, you have about a quarter and a half of your dual play voice data bundle to the [inaudible] subscriber base. Can you sort of talk about any traction there how you will be addressing to get them to come on board? And, a question for Mike, on your free cash flow there’s sort of an add back of $220 million of tax payment on non-operating items, can you just explain what that is?
Stephen B. Burke
On the two play bundles, right now if you look at the whole company, about 20% of our 24.5 million video customers takes all three products. Our triple play customers net-net, that’s up dramatically over the last couple of years. About 55% of our customers take two products and what we’re finding is the two product bundles, particularly in this kind of economy, this is an area where the economy clearly impacts our business, if we can offer low price two play bundles, it seems to be getting some real traction. Really, what we’re doing is we have a mix of offers, there are three product offers, the Wii offer which we referred to is actually a relatively high end offer but then we have two product economy offers for people who may not be able to afford all three products or for whatever reason don’t want to shift on one of the three. I think we’re getting better at managing the sort of spectrum of promotional offers.
Michael J. Angelakis
We can walk you through offline a little bit of the detail, but this is really a bunch of working capital items as well as taxes paid on things below the line. But, we can go through the details, it’s a lot of different items.
Our next question comes from Doug Mitchelson – Deutsche Bank Securities.
Doug Mitchelson – Deutsche Bank Securities
Two questions, one for Brian, and one for Steve. Brian, you talked about the balance sheet as a terrific asset in this environment so my question is, is it an asset you’re willing to use aggressively for acquisitions or does it just help everyone sleep better at night? Then for Steve, you talked about DSL being the new dial up, that’s a nice catch phrase. So, are you seeing these broadband share gains continuing in to the third quarter and how do you feel about the overall broadband marketplace? It’s hard to imagine the telcos are just going to take these market share gains laying down.
Brian L. Roberts
Well, I think the point that I was trying to make was that you see a lot of companies that can’t access the capital markets that are having issues with the stability of their balance sheet and its impacted their business in a radical way. That’s not hopefully ever going to happen, that’s something that we are very proud that we have got all our financing in place, we are generating free cash flow, we were able to use that free cash flow so I think it’s the strength of the balance sheet, as you put it to sleep at night. At the same time obviously there’s always an opportunity to take advantage of situations and having strength that has always proved well and the way we look at new opportunities. Mike do you want to add anything there?
Michael J. Angelakis
Sure. I think what Brian is referring to is obviously we’re in a pretty severe credit crunch so having a strong balance sheet we think clearly is an asset. Secondly, with regards to I think where you’re going Doug is on acquisitions and I think you can hear from the tone of the call today, we’re very focused on execution. But, as we said before, we also look at a number of acquisitions and we’ve made a few and I referenced a few of them in the call today with a key that we’ll be very disciplined and we’re really looking to build long term shareholder value so I think that’s where our head is at.
Stephen B. Burke
In term of cables relative share with DSL, if you look at what’s going on now on the Internet, we had a meeting the other day where we looked at the amount of video that’s being streamed on the Internet and the growth in that usage is phenomenal and in some ways that growth trend is faster than other technologies like DVRs or DVD usage or even cell phones. What I think people are finding as they use more and more bandwidth intensive applications, having half a meg or meg of down speed capacity just doesn’t cut it and so I think we have a platform advantage in that we’re offering much higher data speeds and we plan to continue that advantage and certainly continue our business moving in the future. The main way that we intend to get very aggressive in this space really going in to 2009 is a technology called DOCSIS 3.0 which is going to allow us instead of devoting one analog channel to our high speed data business to devote three or four and instead of offering speeds at 6 or 8 megs, go to 50 or even 100 meg and do that in all of our footprint, not just in specific areas.
If you look at the broadband market place, there’s no question that the conversion of narrowband to broadband is slowing down because there are just less narrowband customers out there left to convert. But, there’s also no question in my mind that consumers are going to go for higher data speeds when they are available and we intend really ubiquitously throughout our footprint to have very, very competitive data speeds and DOCSIS 3.0 is going to let us really shift in to another gear next year.
Doug Mitchelson – Deutsche Bank Securities
The hope is to the extent that with the DVR box, to try to cut price to normalize that share is not going to work because the demand for video is so high right now?
Brian L. Roberts
I don’t think it’s about price. The functionality and the use and the advantage of having a really fast Internet connection – for the last five years you’ve always been able to get lower speed product at $9 or $19 so that the price point I think is not the issue, I think the issue is what’s the value that somebody gets and what are they using the Internet for? If you just look at your own behavior or that of your kids or friends, when you’re streaming video you really want to have a fast data connection and whether it’s $9 or $40, if you’re using it every day for an hour a day you’re prepared to pay the higher price to get those kinds of speeds.
Our final question comes from Brian Goldberg – JP Morgan.
Brian Goldberg – JP Morgan
A question on your digitization efforts of the cable network. Can you share with us any important operational lessons you learned in Chicago? Was the process more or less disruptive to your customers or to your organization than you thought heading in to the process? Then secondarily, in the current economic environment have you seen any change in premium video downgrade trends.
Brian L. Roberts
The answer to the premium video downgrade trends is no, we really haven’t seen that. We are seeing more promotional activity on the part of consumers when they sign up. People I think are much more inclined to comparison shop and look for deals. We also have some customers which we really didn’t have a year or two ago that will call us up and say, “Look I’m paying $120, I really need to get that number down to $90.” So there is clearly an economic tangent out there but I wouldn’t say we’re having premium customers downgrade. We continue to add set-top boxes, etc. In terms of Chicago and the experience we’ve had on the digital conversion, the good news is right now we’re coming up on 70% of our customers having digital service already and of the remaining 30% about half of those remaining 30% are what we call lifeline or B1 customers, a little less than that so really you’re down to call it 15% of your base that you need to convert. For that 15% it’s a complicated and intrusive process. You’ve got to get set-top boxes or converters in to that home and that’s not without some pain.
That having been said, we’re planning this very, very carefully, we’re going to be doing it node by node and we’ve done other things like billing conversions and upgrades that have also been intrusive and in the scheme of those things we don’t think this is worse. The good news from Chicago is once we made those changes, once we took the market all digital, everything else financially has been much better than we thought since we did it. Now, that might not happen in every market but we’re pretty comfortable that once you go through that change, by the way we’re going to be giving customers more products and services after they make the digital transition, their picture quality will be better, they’ll have VOD, they’ll more channels, so once you get through it that coupled with the operating savings and everything economically it clearly is a good tradeoff realizing when you go through it for some people it requires a truck role and an intrusive process.
Michael J. Angelakis
It’s really a re-launch of our cable operations. It’s going to give us a new platform so like any of these major initiatives there will be some minority noise around customer experiences and I think we’re very sensitive to it, very focused on getting it right. It’s going to be done gradually, we’ll learn as we go so I don’t personally think it’s going to be super disruptive. People who have digital today, if they have a second, third, fourth or fifth set that doesn’t have digital they may want to get a box so there’s going to be an opportunity. We think we have a very exciting little unobtrusive device that’s much, much smaller than any box anyone has ever deployed before for people that want that just without VOD capabilities and then we have our standard box with VOD capabilities and then we have the high def box and the DVR boxes so there’s going to be a suite of choices, many, many more things than what you traditionally think of coming from cable. So, I think it’s going to be great.
Marlene S. Dooner
Thank you all for joining us this morning.
Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.
THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.
If you have any additional questions about our online transcripts, please contact us at: firstname.lastname@example.org. Thank you!