Time Warner Cable, Inc. Q4 2008 Earnings Call Transcript

| About: Charter Communications, (CHTR)

Time Warner Cable, Inc. (TWC) Q4 2008 Earnings Call February 4, 2009 10:30 AM ET


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


Ben Swinburne - Morgan Stanley

Spencer Wang - Credit Suisse

Craig Moffett - Sanford C. Bernstein

Jessica Reif-Cohen - Merrill Lynch

Ingrid Chung – Goldman Sachs


Welcome to the Time Warner Cable fourth quarter 2008 earnings. (Operator Instructions) Now I will turn the call over to Mr. Tom Robey, Senior Vice President of Time Warner Cable Investor Relations. Sir, you may begin.

Tom Robey

Good morning everyone. Welcome to Time Warner Cable's 2008 full year and fourth quarter earnings conference call. This morning we issued a press release detailing our 2008 full year and fourth quarter results.

Before we begin, there are several items I need to cover. First, we refer to certain non-GAAP measures, including operating income or loss before depreciation and amortization, and adjusted operating income before depreciation and amortization or adjusted OIBDA. Schedules setting out reconciliations of these historical non-GAAP financial measures to the most directly comparable GAAP financial measures are included in our earnings release or our trending schedules.

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 economic, business, competitive, technological, strategic and/or regulatory changes that could affect our business. 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.

Finally, today’s release, trending schedules, presentation slides and related reconciliation schedules are available on our company’s website at www.timewarnercable.com/investors. A replay of today’s call will be available today beginning approximately two hours after the call has ended and will run through midnight Friday, February 6.

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

Glenn Britt

Thanks Tom. Good morning everyone. Despite a rough economy and increased competition we grew both revenues and adjusted OIBDA in 2008 by 8% each. We delivered a record $1.8 billion in free cash flow. From this perspective 2008 was a very good year for Time Warner Cable. Of course it was also a tough year in several ways. Reflecting the difficult economy advertising revenue was weak, growing only 4% despite strong political spending in the second half of the year.

Because advertising tends to be a high margin business, this slower growth weighed on the company’s overall profitability. We added 2.2 million revenue generating units in 2008, a large number but much slower than 2007 due to dramatically slower fourth quarter RGU growth. We warned of this slow down during our last earnings call but now it has happened so we should spend a few minutes talking about it.

Remember that our business is characterized by a large number of transactions; connects and disconnects. They net to a relatively small change against a large base of subscribers. These net changes are determined by two things. First, forces in the business environment and second our own actions.

Though the details vary by product and vary by geographic region the broad trends are very consistent. So what is going on around us in the business environment? First the economy is weak, that is not news to anyone. Consumers are spending less on a broad range of goods and services.

Second, Telco competition has expanded to a more significant fraction of our footprint. As they enter new areas they have initial gains and subscribers. You remember that we benefited from the same phenomenon when we rolled out digital phone a few years ago.

So that’s what is going on in the environment. What about our own actions?

We are always balancing subscriber growth versus profits versus long term quality of our subscriber base. The primary tools we use are offer strategy, credit policies and marketing spend. The fourth quarter we remained conservative on credit policies. We tried to hold the line on pricing and we took a measured approach to marketing spend.

These actions change over time and we constantly debate the right balance. My take away from 2008 performance is that we are not immune to the economic and competitive forces around us. However, our strong subscription relationships enable us to perform better than many other businesses even in these difficult economic times. We have continued to grow as many other industries contract and we have demonstrated that our business can continue to generate impressive levels of free cash flow.

Turning to 2009, I would like to highlight several specific areas in which we expect to focus our efforts. First, we will continue to focus on striking the right balance between subscriber growth and profitability. As we enter 2009 the environment obviously is not improving. However, we are cautiously increasing marketing spend and we are seeing some positive impact from that.

Second, we are going to pay a lot of attention to costs. This isn’t something new for us but there is a heightened need for disciplined management of costs both indirect and direct costs in this economic environment. We intend to reduce indirect costs and will continue to find ways to operate our business more efficiently. We believe these measures will enhance the long-term value of our business.

We are also looking hard on costs that directly relate to activity levels. Fewer consumers are moving and RGU growth is slower than it was before the economy turned. That means we need fewer front line personnel. At the moment we believe we can match our costs to activity levels through attrition but we are going to continue to monitor that situation closely.

Third we expect the Telco’s to continue the expansion of their video footprints. We are going to focus on differentiating our product rather than just price competition. We are going to approach this through innovation and by more clearly defining our brand and its meaning to consumers. Our efforts will be guided by our understanding of what consumers really want rather than simply copying our competitors. We will market our services aggressively asserting our competitive advantages.

Fourth we will continue our focus on commercial business which we see as our biggest near-term growth opportunity. Our commercial revenues grew at three times the rate of residential revenues in 2008. We expect that in the year ahead they can continue to grow at very healthy rates despite the weak economy. It is important with that expectation we are structuring our commercial business to give it the attention and resources that it requires.

Fifth, we expect to make meaningful progress in further defining our wireless strategy. As we said before we have no intention of creating another cellular telephone company. However, we do see opportunity over time to offer a broad array of services to a variety of devices over both wired and wireless transmission technologies. As part of this we plan to roll out an additional offering in conjunction with Clear Wire in at least one city later this year.

Sixth, we expect near, tangible progress in advanced advertising from the Canoe venture.

Turning next to the financial outlook I think you will agree in the current environment it is very difficult to forecast financial results with any precision. As a result we will share with you a forward looking perspective that includes both quantitative and qualitative elements but perhaps in less detail and less formal manner than in the past. We intend to provide updates throughout the year. Rob will speak more to our forward looking views in a minute.

To summarize, we have a fundamentally strong business built primarily on subscription relationships with more than 14.5 million consumers. We think this makes Time Warner Cable better positioned for the current economic environment than any other businesses.

In financial terms we are focused on growing the business in 2009 as we continue to balance subscriber growth and profitability.

We intend to drive 2009 performance through differentiation from our competitors and relentless focus on costs. We have the ability to manage spending, both operating expense and capital to fit the economic realities as the year progresses. As a result we expect to generate healthy levels of free cash flow even in periods of more moderate growth.

Before we go to Rob let me briefly update you on the separation from Time Warner. Although nothing is ever certain we hope to get the regulatory approvals and complete the transaction in the very near future.

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

Robert Marcus

Thanks Glenn and good morning everyone. As Glenn mentioned, despite the very challenging economy and increased competition 2008 was a good year for Time Warner Cable with solid subscriber and financial results. Let me start with the 2008 highlights on slide three.

We reported a record $1.8 billion of full-year free cash flow, up an extremely healthy 67% over last year. We grew full year 2008 revenues and adjusted OIBDA 8% meeting our full year guidance. For the year we added over 2.2 million net RGU’s bringing our total to 34.2 million. We continued to add bundle customers, ending the year with over 3 million triple-play customers and 7.9 million customers in either double or triple play packages. That is 54% of our total customer relationship that are in bundles now and that generally means lower churn and higher ARPU.

Finally, we continued to make progress in our commercial operations with year-over-year revenue growth exceeding 20% for the fourth quarter and the full year.

Turning to the next slide let’s review our subscriber metrics. Before I get into the numbers I want to remind you of several items that affected our subscriber metrics.

First, our year end subscriber counts in all categories reflect the elimination of approximately 126,000 RGU’s including 78,000 basic video subscribers from the non-core systems sale that closed during the fourth quarter.

Second, we lost between 8-9,000 RGU’s as a result of Hurricane Ike. That adjustment reduced our fourth quarter and full year net additions. Third, as we continued to refine how we count residential and commercial customers we reclassified 15,000 commercial HSD customers to residential HSD subs.

Let me quickly summarize the full year subscriber story and then I will get into the fourth quarter results. For the year we had a basic video net loss of 104,000 which was an improvement over the 144,000 basic subs we lost in 2007. Digital video subscribers increased nearly 8% with HD capable subscribers climbing nearly 50% and DVR subs increasing nearly 20%.

Residential high speed data subs grew nearly 11% with over 40% of HSD net ads choosing our turbo service. Residential digital phone subscribers rose 30%. We also added 40,000 net customer relationships for the year ending 2008 with 14.6 million.

Turning now to the fourth quarter, as we told you when we reported our third quarter results we witnessed a dramatic slow down in RGU net additions as the fourth quarter began. That trend actually worsened in November which was the low point for the quarter and then improved modestly during December.

Nonetheless, RGU net adds were down substantially year-over-year in each month of the quarter resulting in fourth quarter RGU additions of 175,000. The RGU slow down affected all six of our regions and all RGU categories. We saw both a reduction in connects as well as an up tick in disconnects.

We also continued to see signs of weakness in some of our premium services such as DVR’s where net additions have been slowing since the fourth quarter of 2007 and pay TV where subscribers declined in the fourth quarter.

We lost 119,000 basic video subscribers in Q4 compared to 50,000 basic video subs lost in the fourth quarter 2007. Fourth quarter digital video subscriber net adds slowed to 44,000 versus 168,000 in the prior year quarter. We added 313,000 HD capable customers and more than half of our digital subs are now HD capable.

DVR subs increased by just 87,000 versus 253,000 in last year’s fourth quarter. At year end nearly 47% of our digital video subscribers had DVR’s. Residential HSD net additions were 124,000 in the fourth quarter including the reclassification that I mentioned earlier. That compares to 214,000 net adds in last year’s fourth quarter.

Residential HSD penetration approached 32% at year end. Residential digital phone net adds were 130,000 in the fourth quarter compared to 282,000 in Q4 2007. As of year end, residential digital phone penetration stood at nearly 14.5% of service ready homes. As Glenn explained we largely attribute the RGU slow down to three factors.

First, the weak economy has undoubtedly had an impact. Second, competition is increasing in our footprint and third on the digital phone side we believe that wireless substitution is having an increasing impact on both connects and disconnects and this phenomenon appears to have accelerated as the economy has weakened and consumers have looked to cut costs.

Before we leave subscriber performance I want to give you some sense of what we are seeing so far in 2009. As I mentioned earlier November was the weakest month of Q4 with modest improvement in December. As we have ramped our marketing efforts we are seeing continued improvement in the New Year and that is particularly true over the last several weeks.

To be sure, net adds are still dramatically below last year’s levels but we are somewhat encouraged by the recent trends. Moving on to our financial results on the next slide.

We had solid revenue growth of 8% in both the fourth quarter and the full year. Fourth quarter revenues of $4.4 billion grew $313 million over Q4 2007. Subscription revenues increased 8% while ad revenues grew 6% during the quarter. On the subscription revenue side the 8% increase was driven by year-over-year growth in RGU’s as subscription revenue for RGU was stable.

Breaking down our revenues by product line, video grew 4%, HSD increased 11% and voice grew 29%. On a dollar basis, growth was relatively evenly split across all three services. Residential subscription revenues grew 7% while commercial revenues grew over 20%. I am going to come back to our commercial operation in a moment.

Advertising revenues reflected higher political advertising in October and early November and some changes that occurred during the last 12 months that we previously discussed including our taking over management of Charter’s global ad sales business in L.A. These positives were largely offset by a year-over-year decline of 13% in our core ad business. That decline is symptomatic of general weakness in the ad market place and in particular in the auto and retail categories on which we are especially dependent. This weakness has continued into the first quarter of this year.

Total ARPU for basic video subscriber increased 8% year-over-year in the fourth quarter to approximately $111 per month with subscription ARPU up 9% to about $105 per month. Looking at ARPU by product line for the quarter video ARPU increased year-over-year driven primarily by higher basic video ARPU and increased digital video penetration.

Total HSD ARPU declined slightly reflecting a small decline in residential HSD ARPU which was partially offset by a healthy increase in commercial HSD ARPU. Total voice ARPU declined modestly year-over-year with both residential and commercial voice ARPU declining.

Lets turn to our commercial operations in the next slide. As I mentioned earlier, commercial revenues grew over 20% both for the full year and the fourth quarter and we approached $800 million of commercial revenues for the year. We expect commercial revenues to continue to grow more than twice as fast as our residential revenues in 2009. Although the commercial business continues to represent a relatively small portion of our total revenues, less than 5% in fact, it accounted for over 10% of our total revenue growth in both the fourth quarter and the full year.

Excluding the reclassification I mentioned earlier, we grew commercial HSD subs by 4,000 in the fourth quarter ending the year with 283,000 customers. Commercial phone net adds were 7,000 and we ended the year with 30,000 subs. Average lines for commercial voice customer increased to 2.75 at year end up from 2.2 at the end of 2007.

As you can see from the chart approximately 2/3 of the total commercial revenues in 2008 came from data. Video comprised much of the remainder while we had a small, but growing, contribution from voice. As Landel will detail more in a minute, we are increasingly focused on structuring our organization to support the rapid growth in our commercial services.

Turning to adjusted OIBDA on the next slide, for the full year adjusted OIBDA increased 8% to $6.19 billion with the margin remaining flat at 36%. This despite softness in our high margin advertising business. Fourth quarter adjusted OIBDA of $1.66 billion grew 6% year-over-year. Our adjusted OIBDA margin for the quarter declined 50 basis points year-over-year to 37.7%. The modest decrease in margin resulted from small increases in a variety of expense items including employee costs; professional fees and hurricane rebuild costs.

As a reminder, adjusted OIBDA excludes the previously disclosed $14.8 billion FAS 142 impairment of cable franchise rights and a $58 million loss on our sale of certain non-core cable systems, $13 million of which hit in the fourth quarter.

As we look towards 2009, we expect to continue to grow adjusted OIBDA despite accelerating program expense increases, loss of high margin political advertising and significantly higher pension expense. We plan to do this in part by aggressively managing our controllable costs especially manpower expenses.

Landel will cover our organizational initiatives in more detail but in this regard we expect to take restructuring charges in the course of 2009 totaling somewhere between $50-100 million pre-tax. I should note that when we talk about adjusted OIBDA for 2009 it will exclude these restructuring charges as well as roughly $20-40 million of pre-tax costs associated with granting new TWC equity awards to Time Warner Cable employees to make up for the previously granted Time Warner, Inc. awards that will go away or will be reduced in value in connection with the separation.

Moving on to our 2008 full year per share results on slide nine. We had a basic and diluted loss per share of $7.52. However, 2008 loss per share included a number of items affecting comparability that in the aggregate reduced EPS by approximately $8.77. These items are highlighted on the slide and are detailed in our press release.

Excluding both the 2007 and 2008 items, EPS would have increased by more than 15% year-over-year.

Looking forward to 2009, we expect that full year diluted EPS will be around $1.00 despite higher interest costs as well as the restructuring and equity compensation replacement costs I mentioned earlier. Before I move to capital I should note that in connection with the separation and a $10.27 per share special dividend we are considering a reverse stock split which if implemented would affect our share count, our per share price and our per share results.

Turning to capital on the next slide, our full year capital spending was $3.5 billion, an $89 million increase from 2007 and in line with our expectations. Residential capital spending declined year-over-year but that decline was offset by increased commercial CapEx. Total capital expenditures as a percentage of revenues declined to 20.5% from 21.5% in 2007.

Taking a look at the specific categories, only CPE spending increased as demand for advanced high definition set top boxes remained robust. Looking forward we expect 2009 capital spending to decline both in absolute dollars and as a percentage of revenue.

Let’s look at free cash flow in the next slide. We generated a very healthy $1.8 billion of free cash flow for the full year 2008. That is 67% better than last year. We converted 29% of our adjusted OIBDA into free cash flow for the year up from 18% last year. Free cash flow growth was driven by higher adjusted OIBDA, favorable working capital comparisons and lower net tax and interest payments. These items were offset in part by significantly higher pension contributions.

Let me elaborate a bit on some of these drivers. First, lower cash interest payments resulted from lower net debt levels and the timing of interest payments. We expect that cash interest will increase in 2009 as a result of increased debt incurred to pay our $10.9 billion special dividend. As a reminder, we issued $7 billion of debt securities in 2008 in anticipation of this special dividend and the first coupon payment on these bonds didn’t begin until 2009.

Second, 2008 free cash flow benefited from the bonus depreciation provisions of the economic stimulus act. Current expectations are that bonus depreciation will continue into 2009. If not, 2009 cash taxes will increase and the 2008 cash tax savings would reverse over the next 5-7 years.

Finally, the increase in pension contributions was in response to the impact of the overall stock market decline had on our pension plan assets. At year end our qualified pension plans were 87% funded.

While adjusted OIBDA and free cash flow remain important metrics for us in evaluating the overall strength of our business we are also very focused on adjusted OIBDA less CapEx, a metric that will in effect drive our annual compensation in 2009. Increasingly we are focused on this metric in addition to OIBDA because it reflects operating costs and capital expenditures.

For 2008 adjusted OIBDA less CapEx grew 15%. As we look forward we expect our adjusted OIBDA minus capital expenditures will grow at least as fast in 2009 as it did in 2008.

Turning to the last slide, at December 31, our net debt and mandatorily redeemable preferred equity totaled $12.6 billion which put our leverage ratio at two times. At year end we had more than $13.1 billion of available committed sources of funds including $5.4 billion of cash as well as $1.9 billion under our bridge facility and $5.7 billion under our revolving credit facility. Therefore, after paying the $10.9 billion special dividend we will have at least $2.3 billion of excess committed availability.

Our liquidity will be further enhanced by any free cash flow we generate after December 31. Following the special dividend and the separation from Time Warner we expect to de-lever rapidly which is consistent with our commitment to maintaining our solid investment grade ratings. Although somewhat dependent on when these close, we expect that our leverage ratio will be around 3.8 times at separation and will be back down to around 3.25 times within about a year thereafter, comfortably within rating agency guidelines.

With that I will turn it over to Landel.

Landel Hobbs

Thanks Rob and good morning everyone. In this difficult economic climate our operations team has focused primarily on two areas; first competitiveness and second operational efficiency and cost management. In the next few minutes I want to share with you some of the initiatives we have in place to address both.

Competition is nothing new to Time Warner Cable. We recognize that the competitive landscape is changing. In addition it is pretty clear that the effects of competition are inter-related with those of the increasingly challenging economy. Let me note that in any environment including this one we are constantly evaluating among other things ARPU, profitability and market share.

We made proactive decisions with regard to the various levers such as price and marketing that impact these measures and we can change the emphasis of the various levers we think in the best interest of the business.

Now let me first outline the status of competition, then I will share with you our initiatives on this front. Satellite competition has not exhibited substantial change in recent quarters. Our internal models indicate that we lost very few basic video subscribers to satellite operators in the fourth quarter of 2008 following a quarter in which we actually gained subs on a net basis. We feel good about our competitive position here.

Telco competition hasn’t necessarily become more intense and we have seen fairly similar tactics over time. However, it has expanded to a more significant fraction of our footprint. We estimate that as of the end of 2008 Telco video offerings were available to around 21% of our footprint. That is up from approximately 18% a quarter earlier and 6% at the end of 2007.

In the fourth quarter AT&T’s Hubris product was available to roughly twice as many of our homes as Verizon’s video offering and consequently it had a more significant impact. As Glenn indicated, the growth in the Telco video offerings in our footprint is not unlike our own situation when we were launching our own digital phone products. We see a more significant impact during the loss phase.

With that as a backdrop I will outline several initiatives supporting our strong competitive position in a time of increasing economic and competitive pressure. These initiatives will go to the heart of how we compete.

In a few areas like HD programming we consider what we are doing as table sticks. Other initiatives are meant to differentiate us from our competition. First, I will cover high definition. High definition programming as we have said before is a matter of not only the amount of content but also the quality of that content. Over time we are providing both but we are focused on providing the most important channels first.

We now have an average of 57 HD channels in our footprint and these encompass the most popular channels. In certain key cities we have much more. For example, in New York City we as of today have 100 HD channels available. Remember, Time Warner Cable is home of the free HD. In 2009 we plan to add even more of the best HD content across our entire footprint.

Second we are focused on Hispanic households. In 2008 we increased the number of subscribers to our Hispanic tiers in New York City, Los Angeles and Texas by roughly 1/3. In L.A. our [el pachatazo] full basic product in particular continues to attract new and bundled subs. In fact, 69% of [el pachatazo] subs are new to Time Warner Cable and 75% take multiple products.

Nationally our brand awareness staff with Hispanics have jumped. At the beginning of 2008 only 35% of Hispanics mentioned Time Warner Cable in a survey of un-aided awareness. By year end that number had jumped to nearly 50%. This is a great start and we will continue to drive our Hispanic offerings in 2009.

Third, within our competitive set we recognize the importance of differentiated value oriented offerings in the current economic environment. We have had tiered offerings in each of our three primary residential services for quite some time. We have talked about our high end, Road Runner Turbo products which accounted for more than 40% of 2008 net adds. In 2008 we completed the roll out of Power Boost to Turbo subs system wide and now we are bringing it to all Road Runner standard customers as a value added feature. Power Boost delivers burst speed up to 22.

We continue to expand the capability of our high speed data network in terms of both speed and track. In 2009 we will make higher speed of 3.0 services available in select markets and we believe that some customers will find these higher speeds and higher priced services attractive. To enable us to continue to accommodate these higher traffic volumes we believe it is important to add the dimension of amount consumed to the consumer equation. That idea may put to rest much of the net neutrality debate.

To that end we will increase the number of cities where we implement consumption based billing this year. In addition, we also have two lower speed tiers that fit tighter budgets. In some of our service areas we sell our Road Runner Light product for as low as $14.95 per month when bundled with another service. In addition, we have also had considerable success with our Road Runner basic tier which simply provides downstream speeds of between 1.5 and 3. Together, these two value tiers comprised about 1/3 of our net adds last year.

Similarly, we have three principle tiers in our digital phone product set and while the unlimited tier continues to attract almost 70% of the net adds in the fourth quarter we saw an increasing percentage of new subs attracted to lower price, local and in-state calling plans. Just as a note, it is hard to exactly quantify the impact of wireless substitution especially now that economic [inaudible] is far more prevalent than some technological notion of going wireless.

What we do know is that some customers are eager to right size their bundle with us and digital phone is the most mentioned item for down sizing. We are combating this trend with programs like price lock guarantee and also a value center promotion for digital phones. In the Carolinas, for example, we have been offering a promotional price of $19.95 per month for six months. This has stabilized digital phone net add levels while providing a peak in promotion for up selling into price lock guarantee.

Fourth, in addition to our focus on value we are introducing ways to make our customer’s lives simpler. One of the most prominent is start over which enables time shifting without the need for any prior plan. At the end of 2008 start over was available to 3.2 million digital subscribers in 22 cities and we delivered over 60 million start over streams during the year.

Another application that has been a real hit among our subscribers is caller ID on television. More than 2/3 of our digital phone subs can see who is calling without leaving the comfort of the sofa. In December alone we delivered over one half billion caller ID messages to customer’s televisions. In addition, we introduced a completely revamped Timewarnercable.com last week. Our primary objective in the redesign was to make it a more effective sales and support channel for bundled services by encouraging self-care through our new online knowledge base, click to talk and click to chat capabilities and we expect to empower customers to solve problems and at the same time reduce our call center volumes.

In addition, by seamlessly guiding users through the purchase process we expect to more quickly meet their needs by more effectively up selling and bundling our services.

Fifth, bundling and price lock guarantee remain the lynch pins of our marketing strategy. In 2008 alone, nearly ¾ of a million customers signed up for the value convenience of our triple play package. We now have more than a million customers taking advantage of the price lock guarantee. This program answers the customer’s right sizing urge while effectively maintaining ARPU. Deterrence statistics among this group remain impressively low.

We are now deploying a proprietary, purpose built segmentation tool to help us with targeting both for PLGF selling, Hispanic targeting or just more effectively defending our competitive position. This is not an off-the-shelf product but one that narrows the field to a few key segments each with unique characteristics that will help us tailor not just our marketing but also product and care delivery.

Moving next to operating efficiency, I want to highlight a couple of restructuring and cost reduction measures. As I mentioned last quarter during 2008 we restructured our operations into six regions from the couple dozen operating divisions we previously managed. Through the end of last year this restructuring reduced the size of our organization by roughly 500 positions and we now have a leaner, more agile structure.

Now it is time for the next step. In each of our six regions we are appointing three senior executives reporting to the regional executive vice president. First we will head up residential services will be 100% focused on driving the growth of our residential subscription business. Next, recognizing that our commercial business has come of age and has characteristics distinctly different from residential we are appointing an executive in each region to lead commercial services.

These two executives will have responsibility for refining our market segmentation and driving the growth of their respective businesses. Third, supporting these two businesses each region will have an executive responsible for managing the plant and network operations that underlay the two businesses. We expect that this structure will enable us to sharpen the focus that we bring to our two subscription based businesses and to further strengthen and standardize the infrastructure on which they built.

In addition, this round of restructuring will allow us to continue to take costs out of the business. We expect to eliminate 1,250 employees most of which will come out of our non-customer base ranks saving us close to $90 million on an annual basis.

In conclusion we are focused on very specific initiatives to further strengthen our competitive position in this difficult economic climate. We are delivering more products that are easy to buy, easy to use and easy to afford. We are aggressively taking costs out of our business and structuring it to drive growth efficiently.

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

Tom Robey

We are ready to begin the Q&A portion of the call. As usual we would ask each caller to ask just a single question so we can accommodate as many callers as time permits.

Question-and-Answer Session


(Operator Instructions) The first question comes from the line of Ben Swinburne - Morgan Stanley.

Ben Swinburne - Morgan Stanley

My question centers around programming costs. You talk a lot about cost initiatives across the board in 2009. I don’t know if you can speak to what you expect your programming cost budget to grow roughly in 2009? I think you have a number of contracts like Fox News which will be up on a year-over-year basis and some re-trans payments. Then more strategically you have talked about the migration of content online by your suppliers. What can you do contractually as you start moving through more and more contract renewals to try and get some of these people to lease given the proliferation of content deployed on multiple devices? It seems like you have got maybe more leverage there than we are seeing in the model right now.

Robert Marcus

You will notice that programming cost increases in Q4 were actually notably low 5% up over Q4 of 2007. That is the product of a number of ins and outs but we had in addition to the lower basic sub numbers in the quarter we also had some one-time items that positively affected Q4 this year. As we look forward into 2009 I think implicit in your question is that programming costs are going to go up and I think that is a fair assumption. A bunch of things in there; one, we do have increased re-transmission consent costs that we are expecting in 2009 over 2008. In addition we have a bunch of new services. We have the full year of the big ten. We have the launch of the MLB network. In addition to that we have our usual contractual rate increases. Overall I would expect programming costs to increase more in 2009 than they did in 2008 and while there are still some moving pieces here I am thinking they might approach double digit growth is not unreasonable.

Glenn Britt

Just one more piece of programming costs, I may have done this last quarter but let’s talk about re-transmission consent for a minute. I think that re-transmission consent is a mechanism is broken. At least the way in which negotiations are conducted and the holding hostage of the public. If you go back to the origins of this law I think it goes back to the 1992 Telecom Act so it goes back a long time now. That was a very different environment. If my memory is right at that time more than half of the homes in the country still watched TV directly off air. Congress was very concerned about what looks like the gradual deterioration of the broadcast industry at that point in time.

The inspiration behind re-transmission consent was to have the cable industry and cable subscribers subsidize and put sort of save “free TV.” Also at that time there wasn’t much direct competition to cable although there was indirect competition. So fast forward to now there is lots of multi-channel video providers and probably only 10% of the homes watch TV directly off air. Everybody else watches through cable or satellite or increasingly Telco. So a very different environment. So you effectively have a mechanism to potentially tax 90% of the homes to save the broadcast mechanism for 10%.

I don’t have any quarrel with that notion. If Congress wants that I certainly have no quarrel with that. But there ought to be a better mechanism for figuring out what the amount of that tax is other than sort of [mixmanship] that we have seen and that doesn’t really serve anybody well. So you will be hearing more about that going forward.

On the online issue, I think just to clarify what I have been saying, the whole cable network industry and cable operator, when I say cable operator I mean all distributors satellite and Telco too, this whole economic ecosystem is dependent on subscription revenue and ad revenue and what I have really been saying is that as cable networks put more and more content online for free that will over time start eroding the subscription revenue source. There isn’t a whole lot that we can do about that. This is the program networks that are doing it. The reality is we are starting to see the beginnings of core cutting where people, typically young people, are saying all I need is broadband. I don’t need video and obviously they are already saying they don’t need wire line phone.

So the impact of that potentially over time is to reduce the number of customers. I am saying all this because my remarks get misinterpreted. I am not saying these things as a negotiating ploy. I am really saying them to predict that people will choose not to buy subscription video if they can get the same stuff for free. In other words, free wins. If we don’t have a customer then the programmers don’t get paid for the customer that we don’t have anymore.

I think I am right that about ½ of the average cable networking revenues are subscription and half are advertising. So I think the danger here is that over time the subscription revenue could erode. We, by the way, have a very nice broadband business so we can figure a way to be in a nice place. I think the cable network business will suffer mightily if this trend continues. So that is really what I have been talking about.


The next question comes from Spencer Wang - Credit Suisse.

Spencer Wang - Credit Suisse

I guess the first question I have is regarding margins. EBITDA margins have been pretty flattish over the last two years and it seems like when you bought the Adelphia systems there was this expectation over some longer term period margins would actually increase. I was wondering if you guys still expect that or if not what has changed? Is it the programming cost growth which seems to be accelerating? Then a quick housekeeping question, can you give us a sense of how much in capital you plan to deploy for commercial in 2009?

Robert Marcus

On margins, I guess your question is what are we thinking about for 2009 margins. As Glenn said in his remarks one of the vagaries of the current economic environment is that it is very tough to forecast and it is even more difficult to forecast individual line items of the P&L. So we are clearly shying away from that and focusing on the fact that under certain circumstances we will react in different ways to manage the bottom line number. I can’t tell you exactly where the various pieces are going to fall out and whether or not margins will be up or down. I don’t expect a material difference in margins in 2009 but it could go either way.

Spencer Wang - Credit Suisse

Even beyond 2009, long range margins. I guess has the integration of the Adelphia systems been in line with your expectations? Better or worse? What is different?

Robert Marcus

Both L.A. and Dallas while margins have improved throughout this year are still substantially lower margin systems than the footprint as a whole. So that gap is still there. It is shrinking but it is shrinking at a relatively slow pace.

Landel Hobbs

The only thing I would add in is remember the Adelphia acquisition what is also impacting the margin expansion there is of course the economy. We didn’t anticipate when we currently looked at margin expansion. It is happening in Dallas and L.A. as Rob indicated at a slower pace but then we had the economic conditions that we didn’t anticipate. You were right, programming will continue to impact margins.

Spencer Wang - Credit Suisse

On commercial Rob?

Robert Marcus

I’m sorry, what was the question?

Spencer Wang - Credit Suisse

In terms of 2009 capital, a rough sense of how much you expect to be devoting to commercial.

Robert Marcus

Again, I said in aggregate that capital would be down absolutely and as a percentage of revenues. I think it is fair to say that residential capital will continue to come down and commercial capital will likely go up but that is all I’m going to say at this point.


The next question comes from Craig Moffett - Sanford C. Bernstein.

Craig Moffett - Sanford C. Bernstein

Let me drill down a little bit more on CapEx. CapEx was clearly down year-over-year but a little higher than we expected in the fourth quarter. Can you just give us an update on where you are with respect to DOCSIS 3.0 and switch digital? You talked about lower HD DVR demand than a year ago. I assume that ASP’s for those units have come down significantly as well. I’m just trying to get my mind around sort of where the capital is going. Related to that, is there some room in the stimulus plan as you current read it particularly in the Senate version to get some offsets for broadband spending around DOCSIS? The second question now you have seen a second test market in the digital TV transition with the transition in Hawaii and I’m wondering if you can sort of reflect on what you have seen in Hawaii and Wilmington now combined for the DTV transition?

Glenn Britt

There is actually four or five questions in there. Let me take a couple and hand it back to Rob. First of all, switch digital video we continue to roll out. We are getting close to being done with that and I’m not quite sure we are there.

Robert Marcus

We should finish switch digital video implementations in 2009. The only factor out there we are still working on is the switching fabric in Moto. That may impact the time. We will buy in large be complete in 2009 with switch.

Glenn Britt

DOCSIS 3.0 we are very bullish on the technology and we are going to deploy it where we think it is appropriate competitively. I would say and this was implied in Landel’s remarks that the speed thing is largely a marketing ploy at this point. Very few people have the need for the really high speeds that are being talked about and in reality very few PC’s are equipped to even handle those speeds. This is more about marketing noise than about reality in our opinion. We will play the game where we need to.

The stimulus plan although obviously the details are being worked out and sausage is being made in Congress it appears that the broadband part is mainly focused on constructing broadband in rural areas which by the way we support that. We think that is appropriate. We don’t think it is appropriate to stimulate broadband where it already exists. We are not quite sure what the purpose of that would be. We are also very mindful and participate in lobbying in that we think whatever stimulus there is needs to be neutral across the parties. So, the outcome favors one competitor over the other is not something we would be in favor of.

Finally, the DTV transition we have actually experienced it twice. As you pointed out Hawaii went early and also Wilmington, North Carolina which is largely our cable market although partly Charter. That went last summer. I would say we have seen modest results in both places. Wilmington we gained some people from the off-air group. I think it was a little over 5% of the off air people we thought we gained. In Hawaii the numbers were much smaller but Hawaii is a historically very highly penetrated market for us so that is a very different situation.

Robert Marcus

On the mechanics on the capital side, a couple of points I would make. One we did have capital $3.5 billion for the full year which is exactly where we said we were going to land it. Two, and I think you pointed this out in your question, residential capital was down for the quarter about 10% year-over-year. I would mention that our HD capable net adds for the quarter were in fact 313,000 so a pretty significant number despite the overall RGU slow down. The last point that I would make which accounts for some of the fact that CPE capital was a little stronger or heavier than you might have thought in the quarter is that we did build up our box inventories so we go into the year with a larger inventory than we went into 2007. So that probably explains the delta.


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

Jessica Reif-Cohen - Merrill Lynch

Can you comment on what you expect incremental marketing costs to be and pension costs to be this year? You discussed, as have other cable companies, having the newer version of a program guide in early 2009 which I was wondering if you could tell us where you are on that and if you think there is an opportunity finally for video on demand, given the weakness in DVD’s I wonder if there is an opportunity now to access consumers demands for films?

Glenn Britt

Let me take a couple of those and I think Landel will jump in too. First of all on marketing costs as both Landel and I talked I look at the business as there is kind of an efficient frontier that we move along between short-term profits, subscriber growth and subscriber quality. The levers we use are pricing tactics, credit policy certainly in this environment and marketing spend. The environment essentially dictates what is possible and then within that we can move around the curve towards more subscribers and more profits.

As I said in the fourth quarter we were quite conservative on credit policy which I think is appropriate. We have not engaged in extreme discounted offers as some other people have in the market. We were moderate on our marketing costs trying to understand what was going on in the economy. We started cautiously increasing marketing spend and that has based positive results which I think Landel will expand on.

On the program guide, we have in a number of places rolled out a new program guide and we think it is better than the old one. I think this is going to be an ongoing process. We in fact have a new generation program guide in development right now. I don’t think program guides are going to be static over the next several years. I also think you will see different customers opting for different experiences so we don’t think one size fits all.

Landel Hobbs

The only thing I would add incrementally on your marketing question is as we look out in 2009 right now, and it can vary as Glenn has indicated, we will look at that lever each quarter and decide what to do. The way I look at it right now is I am assuming I will spend roughly the same amount of marketing moving from 2008 to 2009. However, that should have a very different impact. RGU levels are lower so the marketing per RGU connect will be higher so we are going to play around with that inter-relationship as we watch what happens in the economy.

I think you had a question on video on demand. The part I will attack from the operating side and Glenn may want to talk more from getting content from the studios, is that we are in 2009 doing a lot of testing around dynamic add insertion which I know we have talked a lot about. We are actually testing that in the labs and working with that in 2009 to see what we can do with it technically. There will be a point in time during 2009 where we will engage a programmer to work around video on demand because I think part of the equation there to make it attractive is not only content but it is putting an economic model around it where you look at ad insertion around VOD.

Robert Marcus

You also had a question on pension expense. Just to level set, 2008 pension expense was around $90 million and I would expect, although we are still doing the final calculations on 2009, it will probably be up $75 million in 2009. So somewhere in the ballpark of $165 million.


The next question comes from Ingrid Chung – Goldman Sachs.

Ingrid Chung – Goldman Sachs

Just really quickly to follow-up on Jessica’s question about marketing spend you said earlier in your remarks that you were cautiously increasing marketing spend and by our estimate you increased marketing spend by somewhere around 15-16% in 2008. Does that mean you are increasing beyond that 15-16% rate or you are just saying it is increasing? Secondly, in terms of ad revenue how much of that was political versus core?

Glenn Britt

The numbers you cited were for the full year and we were really saying in the fourth quarter as opposed to the whole year we were more reserved on marketing spend so earlier in the first quarter we have been cautiously spending more so we are not really ready to predict for the whole of 2009 yet.

So that is the context of that.

Landel Hobbs

On the ad revenue I believe the political component in 2008 was roughly $67 million so that is what was embedded in advertising revenues in 2008. By the way that was a substantial increase if I look back at prior political seasons primarily because we spent a lot of time focusing on political advertising, meeting in D.C. and met with a bunch of folks to make sure that we were focused there so we were very happy with how much political advertising revenue we generated especially in what was an otherwise extremely weak year.

Glenn Britt

Just to build on that for a minute, it was a lot of work behind that. The political advertising didn’t just happen. This was the broad strength of the industry. Political campaigns traditionally focused on broadcast. Starting 18-24 months before the election we spent a lot of time with the people in the political world who buy media, pointing out the benefits of cable so I think we will just build on these results going forward. It is a good thing.

Landel Hobbs

I would just add that of that $67 million of political ad dollars, $38 million showed up in the fourth quarter.

Tom Robey

Thank you all for joining us on the conference call this morning. A replay will be available on the website shortly. Please call if you have a follow up question.

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