Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

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

Craig Moffett – Sanford C. Bernstein

Jason Bazinet – Citigroup

Vijay Jayant – Lehman Brothers

Jessica Reif-Cohen - Merrill Lynch

Douglas Mitchelson - Deutsche Bank Securities

Benjamin Swinburne - Morgan Stanley

Richard Greenfield - Pali Research

Ingrid Chung - Goldman Sachs

Tuna Amobi - Standard & Poors

Thomas Eagan - Collins Stewart LLC

Time Warner Cable Inc. (TWC) Q2 2008 Earnings Call August 6, 2008 8:30 AM ET

Operator

Welcome to the Time Warner Cable second quarter 2008 earnings conference call. (Operator Instructions) Now I’ll turn the call over to Tom Robey, Senior Vice President of Time Warner Cable Investor Relations.

Tom Robey

Welcome to Time Warner Cable’s 2008 second quarter earnings conference call. This morning we issued two press releases, one detailing our 2008 second 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, including operating income before depreciation and amortization or OIBDA and adjusted OIBDA. Adjusted OIBDA excludes the impact of any non-cash impairment of good will, intangible and fixed assets, as well as gains and losses on asset sales. For the second quarter adjusted OIBDA excludes the impact of a non-cash pretax impairment loss of $45 million triggered by our previously announced agreement to sell certain non-core cable systems.

Schedules setting out reconciliations of these historical non-GAAP financial measures for the most directly comparable GAAP financial measures are included in our earnings release or our trending schedule. 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 Friday, August 8th.

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 including the planned separation from Time Warner Inc. These factors are discussed in detail in Time Warner Cable’s SEC filings, including its most recent annual report on Form 10-K and quarterly reports 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 Britt.

Glenn A. Britt

I’m delighted to report that we’ve delivered another strong performance in the second quarter.

There are four key takeaways from our results. First, we posted very strong RGU growth, and that’s despite tougher competition and a weak economy. Second, we remain on track for the key elements of our full year financial outlook. And third, our competitive position is strong; we’re focused on making it even stronger. And fourth, we’re maintaining financial discipline while still investing for growth. I’ll spend a few moments on each item.

First of all, Time Warner Cable generated very strong subscriber net additions in the face of both tougher competition and a challenging economic environment. We added 20% more RGUs this quarter than in last year’s second quarter. That’s fueled by improved net additions in every RGU category. This is clear evidence of our compelling value proposition, our strong competitive position, and the effectiveness of our enhanced marketing efforts.

I’d like to highlight two of our subscriber metrics. We added 201,000 residential high speed data subscribers. That’s up from 188,000 in the second quarter of last year. In light of the performance of our telco competitors this quarter, the clear implication is that we are continuing to take residential broadband share. In addition, we added 15,000 net customer relationships and that’s compared to a loss of 8,000 last year.

The second item, we remain on track for the key elements of our outlook. In the second quarter we posted a 7% year-over-year increase in revenues and a 9% improvement in adjusted OIBDA. Free cash flow in the first six months was 40% higher than a year ago. This performance reflected the mixed impact of the economy in our business. As implied by our strong RGU growth, our subscription business continues to weather the environment well, as has been the case in previous economic downturns.

Our net additions were very strong, but the weak economy is affecting the subscriber business in both positive and negative ways. For example, on the positive side, the economy has led to lower churn, and on the negative side we haven’t been able to rely on high rates of housing growth in some of our markets to drive subscriber momentum.

More importantly, the weak economy has certainly affected our ad sales business. Consistent with performance of other local advertising businesses, ad sales has been weak this year. Advertising, of course, is a much smaller percentage of revenues than our subscription business, but because it has very high margins it moderated the impact of our strong subscription performance in this quarter.

We expect local advertising to remain weak in the near term. Nevertheless, we remain comfortable with our ability to manage our business in this environment. As Rob will discuss in a few minutes, we reaffirmed our full year financial outlook for revenues, adjusted OIBDA and free cash flow this morning, and we’ve updated EPS guidance to reflect transaction and financing costs related to our separation from Time Warner, along with a couple of smaller items.

The third point, we are continually improving our competitive position. Clearly, our high speed data service is competing very well. In the second quarter, we had twice the net ads of the two largest telephone companies combined even though their combined geographic footprint is more than three times the size of ours, and we’re able to strengthen our competitive position even further with DOCSIS 3.0. We’re competing well with video, too, both against the satellite companies and the telcos.

We’ve narrowed the gap in the number of linear HD channels we offer. In addition to our exploding HD channel lineup, offerings like Start Over position us well as the phone companies expand their video offerings in our service areas. We’re planning to greatly expand the availability of Start Over and other enhanced TV applications in our cable systems across the country in the second half of this year. And we’re aggressive in our marketing, especially with our Triple Play bundles and our Price Lock Guarantee. With edgier, more impactful advertising and higher spending in key markets, our value proposition is increasingly resonating with consumers.

We’re accomplishing all of this while maintaining our strict financial discipline. We’re carefully managing our operating expenses as highlighted by our ability to increase our adjusted OIBDA margin this quarter even as we increased marketing spending by 14% compared to last year.

Our capital spending is just as disciplined. Despite the acceleration of demand for HD set tops, we’re right on track to meet our target to spend around $3.5 billion of capital spending this year. At the same time, we’re also making investments to drive future growth, for example, in our commercial business after our planned investment in the new Clearwire.

Before I turn it over to Rob, I also want to mention a significant milestone this quarter. As you know, in May we announced the terms of our separation from Time Warner. In this set of transactions, we’ll increase our strategic and financial flexibility, we’ll simplify our capital structure, enhance the public float and liquidity of our stock, and we’ll return substantial capital to our stockholders. We’re working to complete the separation around the end of the year.

In summary, we’re very pleased with our second quarter results. Our subscription business performed very well despite a weak economy, and we’re directing all of our efforts to ensure that we’re well positioned competitively. Through our intense effort on operations and financial discipline, we’re laying the groundwork for enhanced shareholder returns.

Now Rob will give you additional insight into our financial performance.

Robert D. Marcus

I’m pleased to report this morning on another strong quarter of financial and subscriber performance for Time Warner Cable.

Turning to the first slide, let me discuss the highlights of the quarter. Once again we had outstanding subscriber performance this quarter driven by our intensified marketing efforts. We added 656,000 net RGUs in the quarter, bringing total RGUs to over 33.6 million. This was the 13th consecutive quarter in which RGU net additions exceeded 500,000. Perhaps more notable, our total RGU net adds improved 20% over the second quarter of 2007 which made this our best second quarter ever, a remarkable achievement given the challenging economic environment and increasing competition.

Our subscriber growth was broad based across our footprint, with noteworthy contributions from Los Angeles, which improved year-over-year, and Dallas, which had its best RGU performance since we closed the Adelphia and Comcast transactions in July of 2006.

We added 15,000 net customer relationships in the quarter, driven by gains in HFC only customers and HFC digital phone Double Play customers. We had 14.7 million customer relationships at quarter end.

We ended the quarter with 7.6 million customers in bundles. That’s 51.5% of our total customer relationships, an increase of 1.5 percentage points in the quarter. This growth was fueled by 214,000 Triple Play net adds, pushing Triple Play penetration over 19%. RGUs for customer relationship increased to 2.3 at the end of the quarter from 2.1 at the end of the second quarter of last year.

On the financial front, we had a strong quarter with year-over-year revenue growth of 7% and adjusted OIBDA up 9%. As Tom mentioned, adjusted OIBDA excludes a $45 million non-cash pre-tax impairment loss triggered by our previously announced agreement to sell certain non-core cable systems.

Finally, we are reaffirming our full year outlook for revenues, adjusted OIBDA and free cash flow and are updating our EPS outlook to reflect a number of items which I’ll go into in a few minutes.

Let’s turn to the next slide. Before I get into the details of our second quarter subscriber metrics, I want to highlight that in every RGU category our net additions were better this quarter than they were in last year’s second quarter. During the quarter we lost 9,000 basic video subscribers. That’s a 48,000 subscriber improvement from the 57,000 subs that we lost in the second quarter of last year.

Digital video subscriber net additions were 200,000 and penetration reached nearly 64% of basic video subscribers at the end of the quarter. That’s the seventh consecutive quarter in which we’ve added at least 1.4 percentage points of digital video penetration.

HD-capable subscribers increased by 351,000 and at the end of the quarter represented over 44% of our total digital subs.

DVR growth slowed a bit this quarter, with DVR subs increasing by 160,000 versus 186,000 in last year’s second quarter. At quarter end, just under 45% of our digital subs had DVRs.

We had another very strong quarter in residential high speed data, adding 201,000 HSD subscribers, which is 7% more than we added in last year’s second quarter. Residential HSD penetration was nearly 31% as of June 30th. We’re still not seeing any indication that we’re reaching any sort of a penetration cap. In fact, at the end of the quarter we had five divisions with over 40% residential HSD penetration, with one of those divisions now approaching 50%. And to be clear, that’s 50% of our homes passed. We also added a record 139,000 Roadrunner Turbo subs during the quarter.

Our residential digital phone net additions of 251,000 improved 5% year-over-year with penetration of eligible homes passed increasing 160 basis points to 13.4%. This marks our fourth consecutive quarter of more than 250,000 net adds. As with HSD, higher phone penetration hasn’t resulted in slower growth. We continue to experience substantial penetration gains in some of our most highly penetrated markets. We now have four divisions with penetration exceeding 20%, including one division that’s over 30% of eligible homes passed.

We also continue to gain momentum in our commercial business by adding 7,000 net commercial HSD subs and 6,000 net commercial phone subscribers in the second quarter. At quarter end we averaged 2.6 lines per commercial phone customer, up from 2.2 at year end 2007.

Moving on to the financial results, second quarter revenues of $4.3 billion grew $284 million or 7% over the second quarter of 2007. Subscription revenues increased 7% while ad revenues grew just 3%. Let’s touch on ad revenues first.

As was the case last quarter, the 3% ad revenue growth benefited from some changes which occurred during the last 12 months, including our taking over management of Charter’s local ad sales business in LA. Eliminating these changes, ad revenues actually declined slightly versus the second quarter of last year.

The soft advertising performance is reflective of the overall economy and its impact on the local ad market, which was only partially offset by incremental political advertising. In particular, we’ve seen weakness in those advertising categories that have been hardest hit by the economy such as auto, retail, telecom and financial services. We have been hoping that the local ad climate would improve in the second half of the year, but cancellations increased at the end of Q2 and the slow growth trend appears to be continuing into the third quarter.

Moving to subscription revenue, the 7% improvement was driven by continued RGU growth. Broken down by product line, subscription revenue growth was driven by 2% video revenue growth, 12% HSD revenue growth, and 39% voice revenue growth. Slower video revenue growth was largely the product of lower basic video subscribers during the quarter than in Q2 of '07 as well as lower pay-per-view revenues. You may remember that the Mayweather-De La Joya fight boosted pay-per-view revenues in last year’s second quarter, and there was no equivalent pay-per-view event this year.

On a dollar basis, total subscription revenue growth was driven primarily by HSD and voice, with each contributing around $110 million of the year-over-year revenue increase.

Approximately 12% of our year-over-year revenue growth came from our commercial business. Commercial revenues grew more than 20% for the quarter to approximately $190 million driven primarily by commercial HSD. Total ARPU increased 8% year-over-year to $108, with subscription ARPU also up 8% to nearly $102.

Turning to the next slide, second quarter adjusted OIBDA of $1.57 billion grew 9% year-over-year. Adjusted OIBDA growth reflects our 7% revenue growth and a 6% increase in operating expenses. We effectively managed our year-over-year operating expenses this quarter despite a 14% year-over-year increase in our marketing costs and a 20% year-over-year increase in our gasoline costs.

Employee expense did benefit from a $19 million decrease in equity based compensation expense due primarily to the timing of equity grants that were made in the first quarter of this year but in the second quarter of last year, however that benefit was almost entirely offset by increases in our pension and group insurance clauses.

Our adjusted OIBDA margin for the quarter improved 50 basis points year-over-year to 36.5%.

Turning to earnings per share basic and diluted EPS in the second quarter were $0.28. That’s the same as last year’s second quarter, however this quarter’s EPS included a number of items affecting comparability - which are detailed in our press release - that in the aggregate reduced EPS by approximately $0.06 per share. If you exclude these items, EPS would have increased more than 20%.

Looking at free cash flow on the next slide, we generated a healthy $825 million of free cash flow in the first six months. That’s 40% better than in the first half of last year. Higher adjusted OIBDA, lower income taxes paid, and favorable working capital comparisons all contributed to free cash flow growth. These items were offset in part by higher pension contributions as well as higher Capex, which I’ll discuss in a minute.

The lower income taxes paid were in part due to the benefit of the Economic Stimulus Act of 2008, which provides for accelerated depreciation on capital placed in service this year.

We converted 27.8% of adjusted OIBDA into free cash flow during the first six months of the year. That’s up from 21.5% in the same period last year.

Let’s move to Capex on the next slide. In the second quarter, Capex was $862 million, a 4% increase over last year’s second quarter. The year-over-year Capex growth was largely attributable to growth in our commercial capital expenditures while residential capital essentially stayed flat. Capex as a percentage of revenues continued to decline to 20.1%; 76% of our capital spending in the second quarter of 2008 was variable or success based, with CPE comprising over 60% of the variable spending. The growth in Capex was driven primarily by increased spending on scaleable infrastructure, which reflects our continued investment in our sustainable network strategy which includes deployment to switch digital video and our enhanced DV suite of services including Start Over and Look Back.

CPE expenditures also increased, driven primarily by continued deployment of HD boxes. You’ll note that line extension capital is flat year-over-year, but I point out that that reflects a roughly $30 million decrease in residential line extension spending offset by an equivalent increase in commercial line extension at Capex. Finally, capital expenditures through the first six months of the year totaled $1.7 billion, which puts us right on track for full year Capex to be roughly equal to our 2007 Capex of approximately $3.5 billion.

Turning to net debt on the next slide, at June 30th our net debt and mandatorily redeemable preferred equity totaled $12.9 billion. That’s a reduction of $731 million from where we ended 2007, and that’s driven by our strong free cash flow. That puts us at a 2.2 times ratio of net debt and preferred equity to trailing 12 months adjusted OIBDA. As I’ve said before, after paying the planned $10.9 billion special dividend and making our investment in Clearwire, our leverage ratio will be between 3.7 and 3.8 times. As we’ve also said before we expect that our strong free cash flow and OIBDA growth should reduce leverage and increase our financial capacity rapidly and I anticipate that we’ll be back down to our 3.25 times leverage target within a year after completing the separation.

And finally let me review our 2008 outlook on the last slide. As I mentioned a few minutes ago we are reaffirming our full year outlook for revenues, adjusted OIBDA and free cash flow. However, due to continued under performance in our high margin advertising business resulting from softness in the overall economy, we now believe that our full year adjusted OIBDA growth rate will likely be toward the low end of our outlook range.

As I mentioned at the beginning of my remarks, we are updating our EPS outlook to reflect the impairment loss on cable systems held for sale that I mentioned earlier as well as costs already incurred and anticipated to be incurred during the remainder of the year relating to our separation from Time Warner and our related financing activities. These are fairly mechanical adjustments that result in a $0.15 reduction in our previous EPS outlook range. Accordingly, we now expect that full year EPS will be between $1.10 per share and $1.15 per share.

That concludes my remarks. Thanks for listening and I’ll now turn it over to Landel.

Landel C. Hobbs

Our operations performed well the second quarter, reflecting our focus on the fundamentals and constantly improving our competitiveness. We achieved a steady performance in the face of a weakening economy and increasing competition so let me share with you an update on several of the key initiatives driving our competitiveness.

We continued to invest in marketing in the second quarter at a rate higher than last year. In fact, we spent 14% more. This increase in spending was both broad based and surgical.

For example, on the broad base front we have continued with aggressive promotion of our Price Lock Guarantee - or PLG, as we call it - which is now available in almost all divisions. In this quarter alone we added almost 200,000 PLG subs, increasing the number of customers taking advantage of our voluntary contracts by more than 70% in a single quarter. The impact on churn is dramatic. For example, in one division total relationship churn is down 20% year-over-year and voluntary churn rates were over 45% lower.

As an example of the surgical impact, we concentrated marketing efforts on our initiatives in the Hispanic market. As we indicated on our last call, we launched our new video offering for Hispanic households  El Paquetazo  in about a third of our LA footprint in April. During its first quarter of availability, it was a big hit. Although still relatively small in number, more than half of all the El Paquetazo subscribers are new customer relationships for us and more than half are signing up for bundles. Based on the success in our first deployments, we are rolling it out throughout the Los Angeles area as well as in New York City this year, and Texas will follow.

Now let me highlight some of the ways we’re making each of our product lines even more competitive.

In video we’re making good on our promise to add a lot more HD channels. Currently three divisions offer more than 50 HD channels. These are led by Albany with 59, San Antonio with 57, and parts of New York City  more specifically, Staten Island, Brooklyn and Queens also with 57. As the expanded deployment of switch digital video and complete the all-digital project in New York City, network capacity will not be a constraint on our ability to offer all the HD our customers want to watch.

Besides quantity, we offer consumers value. That’s because HD is free to Time Warner Cable digital video customers. And our consumer research shows that we’re holding our share of HD households.

In residential high speed data, we’re clearly taking share. Our 201,000 net adds in the second quarter were twice the broadband net adds of Verizon and AT&T combined. And consumers are demonstrating that they’re willing to spend more to get an even better Internet experience. Our continuing success with our Turbo offering proves that. When we need to go beyond Turbo to meet our customers' needs, we’ll be able to launch even higher speed services on the DOCSIS 3.0 platform.

Digital phone is a great story of steady consistent growth. While approximately 91% of our digital phone customers take our unlimited calling plan, we’re increasingly meeting the needs of other customers with offerings like unlimited in-state, local and our international one price plan. As a result we continue to take phone customers from the phone companies at a much faster pace than our modest video losses.

And commercial services are growing nicely. In particular, our business flat phone service is continuing to accelerate. We had net additions of 6,000 customers in the quarter, and just the other day we hit a significant early milestone - 50,000 lines in service.

I’d be remiss in talking about competitiveness without addressing our preparations for new video competition in New York City. Listen, we understand that events in New York City tend to receive hyper-intensive media coverage and the grant of a franchise to Verizon actually got more press than the All Star Game. But, listen, we and other cable operators have been facing this competition at other markets for some time now. Our efforts in the city mirror what we have done and continue to do in other parts of our footprint facing competition, and our preparations in New York City have been underway for some time.

First, our video products are very strong and we’re making them even better. As we outlined last quarter, we are aggressively adding HD channels to the line up in the city as we complete the conversion to all digital, so we expect to be able to offer 100 channels of HD content our customers want throughout New York City by the end of the year. In addition, our video service also has features that Verizon can’t offer, like Start Over and New York One, our local 24-hour news station which is available in both English and Spanish.

Our Roadrunner high speed data service competes very well, and we’re taking steps to make it even stronger. In the past month, for example, we introduced Power Boost, which increases instantaneous data rates. And, by the way, initial customer reaction is extremely positive.

Our digital phone service is also very effective at winning subscribers from the phone company and our international one price service in particular has been a success in the city. More than a third of our 50,000 international one price customers are in the New York City region.

On the marking front we have aggressively promoted the Price Lock Guarantee, and it clearly has reduced churn. And of course our bundling strategy has been effective in New York City as well, where we had more than 325,000 Triple Play subscribers at the end of the quarter for penetration of over 20%.

So let’s summarize. We performed well in the second quarter because we continued to focus on the fundamentals, striving to give our customers an even better experience. At the same time, we made our operations even more efficient. We also are no strangers to competition. We are consistent in our preparedness and our approach.

Thank you, and with that, I’ll turn it over to Tom for the Q&A portion of the call.

Tom Robey

We’re ready for the Q&A portion of the call.

Questions-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Craig Moffett – Sanford C. Bernstein.

Craig Moffett

First, for Landel, commercial is coming along. You described it pretty positively, but the numbers are still relatively modest. I wonder if you could just update us a little bit on commercial as to what we can expect in the back half of this year and into '09? Can we expect it to accelerate as you’ve got more fire power and with the voice products ready or is this kind of what we’re going to see now is this kind of run rate?

You know, as you come out of '09 and you’re - having paid the one time special dividend, your leverage will be back down into your target range. Can you update us anymore on what you’re thinking about capital structure post '09 and the deleveraging that will come in the wake of the special dividend?

Landel C. Hobbs

On the first one, Craig, listen, on commercial, as we said in the past, the way we - our approach to this business is we’re taking a very measured and consistent approach. And yes, we do expect it to continue to grow like you’ve seen in previous quarters. So quarter in and quarter out, we’re seeing acceleration in the phone product. And remember, that’s only one small part of the business. We’ve got a commercial data product and we’ve got the phone product.

I think last time we were together I mentioned that we also have what we’ll call our big business, which is focusing on Internet - dedicated internet access and metro Ethernet. It’s also Cell backhaul. So what we’re doing right now out in the field is working on putting back rows together. We’ve hired the personnel. And now you’re beginning to see it gain traction. So each quarter as we progress, we expect this thing to accelerate.

Robert D. Marcus

So, Craig, before I get to the capital structure point, the one thing I would encourage you to do is not focus inordinately on subscriber growth on the commercial side. And if you’ll look at our commercial revenue growth, I think the growth is quite substantial, and increasingly we’re going to try to give you better metrics to measure our performance on the commercial side because I think looking at subscribers alone just falls short.

On the capital structure question, you know, I’ve said this before. We’re committed to maintaining our solid investment grade rating. We’ve set as a leverage target around 3.25 times, and I’ve also said that, as you mentioned, coming out of 2009 we should be back in that ballpark. So as we start to build financial capacity there’s no question that we’ll be considering how best to deploy that financial capacity and we’ll consider all the alternatives including, you know, the institution of a regular dividend as well as implementing a share buyback.

Operator

Your next question comes from Jason Bazinet – Citigroup.

Jason Bazinet

I just have a question on the cablevision network DVR case. Assuming that gets upheld by the higher courts, how long do you think it would take you to make the transition to a network DVR. And then strategically, you know, how do you think about that opportunity in the context of potentially, you know, capturing more advertising revenue from the business and/or, you know, getting more unfettered access, I guess, to VOD content?

Glenn A. Britt

Jason, this is Glenn. Let me try to handle that. I think, first of all, on the basic technology we’ve said for a long time that centralized network DVR is a better engineering solution than having hard drives all over in everybody’s home. That’s almost self evident from a technical sense.

And obviously, if this particular court case is upheld and that becomes the law, we will deploy that. I would also point out that this company actually has developed a lot of the technology underlying this idea, and Start Over and enhanced TV uses that. So it could be deployed fairly quickly.

But I also think that, if you talk to a bunch of the lawyers, like lots of things in the law, this is a lot more complicated than the headlines appear. So maybe this will all be fine and we’ll deploy it, but I don’t think we fully know that yet.

Operator

Your next question comes from Vijay Jayant – Lehman Brothers.

Vijay Jayant

You guys are probably the test market on this digital transition in Wilmington, North Carolina, I think. Can you just talk about so far given everything, the transitions in early September, have you [got many] left, you know what’s the conversion rate, and, you know, how is the transition really going there? Any comment would be great.

Glenn A. Britt

Thank you. This is Glenn again. Yes, for those who haven’t followed all this, there is the broadcast to digital transition next February, and the FCC, working with broadcasters and ourselves and Charter in the Wilmington, North Carolina market, has decided to do that transition early in September as kind of a trial run. And actually there’s a public event around that tomorrow that I’m going to be at along with some of the commissioners.

It’s really too early to report anything, Vijay, I think. And I know different cable operators have different opinions about what this may mean for cable. My own view is that we will probably gain some subscribers from it at the end of the day, but I’m not sure that it’s going to be that big a deal. I think the people who were still watching only off air TV are certain demographics. They’ve probably been marketed to numerous times over the last 20 years. And it's not like they haven't known about multi-channel TV and it's not like they haven't decided not to buy it. So, yes, a few of them will come over, but I don't think it's going to be a big wholesale shift.

Landel C. Hobbs

The only thing I'll add is Glenn's exactly right. You know, what we've seen today is on the margin we can see very, very little movement in the over the air - the OTAs, as we call them. And the same thing down at Wilmington, even though that market is being inundated with advertisements around what's happening, trying to educate folks. The next big learning milestone, as we call it, is the day after.

So I think we'll have some learnings after the shift and see what happens the day after, but leading up to it, in that market and other markets, we've seen very little activity.

Operator

Your next question comes from Jessica Reif-Cohen - Merrill Lynch.

Jessica Reif-Cohen - Merrill Lynch

On voice I'm wondering if you can comment on how much more room there is for improvement. It looks like the gross margin went from 62% last year to 67%, so as you scale up what do you expect to get to?

And then secondly, on programming expenses, the 6% growth was relatively modest and, you know, after listening to all of the second quarter calls of many of the programmers, we're talking about - it feels like expectations on the programming side are much higher, and I'm just wondering if you can comment on how you expect programming expenses to ramp up, not just for the back half of the year but over the next few years?

Glenn A. Britt

Jessica, why don't we have Rob do both those, and Landel and I can jump in if we see something to add?

Robert D. Marcus

So most of the direct costs on the voice side, Jessica, is in fact variable. What you're seeing the benefit there in the uptick in gross margins is a one-time renegotiation we had with our provider on this, so that's what you're seeing there. So I wouldn't expect anything like that improvement to continue.

On the programming side, yes, the 6% is more moderate that you've seen previously, and that's largely a function of the fact that we had lower subscribers during Q2 of this year than we did in Q2 of last year. We mentioned the decline in pay-per-view reviews. That had an associated cost benefit with it. And we also had no new services during the quarter. So I would expect that programming costs are going to be higher on a growth basis relative to prior years as we go through the remainder of the year.

We do have a significant reset of a particular network in the third quarter and that'll have some impact, and we'll also start to see the impact of increased subscribers as we close out the year.

Operator

Your next question comes from Douglas Mitchelson - Deutsche Bank Securities.

Douglas Mitchelson - Deutsche Bank Securities

I'm curious on your view on the sustainability of these strong subscriber numbers since there's been a lot of volatility over the last year, and so if you can comment on how much your increased marketing spend has been the driver and how sustainable those efforts can be on subscriber growth since marketing impacts can often be short lived. How much of this is a change in the competitive environment, given you've gained a lot of share in the [R box] and they might not just sit still. And then how much of this was easy comparisons in Dallas and LA? Obviously, you had a pretty big improvement in 2Q trends from 1Q. I'm just trying to disaggregate how sustainable the 2Q results were.

Glenn A. Britt

Doug, I think Rob can handle that. I would just say I think it's a mixture of all those things, but Rob, why don't you dive in?

Robert D. Marcus

Well, I was simply going to say that it's a combination of our intensified marketing efforts. Yes, we're starting to see the benefits of increased penetration in the LA and Dallas markets. So I'm not sure there's much more to say than that.

To the point of whether or not this is sustainable, we continue to get encouragement from the fact that in our most highly penetrated markets on the HSP and phone side, we're still seeing substantial growth.

Landel C. Hobbs

The only thing I'd add to that is remember that marketing spend, the increases you've seen in the first part of the year, we're trying to be pretty targeted, so it's been around Price Lock Guarantee, which is selling great consumer acceptance. So that we expect will continue. We'll keep focusing on the Price Lock Guarantee. Our focus on Hispanic, we've seen real traction there.

So when we think about this marketing, as you know, we track it specifically. We look to make sure we're [inaudible] that it's actually having the returns we want. So we evaluate that each quarter as we go forward.

Douglas Mitchelson - Deutsche Bank Securities

And maybe then, just to put a short-term focus on it, is it fair to say that the trends we saw in 2Q are continuing into 3Q?

Landel C. Hobbs

Listen, Doug, we're not going to give guidance on the next quarter's RDU growth. What I would say - just one thing, so everybody remember - is seasonality affects Q2 and Q3 in a similar nature. Typically you have one strong month in both of those quarters and two weak months. So I'm not going to lean into guidance there, but just remember seasonality affects us pretty similarly in both of those quarters.

Operator

Your next question comes from Benjamin Swinburne - Morgan Stanley.

Benjamin Swinburne - Morgan Stanley

One on commercial, Rob. You talked about how we should be looking at this business, and I think you mentioned two and a half lines per sub on the phone.

Robert D. Marcus

2.6 lines we're up to.

Benjamin Swinburne - Morgan Stanley

Yes, 2.6 lines. If you look at your commercial high-speed data sub base or customer base, what's the average line there? It seems like there'd be some real low-hanging fruit here to drive a lot of revenue without even driving a lot of net new customer growth.

And then just one quick follow up. If there's any way to quantify on the basic sub side how much the new Latino tier, which I'm not going to even try to pronounce, benefited the quarter, that would be helpful.

Robert D. Marcus

Okay, on the commercial side, you know, as I said, we're still trying to figure out what the best way to measure our performance there is, both for us internally as we manage the business but also to report to you guys so you have a better feel for what's happening.

On the phone side, we have started to look at this lines per customer. For actually the HSB side, the better way to look at it is in our ARPUs, and our commercial HSB ARPUs have been improving nicely. I think we're up to this quarter somewhere in the neighborhood of $153, $154 a customer, and that's up fairly meaningfully from last year's second quarter. But I think that's probably the better way to look at that particular one because it doesn't lend itself to the same lines per customer count as the phone business does.

Benjamin Swinburne - Morgan Stanley

I guess I asked it poorly, but if you look at your commercial high speed data sub base, are those customers using 10 lines per business with the telco so that if you can convert them over you've got a lot of revenue to go after?

Robert D. Marcus

It is certainly the case that a prime target market for us on our phone business is our existing HSB customers, if that's what you're asking.

Landel C. Hobbs

And those businesses we've got are primarily small businesses, even on the high speed data product. So the exact number of lines I would say is probably smaller, somewhere less than 10 lines per, but that is a focus of ours. The first place we're going, that SMB business, is to try to bundle. That's where it is. A little somewhat of residential is we're going to try to focus on bundling, especially in those small businesses.

Glenn A. Britt

I would just repeat on commercial. I think we're trying to find - it's a very complicated set of businesses, different products, and we're trying to figure out metrics to report to help all of you understand it better as just opposed to saying here's the revenue or here's lines because lines don't really capture the whole thing.

Landel C. Hobbs

Ben, I think your other question was on El Paquetazo, and you're right, I'm sure I don't pronounce it properly either. In LA, just an example, it was around 3,700 new subs, so one of the places in LA that we're looking at for basic growth is the Hispanic marketplace.

Now remember, El Paquetazo doesn't mean we've never had an Hispanic focus. Basically, though, what we've done there is augment the package where we have more Hispanic-focused content than anyone else in that market out there. So what we've seen early on is it's very attractive to our customer base, so much so that we're trying to put together now a similar package in New York City for launch later this year.

So in the battleground for basic subscribers, we see this as a real opportunity for us.

Operator

Your next question comes from Richard Greenfield - Pali Research.

Richard Greenfield - Pali Research

A couple of questions. One, just to follow up on a question that was asked earlier on network DVR, I was just hoping for Glenn's perspective because one of the parties, I believe, to the lawsuit is actually Time Warner at the Cartoon Network actually suing to prevent network DVR, and just was hoping that you could give some color on how you think that reconciliation goes between you and Time Warner parent.

And then two, just looking for a view, Univision has now filed for retransmission consent negotiations at the end of this year and wanted to get your perspective on how you think that plays out and how willing you would be to pay cash for carriage of those stations given your markets.

Glenn A. Britt

Okay, Rich, I'll do the network DVR and let Rob do the Univision one.

Actually, the network DVR thing I think is pretty straightforward both outside and inside Time Warner. I think there's - essentially how our system works, there's a question about what the law really is in this area. And the plaintiffs, which include Time Warner, are arguing that the law says this requires copyright permission from the copyright holders, and the other side, Cablevision, is saying it doesn't, and it's the role of the courts to determine that.

And I think, you know, as I've said, the engineering attraction of the network DVR is clear. What isn't clear is the law. And we'll do whatever the outcome is. If the outcome is we have to get copyright permission, that's what we'll do, as we've been doing. We'll start over. And if the outcome is network DVRs don't require copyright permission, then we'll do that. So there really isn't any particular conflict over this issue.

Robert D. Marcus

So, Rich, on Univision, I'm obviously not going to comment on the specific discussions or potential discussions with Univision or comment on our willingness to pay any demand that they might make, but what I will say is the fact that Univision has elected retran as opposed to must-carry is, you know, comparable to what numerous other broadcasters are doing in this retran cycle.

We've been through it many times before. We've always come to successful conclusions of those negotiations, and I'm confident that we have a mutuality of interests here with broadcasters in bringing product to our and their respective customers. And I'm confident we'll reach satisfactory conclusion this time as well.

Richard Greenfield - Pali Research

Can you give us any sense of how important in that Latino package that you're rolling out Univision is to that package?

Robert D. Marcus

Look, Univision's very popular programming, and we're anxious to deliver it to our customers. And I trust that they also place a very high value on the distribution that we provide. So I think it leaves us to get to the right place in the end.

Operator

Your next question comes from Ingrid Chung - Goldman Sachs.

Ingrid Chung - Goldman Sachs

So just two quick questions. Given the relative weakness from the telco 2Q results, I think it was basically implied that they're going to increase their marketing and promotional spend in the third quarter. I was just wondering if that's the trend that you've been seeing versus 2Q, and do you expect your own competitive response to basically accelerate in the second half?

And then separately I was wondering did you say earlier that you've seen churn be reduced across all your products year-over-year?

Glenn A. Britt

I'll just do the churn thing, and then Landel can talk about marketing.

I think we have generally been saying lower churn this year, and we think that's being affected by the economy. Unfortunately, the biggest cause of churn for us is people moving, and the way we count churn is even moves within town where people may disconnect and reconnect up on another street, as well as moves out of town. So what we're seeing is lower churn, and I think it's unfortunately a sign that people can't sell their houses and they're just not moving as much as they were. It happens to be good for our business because we don't have the expenses, but that's what we're seeing and it clearly is an economic thing.

Robert D. Marcus

Ingrid, the mechanical answer, though, is that yes, year-over-year, every RGU category has got lower churn this year than last.

Landel C. Hobbs

Ingrid, on the marketing question, a couple of things. No, we have not seen a dramatic increase in their marketing around their DSL products yet. We may see that in the third quarter. I'd say our approach to it is a couple things.

Remember, I think, if you heard us talk before, our general approach against their DSL product is we're faster, and so that's a component we're focused on and we'll stay ahead of them in terms of speed around their DSL product.

Secondly, on our marketing, as you've seen through the first half of the year, we've increased our marketing spend year-over-year. To the extent that makes sense, and we evaluate each quarter, that will continue, more specifically around high speed data. It's always in the context of our bundles, whether it be in Price Lock or else wise, and where we have different flavors. So we have the standard and particularly Turbo has been doing quite well for us, so a lot of our marketing will be around the Turbo product, which our upsale there has been quite nice, and then the standard as well because it's typically faster than the DSL product.

So that is an area of our marketing spend. When we've increased it, it has been around the focus on high speed data.

Operator

Your next question comes from Tuna Amobi - Standard & Poors.

Tuna Amobi - Standard & Poors

First on the wireless, I guess, for Glenn, with regard for the 3G bundle which you have upcoming with the Clearwire, Sprint, just any update on the timing of that and how that might differ from what you've done in the past with [inaudible]? In other words, I'm trying to get a sense if there's going to be - what the wireless broadband component of that bundle, if any, is going to be.

And separately, I guess, for Landel, on the PLG, it seems to be getting a lot of traction, so that's very good news, but I was wondering if you've done any kind of analysis on the lifetime value of a PLG subscriber vis-à-vis your nonPLG? Any kind of upfront payment that's involved in those subscribers and the dynamics of churn, you know, etc., marketing ARPU. I just don't understand how that, you know, product is directly affecting your bottom line numbers. That would be very helpful.

Glenn A. Britt

Let me talk about the wireless part. There really isn't much new to report on that front. I think we've been pretty consistent. Our view and my view is that the existing technologies represent for us largely something to do if consumers really demand the quadruple play, and we've seen very little evidence of the demand for that so far.

Behind the scenes there is a great deal of work going on on what those products might look like, but we don't feel any compulsion to roll those things out right now, particularly in light of, I think, the overall wireless market seems to be maturing pretty rapidly.

We do see the 4G technology and the Clearwire deal is still going through the regulatory process and has not closed, but we do see that potentially as a very different kind of business, with different products and services and maybe different economic formulas than we've seen in wireless to date. So we're going to [comment] on that as we get it in three years.

Tuna Amobi - Standard & Poors

So just to double check, you're not planning any major rollout on the 3G front end part of it, so it's more like a longer term 4G strategy?

Glenn A. Britt

Yes. I'm really focused on the 4G part, and I think 3G is there if we need it.

Tuna Amobi - Standard & Poors

Okay, helpful. Landel?

Landel C. Hobbs

Sure. Okay, on PLG, a lot of questions in there, and so I'll try to be concise in my answer because there's a lot of things that went into what you described in terms of questions.

First of all, yes, we do think it has a positive impact on lifetime value and is good for our business long term. Here's some of the things we look at when we evaluate it.

Of course, we look at migration, and what I mean by migration is this: One of the great things about PLG - first of all, it's voluntary for our customers - it migrates, for example, singles to doubles or doubles to triples, so you'll selling incremental RGUs every time you quit someone or migrate them through a Price Lock. That's a good thing because we make money on each RGU, then we focus on making sure we take out the right amounts of money on those incremental RGUs.

Of course, the churn reduction has an improvement on the value or the lifetime value of the customer as well.

And then the ARPU takeout of the overall PLG, we make sure we manage very carefully we're taking out the requisite amounts of money.

So we evaluate all those things in terms of is this a good decision. So importantly, it was a good decision for us, it improves the lifetime value. Also a good decision for the customer. It's voluntary and the uptake has been pretty substantial so they're voting, basically, by moving to it. You know, roughly all our divisions - right now we have somewhere around 534,000 PLG customers, and the uptake on that has been accelerating.

Operator

Your last question comes from Thomas Eagan - Collins Stewart LLC.

Thomas Eagan - Collins Stewart LLC

I guess this is for Rob. You know, you're keeping your revenue guidance at 9% for the year. Obviously you must be expecting higher, you know, 9.5% plus revenue growth for the second half. I guess I was wondering if you could talk about what the sensitivities are there like, for example, what might derail that? Is it you need to have continued improvement in the acquired system subscribers, you know, with the R-box? You know, obviously you're going to be marketing it aggressively in the second half, what that could mean.

Robert D. Marcus

Yes, I guess a couple of things that drive our expectation that revenue growth in the back half will be higher than in the first half. One, we start to get the benefit of the increased subscribers that we - or RGUs that we've amassed during the first half of the year, so that gives us some benefit.

One thing that's worth pointing out is that sequentially in 2007 we had actually a decline in revenue from Q2 to Q3 and pretty modest growth in revenue from Q3 to Q4, so it actually gives us a fairly favorable set of comparisons in the back half of the year.

And the last piece is we are expecting some benefit from political advertising as we go into the fourth quarter.

Tom Robey

Thank you all for joining us. That concludes the conference call today. A replay will be available in a couple of hours and will run through midnight Friday. Thanks for joining us.

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: transcripts@seekingalpha.com. Thank you!

Source: Time Warner Cable Inc. Q2 2008 Earnings Call Transcript
This Transcript
All Transcripts