DIRECTV Q2 2006 Earnings Conference Call Transcript (DTV)

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Q2 2006 Earnings Conference Call

August 8, 2006 2:00 pm ET


Chase Carey - President, Chief Executive Officer

Michael Palkovic - Chief Financial Officer

Larry Hunter - General Counsel

Patrick Doyle - Treasurer and Controller

John Ruben - Vice President, Investor Relations


Doug Mitchelson - Deutsche Bank Securities

Douglas Shapiro - Banc of America

Spencer Wang - Bear, Stearns

Lale Topcuoglu - Goldman Sachs

Jessica Reif Cohen - Merrill Lynch

Aryeh Bourkoff - UBS

Ben Swinburne - Morgan Stanley

Tuna Amobi - Standard & Poor's

Qaisar Hasan - Buckingham Research

Thomas Eagan - Oppenheimer & Co.

Jason Bazinet - Citigroup


Good day, and welcome to the DIRECTV Group second quarter 2006 financial results and outlook earnings call. Today’s conference call is being recorded.

At this time, for opening remarks and introductions, I would like to turn the conference over to the Vice President of Investor Relations, Mr. John Ruben. Please go ahead.

John Ruben

Thank you, Operator, and thank you everyone for joining us for our second quarter 2006 financial results and outlook conference call. With me today on the call are Chase Carey, our President and CEO; Mike Palkovic, our CFO; Larry Hunter, Group’s General Counsel; and Pat Doyle, our Treasurer and Controller. In a moment, I will hand the call over to Chase and Mike for some introductory remarks, but first I am obligated to read to you the following: on this call, we make statements that may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve known and unknown risks, uncertainties and other factors that could cause actual results to be materially different from those expressed or implied by the relevant forward-looking statements.

Factors that could cause actual results to differ materially are described in each of the DIRECTV Group’s and DIRECTV U.S.’ Annual Report on Form 10-K, quarterly reports on Form 10-Q, and our other filings with the SEC, which are available at

Additionally, in accordance with the SEC’s regulation G, that requires companies reporting non-GAAP financial measures to reconcile these measures to the most directly comparable GAAP measure, we provide reconciliation schedules for the non-GAAP measures. These schedules are attached to our earnings release and are posted on our website at

With that, I am pleased to introduce Chase.

Chase Carey

Thanks, John. Good morning, or good afternoon. After the first quarter call three months ago, John told me that a number of you had felt that I had actually been somewhat negative on the call, and again, reality was I believed we had not executed in a few areas as we should have.

At this point, I guess I would be happy to tell those of you who were concerned by my views three months ago that I feel pretty good about where we are today. That is not to say our second quarter results hit all our targets. However, I believe the quarter really exhibited our progress and our commitment to deliver both top- and bottom-line growth. Where our second quarter results fell a bit short, it was due to moves we are certainly executing to strengthen ourselves for the mid- and long-term, even if there is a short-term sacrifice required to do so.

I am going to spend a couple of minutes talking about the second quarter specifically, turn it over to Mike to comment in a bit more detail about the quarter, and then I will come back and talk about the rest of the year and a couple of other items.

The highlight of the second quarter was clearly our growth in profit and cash flow. We have talked before about the growth in profits and cash we expect over the next few years. This quarter began to deliver really on that opportunity.

The success in cash and profits was really attributable to broad-based success across really most of the operating areas of DIRECTV.

A few of the metrics that I single out as I look at the quarter, first SAC at $642, which is about flat with last year, down from Q1 which I think really shows the success we are having at finding savings and efficiencies in hardware costs, installations, sales cost that are letting us offset or even more than offset the cost of an increased volume of advanced products.

I think the second area we have made real progress was retention marketing, which benefited from the discipline in targeting. We have been striving to implement. When you do look at the second quarter, I want to point out that it does not yet include any material costs for the MPEG 2 to MPEG 4 conversion, but that being said, I think we felt we really -- to start to get on top of retention marketing.

I guess the third area, overhead and debts, it was also an arena that benefited from improved focus to really improve the margin and take advantage of the economies and efficiencies and disciplines we should be showing in those areas.

The positive results are really not just on the bottom-line and not just on the cost-side of the ledger. Revenue grew 12% year on year, displaying continued strength in our growth defense on the top-line. Our year-on-year ARPU growth of almost 6% was a result of a combination of price increase and increasing the penetration of more services into a customer’s home.

The two second quarter metrics that did not quite exceed or reach our expectations were sub-growth and churn, and I will spend a minute on each.

Our gross adds in subscriber growth were probably 4% to 5% below our target. The primary reason for this was really the restructuring of our third party dealer base, where we look to establish dealers, compensation structures, and tools that really enable us to create a dealer base that complements rather than underlines or competes with our direct sales initiatives.

Now, in a year, this dealer base has gone from about 50% of our sales to about 36% in the second quarter, while direct sales have grown from about 22% to about a third of our sales in the same time.

I want to be clear. It is not to say the dealer network is not important. It is critical and it is a very important part of our business, but we need to have the right dealers focusing on the right customers. We feel we have largely completed this dealer base transition put in place during the second quarter, to put in place dealers that really are complementing our direct sales initiatives. We saw sales stabilize, even grow a bit at the right places, during the last couple of months.

At the same time, we will continue to build our direct sales organization, which really brings us great strength and efficiency and effectiveness as we look to move the business forward.

Direct sales has grown to replace certain dealer activity, but again, when you look at the second quarter, the fact of the matter is the second quarter direct sales did not -- we did not expect them to grow fast enough to replace the dealer restructuring. We knew that was a sacrifice we had to make to position ourselves, position our business for the future.

In addition to the dealer restructuring, the second quarter was also impacted a bit because I think our second quarter offer, the lead offer in the market, in hindsight was probably not as effective as we had hoped it would be.

I want to be clear. We are not saying that increased competition from cable is not a factor. We are facing increased competition in the market place, but in many ways, the competition is largely what we expected. We are finding our telco partners to be an increasingly strong competitive response. There has been a bit more of an impact where we do not have a telco partner, but we are taking steps to address that through initiatives like our recently announced Earthlink partnership and other steps.

The other area I might have hoped for a bit better result was churn, although our second quarter churn was significantly improved on a year-ago, and really pretty close to the target we set out. The competitive pressures from aggressive offers like a $69 triple play bundle from cable in certain markets certainly has had an impact. We are responding intelligently to those offers, but to do so by targeting really the right customers that represent the greatest value.

I think it is important to note that we are not myopically focused on churn reduction. As part of managing retention marketing costs, there is a certain type of customer we are better off churning out rather than spending retention dollars to keep.

With those, the highlights of the second quarter, I think I will turn it over to Mike to make a few more detailed comments, and then again I will come back and sort of give you a bit of perspective of the rest of the year.

Michael Palkovic

Thanks, Chase. Starting at the top, revenues for DIRECTV U.S. increased by 12% to $3.3 billion. Similar to recent quarters, the revenue growth was driven by our largest subscriber base, along with strong ARPU growth of 5.6% to $71.59. Much of the ARPU growth came from price increases on our programming packages, but we also generated solid growth from higher penetration of basic, DVR, and HD receivers, as well as higher advertising revenue.

Although our total gross additions were down, we obtained more higher quality subscribers in the quarter from both an absolute and relative perspective.

As we have talked out on prior calls, this improvement is primarily due to the changes we made to our credit policy and dealer incentives throughout 2005. Specifically, total gross adds of 863,000 were down 10% versus last year, but the number of high quality customers added in the quarter was up by about 11%, or approximately 70,000 more than last year.

Looked at another way, lower quality customers in the second quarter represented only about 15% of total gross adds compared to 30% a year ago. As a reminder, these lower quality subscribers are required to pay us $200 to $300 up front before activating service.

In terms of our distribution channels, we are continuing to see strong growth from direct sales and our telco partners. Importantly, our independent dealer channel has stabilized and has significantly improved their quality of new customer additions.

The trend of adding high quality customers is having an important impact on several key metrics, such as our HD and DVR penetration rates, ARPU, churn, and data expense.

For example, we added approximately 50% more HD, DVR, and HD DVR customers than a year ago. In terms of new subs, the penetration rate relative to gross adds went up from about 10% a year ago to approximately 23% in the current quarter.

With the higher ARPU and lower churn from these customers, we are continuing to see after-tax IRR’s with subscribers that have a DVR HD receiver of about 50% compared to an IRR of roughly 30% for a subscriber with a basic receiver only.

In total, we now have about 4 million subscribers with advanced boxes, split roughly 70% - 30% between DVR’s and HD.

The improved credit quality of new subscribers, plus the higher HD and DVR penetration rates, is driving down our monthly churn rate, which went from 1.69% last year to 1.59% in the current quarter.

The improvement in churn is largely due to lower involuntary churn related to the reduction in the higher risk customers added to our platform. Involuntary churn declined from about 42% of total churn a year ago to 33% this past quarter. We also saw large decline in our first year churn.

Consistent with prior years, we expect to have our highest churn of the year in the third quarter. However, we also expect to continue to improve churn relative to last year.

For example, in the first quarter, our churn rate of 1.49 was four basis points better than the prior year. The second quarter was 10 basis points better. In both the third and fourth quarter, we expect an even bigger improvement in churn relative to last year’s numbers.

Moving on to operating profit before depreciation and amortization, it nearly doubled in the quarter to $977 million. This increase does include capitalized costs for leased set-top boxes of $253 million, broken down to $153 million in SAC and $100 million in upgrade and retention marketing. If you exclude these capitalized costs, operating profit before depreciation and amortization increased by 44%.

The biggest driver of the increased margin was the lower acquisition cost resulting from the reduced number of lower quality gross subscribers added in the quarter. Even though our SAC per subscriber was relatively flat versus last year, our total acquisition costs were about $90 million lower because we added 150,000 fewer lower quality customers.

The second biggest contributor to the margin improvement was the decline in G&A expenses mostly due to a significant improvement in bad debt expense and ongoing scale efficiencies.

So again, it is quite evident that the improved quality of our subscribers is helping drive both the top-line and bottom-line results.

To expand a bit more on SAC, $642 is a solid number, down both sequentially and from last year. The main reason for the lower SAC is the continued set-top box cost reduction that we are capturing.

As an example, a year ago, our basic box had a cost in the mid-$70 range, and today we are paying in the mid- to low-$50 range for the same box. That is a $20 savings per box. When your average customers takes two-and-a-half, 2.6 boxes, that results in roughly a $50 savings per customer in SAC.

This $50 savings is offsetting the higher SAC related to the increased sales of HD and DVR receivers, as well as some additional marketing costs and incentives we are giving to our dealers to ensure we obtain higher quality customers.

Pre-SAC margin, again on a cash basis, of 38.5% was slightly better than a year ago, primarily due to the lower G&A costs I talked about earlier, partially offset by higher programming costs.

The lower programming margin is consistent with the guidance we gave at the investor day in February, and is mostly related to annual programming increases exceeding our price increases and, to a lesser extent, increased credits related primarily to retention programs and bundled offers with our telco partners.

Our cash upgrade and retention costs of $243 million were $20 million higher than last year but about $90 million lower than last quarter. The variance from the prior year was mostly due to a significantly higher number of existing customers upgrading to high definition programming. We also spent around $10 million in the quarter swapping out customers to the new MPEG 4 HD equipment.

The large decline from the first quarter was primarily due to improved customer segmentation and new, highly targeted programs put in place in the second quarter.

For example, we now charge up-front fees to certain of our lower quality customers to offset our upgrade and retention costs. Although this may at times result in higher churn, we are happy to make this trade-off.

I think it is important to point out that, consistent with our stated goals, we kept our retention and SAC costs relatively flat in the quarter, even though we drove significantly higher penetrations with DVR and HD to both new and existing customers, through box cost reductions and improved segmentation.

Looking quickly at our cash and balance sheet, DIRECTV U.S. nearly tripled its cash before interest and taxes by generating $450 million in the quarter, bringing the year-to-date cash number to $660 million. As a point of reference, the same number for all of 2005 was about $760 million.

Total debt at the corporate level remained at $3.4 billion, while cash and short-term investments in the quarter declined by about $450 million from the first quarter, mostly due to our share repurchase program.

As an update, we purchased about 52 million shares in the second quarter, at an average price of $17.10. Year-to-date through yesterday, we purchased about 176 million at a total cost of roughly $2.8 billion.

With that, I will turn the call back to Chase for some closing remarks.

Chase Carey

Thanks, Mike. The remainder of 2006 will clearly be an important time for us as we launch, really, an array of new features, products and initiatives into the market. I guess just to mention a few of the more important ones, first the continued launch of local HD markets. We have already launched 36 markets which give us coverage in over 50% of the U.S., and will launch at least 25 more local markets by year-end.

As we continue to build and marry that to our HD plan for 2007, when we really launch two more satellites, which will really put us in a place to establish ourselves as the market leader in HD programming in 2007.

Second, contrary to recent press, we will begin shipping our HD DVR in the next few weeks, which will really complete our transition to new HD and DVR boxes that will provide the foundation and future for a lot of the new services and content we will be offering. This HD DVR will become a more central part of our sales efforts in the third quarter.

Third, we are going to be launching an array of new, enhanced and expanded content features, some we have actually launched in the last month, like for those of you in New York, interactive Yankee games on Yes. We are going to have a new, expanded U.S. Open Tennis coverage in the next couple of weeks, once that gets started, and new NFL Sunday Ticket features coming later in the year before year-end, our new championship gaming product, VOD offerings, initial video game product -- are all exciting new initiatives that we have before Christmas.

Financially, we are still pretty much in line with the expectations we outlined at the end of the first quarter. Net subscriber growth in Q3 should exceed Q2, and second-half sub adds should exceed the first half, although we expect total 2006 net subscriber growth will be under a million. Third quarter churn, I think as Mike just said a minute ago, is always our seasonally highest churn quarter. We still expect 2006 churn will be below 1.6%. SAC and retention marketing in the second-half will be a bit higher than the second quarter run-rate due to increasing advanced products and a more competitive market place. However, SAC will be comfortably in our $650 to $700 range, while retention will be in the $1.1 billion to $1.2 billion range before MPEG 4 swaps.

Our second-half margin will be down from Q2, as it always is during the NFL Sunday Ticket season, but we will continue to deliver the strong growth of both profits and cash that we have been talking about.

Beyond the day-to-day direct U.S. operations, let me conclude by commenting on a few other items. First, we expect to complete the merger of our Brazil business, essentially the Sky and Direct platforms in Brazil, in the next few weeks. This is the final step in the merger of our Latin American businesses, and the result from Latin America overall really continue to be very strong, and really exceed our plans. That business shows increasing promise as we build on that opportunity.

Mike mentioned we will complete our share buyback in the next month or so, and that is a topic obviously moved much faster than we planned due to some of the deals with the pension fund. We will be discussing subsequent plans in terms of the balance sheet and cash flow with the board shortly.

Finally, let me address broadband for a minute. Our telco partners continue to strengthen as our telephone partners display an increasingly competitive aggressiveness in competing with the cable bundle. We are also expanding these relationships.

Our recently announced Earthlink agreement, which we launched in the last month, will provide us with a bundled solution in the AT&T market, which is where we do not have a direct relationship with that RBOX.

In the next few months, we will also begin to proactively sell the RBOX bundles, or the telephone bundles ourselves rather than just relying on the phone companies to do so. This will increase our voice in the market and also enable us to take advantage of our sales channel’s unique reach to expand and tap into new audiences for our bundled offer.

However, probably most importantly, we believe wireless broadband has taken critical and major steps forward to become a real force in the market. The Intel and Motorola investment of almost $1 billion was just one indication of the opportunity interest in major players.

On a technological front, new developments are improving the capabilities of wireless broadband while at the same time, other developments are providing new cost efficiencies for the deployment of it.

As regards to our own plan, I assume everyone recognizes that we are not going to address specific opportunities before we conclude an agreement. We are actively engaged in both distribution and investment opportunity discussions, and we expect to conclude agreements shortly. We are truly excited by the opportunity wireless broadband provides to bring the next generation of broadband solutions to our customers who look forward to its growth and development.

Thanks very much. With that, I will turn it back to John before we open it up for questions.

John Ruben

Thanks, Chase. Just quickly before moving into Q&A, investors should note that we have members of the media on this call in a listen-only mode. I would like to remind our media that they are not authorized to quote any participants on this call, either directly or in substance, other than the representatives of the DIRECTV Group. We are also webcasting this call live on the Internet and an archived copy will be kept on our website.

Finally, I would like to ask callers to limit your questions to only one or two, until we have had a chance to get to everyone.

Operator, we are ready for the first question.

Question-and-Answer Session


(Operator Instructions)

Your first question is from Doug Mitchelson of Deutsche Bank Securities.

Doug Mitchelson - Deutsche Bank Securities

Thanks, just two quick ones. You noted an 11% increase in high quality subs added year to year. What is the percentage of the overall sub base today that is high quality, as you define it?

Also, just curious, any comment that you can make on the timing and cost of the MPEG 4 swap outs as the new boxes come in?

Michael Palkovic

Doug, I am going to have to guess on that, because I do not have it in front of me, but I think we are looking at something like in the very high, the top-two segments, something like 50% or 60%. We still have probably a few million that have been on the platform, 2 million or 3 million, that would have qualified as lower quality, but I do not have the exact numbers, but that is kind of a rough order.

Chase Carey

I think the MPEG 2 to MPEG 4 is predominantly probably more a next year event. In many ways, we will do, we will probably step it up a bit in the second-half. Again, we did a little bit in the second quarter, but not a material amount.

For us, it clearly is beneficial to the extent we can push it off. Just the box cost alone, if you -- today, if the box cost, I do not know, sort of probably $240 going down to $210 towards year-end, but by the second quarter of next year, we will have box cost down in the $160 range, so to the degree we can take advantage of the ability to drive the hardware costs down before we do it, benefits us, so I think the larger share of that clearly will be probably more next year, where we can take advantage of some of the cost of hardware. I guess, you know, the reality is churn is a lot lower. There is a little bit of churn too, so that is a benefit of pushing it out in ’07 as well.

Doug Mitchelson - Deutsche Bank Securities

And number of subs?

Chase Carey

It is about -- it is obviously a fixed universe. It is about, I mean, I think it will end up being, if you factor it through, we expect it will be about -- it is a little higher now, so factoring in right now the historical level of churn, probably around 800,000 subs, and the number we sort of looked at is depending on -- it gets better as we go out, but it is still in the neighborhood of $400 a sub, so that is -- again, we have the benefit now if it has been a fixed universe for a while, or sort of cast universe. It comes down a little bit with churn as you go, but those are the metrics and obviously that $400 number is assuming some capturing some of those hardware savings, but the more you can push it to the back-end, the more you take advantage of the savings opportunities from cost reductions.


Thank you. Your next question is from Douglas Shapiro of Banc of America.

Douglas Shapiro - Banc of America

Thank you. I also have two things. Chase, just as a follow-up on your broadband comments, I think in the past you have been pretty consistent that you do not intend on making a bet the enterprise bet on broadband, and I think you also implied that you are going to scalp your commitment as you get evidence that the technology works. Without commenting on your plans and the auction specifically, obviously you are in a position to bid on a lot of spectrum, I am just wondering if you could A, say whether you think that is an appropriate characterization I just gave, and then B, if so, has your stance changed on that?

Chase Carey

No, I think I would say what I have said in the past is probably still an accurate reflection of our expectations. Again, we will always have to be opportunistic to the market, but I think it is an accurate reflection, and I cannot comment for an array of reasons on any of the specifics.

Douglas Shapiro - Banc of America

Okay, and then I had one on really the follow-up, which is just as you look at the back-half of the year, and some of the tough comps easing a little bit on the higher credit standards, and I think you say you believe you have fixed the dealer network issues, do you anticipate you are going to get back to gross add growth roughly flat-ish, or closer to flat-ish than it has been on the first half?

Michael Palkovic

Doug, let me try and answer that. What I think we are trying to tell you is that we think one of the transition challenges with our independent channel, they have been declining as a channel sequentially over the last year. We have seen stabilization in that channel. At the same time, we have seen continued growth with direct sales and the RBOX, and in coming out of the second quarter, June was our best month. July followed that up with a strong month, and we are seeing even continued strong results here the first week of August.

So we are very comfortable that we have kind of turned the tide in moving things back up, and as Chase commented, we think that the offers we are going to have in the market place in the second-half are probably going to be more successful competitively in the second-half, so we have some momentum going that we are pretty happy with.

Where that lands us, I am not going to put a number on, but I think that results in a better second-half of the year than a first-half.

Douglas Shapiro - Banc of America

Thank you.


Thank you. Your next question is from Spencer Wang of Bear, Stearns.

Spencer Wang - Bear, Stearns

Hi. Just two quick questions. I know you guys mentioned that you’re close to done with the existing share buyback. Do you talk about if you’d consider other uses of cash, like a dividend or other use?

Then secondly, when you look at the LADMA, that’s historically been a pretty good source of subs for the DVS industry over the last couple of years. Now that Time Warner’s closed on Adelphia, can you talk about how you see the competitive landscape changing there and how you’ll respond?


Chase Carey

Yeah, on the first one, again, probably not going to have a lot to comment on. We have not really had one Board meeting since we announced the buyback again because the pension fund moved awfully quickly for us, so I think it’s a topic, you know, we’ll probably have to discuss with the Board before sort of speculating or discussing publicly what we’d consider. I mean, we still certainly have a – you look at the dynamics around it and we’re going to be generating increasing cash, we have an underleveraged balance sheet, and we have a stock price that still makes no sense. But I think – I’ve done some discussions with the Board, talk with the Board before I sort of discuss them in hypothetical form publicly.

In terms of the LADMA, it is certainly a good market for us and so we expect to continue to be. I expect Time Warner will be aggressive competing there, but I think that probably is true at a lot of our markets. They said, you know, that is, the world we’re in is a world of increased competition and that’s what we have to deal with, that’s the world we have to compete with. I think we have a lot of things that we’re going to bring to this market. As you look at the LA market and, you know, the leadership position will establish something like HD, which I think will have tremendous appeal in this market. I think the LA market’s got a unique appreciation for quality content features. I think it’ll give us opportunities to really take advantage of some of the things that we’re going to be doing, you know, in the contents arena. The size and strength we built in LA really give us actually some great, on the ground installation, sales organizations that really do a great job here.

So I think we will - I expect us to be able to continue to compete, you know, very effectively in the LA market and that’s in the face of what I expect to be increased, you know – Time Warner stepping up the competition. But again, that is, I think that’s going to happen in an array of markets and I think that’s part of our challenge is we’ve got to continue to prove that we can beat back, and think we feel pretty good. We’ve got to build the core strengths that enable us to do so, and that’s a lot of what we’re investing in and dedicating our time to execute. We’ve got to execute on the plans and the opportunities we’ve got.

Spencer Wang - Bear, Stearns

Thank you.


Thank you. Your next question from Lale Topcuoglu. Please go ahead.

Lale Topcuoglu – Goldman Sachs

I left the most amusing question. To the extent that you can answer, there’s been a lot of talk in terms of a combination of the two satellite players in the U.S. When you look in terms of the changes in the marketplace, obviously telecos are talking about a video product rollout but it really hasn’t reached any sort of large scale and in the rural areas you’re obviously still the dominant player. So, when you look into plans longer term, do you feel the regulatory environment has changed enough such that this would even be considered, or is this just wishful thinking on the part of Wall Street analysts? Thanks.

Chase Carey

From a regulatory perspective, I think the environment has certainly changed. I mean, you know, when you look at the consolidation in the telco and cable industry just over the couple of years there’s been AT&T, you know, BellSouth, MCI, Adelphia, you know, on and on, and you do have all the speculation about the Internet players from a different direction. It clearly changed.

I wouldn't say it's a slam dunk, but there are clearly regulatory issues around it. But I think from a regulatory perspective, it's clearly a changed environment in the last -- from the last even -- in the last couple of years.


Does that answer your question, ma’am?

Lale Topcuoglu – Goldman Sachs

Yes, thanks.


Thank you. Ms. Cohen, your line is live. Please un-mute and proceed with your question.

Jessica Reif Cohen – Merrill Lynch

Hi, can you hear me?

Chase Carey


Jessica Reif Cohen – Merrill Lynch

Well, I guess I have to follow up that last question. I mean, how can you let that alone? I mean, so if the regulatory environment’s changed and there’s so much speculation, then can you comment in any way it wouldn’t make sense?

Then two questions that I think you will answer. You mentioned that advertising was very strong. Can you break out in dollars how much it is and how much it’s up year-over-year, where the strength’s coming from?

On churn, it sounds like you’ve really worked through almost all your poor quality subs, I think Mike said there was 2 million to 3 million, left. Wouldn’t you expect churn to settle in over the next year or so?

Chase Carey

Well, you sort of probably answered the first question for me. Yeah, again, they’re clearly – I mean, I think, if you look at the issues, the question of a merger, they’re clearly synergies. I think you do have a changed regulatory environment, while you still have regulatory issues. But, you know, the reality is, there are an array of complexities and I’m just not going to get, you know, out front in terms of speculating as to how manageable, you know, how one would deal with an array of issues related to that.

In terms of the other question, as you might – I didn’t hear it, but Mike did so I’ll let Mike answer.

Mike Palkovic

Jessica, ad revenue was strong again on the quarter, in the low $60 millions. Pretty consistent with Q1, and year-to-date we’re up by 25% over last year. So very strong performance in ad revenue.

Chase Carey

Was there another question?

Jessica Reif Cohen – Merrill Lynch

Yeah, there was a question on churn, and where’s the upside in strength coming from?

Mike Palkovic

Yeah, I guess the way we look at churn is, you know, we’ve managed to do a pretty good job on dealing with the quality issue. We still have people that, both on their initial credit score and they came on the platform and their behavior since they’ve been on the platform as we get more intelligence, they’re still, you know, clearly in a lower-quality setting. We commented in the front of the call that that’s the group that we’re going to be a little bit careful before we continue to make investments and, you know, upgrades and movers and truck rolls, and if there’s a little bit of churn out of that group, you know, we’ll probably accept that versus making additional investments.

The other side of churn, the voluntary side, is really the competitive landscape and how well we do with the bundle and other areas in that and, you know, at least, to this point, we’ve done pretty well. It’s clearly an issue we’re focused on, but that’ll shape kind of where we see churn longer-term, is that.

I’d say that this year we expect in a year below 16, and clearly if we do a good job we’ll be able to keep that, you know, moving down at some reasonable pace.

Chase Carey

I think we thought – and I probably don’t have a different, you know, perspective than I did when we talked about it in February which was, I think, if you look out, you know, a couple of years that we think that churn should clearly go below 1.5.


Thank you. Your next question is from Aryeh Bourkoff of UBS.

Aryeh Bourkoff - UBS

Hi. Thanks. Sorry, Aryeh Bourkoff. Just two quick questions. Could you maybe talk about your decision to file to bid for the AWS spectrum jointly with EchoStar? I think at one point you talked about maybe filing separately. If you obviously do go ahead with this and bid jointly, could you – does it presuppose a merger, that you’re bidding together? Or could you imagine winning a lot of spectrum in that wireless DVS venture without necessarily merging the whole companies?

Question two is, the BellSouth partnership you have obviously has come down a little bit year-over-year from 80,000 adds, maybe that’s gross adds from second quarter 05 to about 63,000 according to BellSouth this year. Are you starting to deemphasize that a little bit ahead of their AT&T merger, or can you talk about that channel versus maybe Verizon? Thanks.

Chase Carey

I guess I’ll look at, my general counsel, Larry Hunter. The reality is, the is auction – there’s really nothing I can say about it because they’ve got such a set of rules around it, I can’t even, you know, follow which side’s up so, there’s isn’t –

Larry Hunter

You know, there’s a pretty tough rule on anti-collusion –

Chase Carey

All these rules and comments, the anti-collusion and hinting -- and so I can’t really say anything about that. I certainly think some of the larger presuppositions you made I think are pretty big leaps, so – but I wouldn’t make any of those leaps, but I don’t think, you know but – the auction itself, I can’t, or why, or, you know, what have you, I can’t due to the rules around it.

On BellSouth, our partnership is still pretty good. I mean, I think the reality probably ends up being whenever you’ve got a place that’s going through an acquisition you probably have little impact on everything they’re doing, you know, so I think that’s probably just in some ways real life.

We have a pretty good transition period built in, post-closing of that, you know. There is certainly still a lot of time for us to take advantage of the BellSouth relationship and we will see where it goes longer-term beyond that with AT&T.

We are moving forward with ways to deal with those markets, but I think with BellSouth, it is a good relationship, one we continue to make sure we maximize the opportunities again. I think to some degree, BellSouth is -- any company going through the size and issues that come with a merger of that size probably has a full plate that has at least some people focused on those issues.


Thank you. Your next question is from Ben Swinburne of Morgan Stanley.

Ben Swinburne - Morgan Stanley

Thank you. I have a couple of questions. First, Mike, the churn numbers you gave us and the involuntary and voluntary mix, was like the voluntary number actually was up year over year a bit. I just wanted to see if I could get some comments whether the lack of a sort of aggressive HD DVR offer in the market place is hurting you guys yet. Cablevision talked on their call about basic sub strength coming partly from HD. I think their HD households were up 114% year on year. So if you focus in on that voluntary number, as you get aggressive with your MPEG 4 box later in the year, does that turn back around again?

Second, you said I think low quality subs were down to 15% of the gross add from the quarter. Do you have a target number for where you want that to be? I am just sort of thinking, if we said only 10%, 15% should gross adds actually start to increase going out into ’07 year on year. Thank you.

Chase Carey

I will let Mike, but I will make a couple -- I would like to touch on a couple of it if I could, a bit more substance. I think there is no question, you know, is the little bit that we had earlier in the year that not being competitive with the market place and the pricing of an HD DVR impacted us. We did it with our eyes open. We thought it was the right decision to make. It clearly has an impact in some places. We will have that HD DVR, like I said, in the third quarter, it will become a much more central part of our sales initiatives and operating initiatives, and I think will enable us to be competitive on a front that we have not been. But that was by design.

By design, we made that decision to push the right box, not to push a box that was not built to serve our long-term needs.

Again, it is part of a short-term sacrifice to work for a long-term benefit, or a medium-term benefit.

I think there are other reasons. I think the fact of the matter, I think as I said, we are going to only start proactively selling ourselves a bundle. One of the most important things to competing with a customer who calls in to churn is being able to have a bundle to put back to them. We have not. We are only putting that in place now, the ability to have a bundled offer we can respond to directly ourselves when a customer calls looking for a bundled price, or shopping against a bundled offer from a cable company.

So I think that clearly gives us a tool that has been a handicap in the last quarter, the last couple of quarters of not having that tool. We will also have a better response. We will have a response to our partnership with the AT&T region, where we have not had that response to have a bundled offer.

So I think clearly there are places we have not had a response to those efforts. I will let Mike add a little substance to it.

Michael Palkovic

On the voluntary churn side, you are right. We are down a couple ticks, if you will. On the involuntary side, we are up a little less than a point, a tenth-of-a-point on the voluntary side. If you add up all the reasons that movers or competitive offers or anything that may have some type of competitive undertone, that is probably somewhere around, maybe up to two-thirds of that.

A third of that increase though is the lower quality subs that we are requiring to pay, so there was a little bit of an up-tick on the voluntary side that we are accepting because we do not want to continue to make investments in customers that are going to churn, and quite honestly, to manage our retention and upgrade spending. That is why we are doing this segmentation, so we can get the right offers to the right people.

It is there. It is not -- I would say it is not killing us, but it is real. We are taking it seriously.

As far as the percentage, we really simplify this for purposes of giving directional trends, 30% to 50%. What that means is 85% of our customers are in the top two highest quality tiers, therefore 15% is everywhere else. About 10% of the people are actually paying the fee. There is a commercial piece to that that does not get the DO fee, and there is a few that kind of all through the cracks that the system did not catch. So that number has got room to come down, but I think the message to our third party guys and even our own direct sales and obviously telcos is to get that number down into single digits.

We were pretty aggressive with what we did at the end of last year, and we are going to let that play out and let the independent guys specifically stabilize and start to be a little bit stronger here in the second-half of the year.


Thank you. Your next question is from Tuna Amobi of Standard & Poor’s Equity Group.

Tuna Amobi - Standard & Poor's

Thank you very much. I have two questions as well. The first is on the Pegasus transaction, which I think you closed approximately two years ago. Up until a few quarters ago, I think you were providing us with some color on the trend in those markets, and how the churn and the ARPU and the subscriber and the marketing spend and stuff like that.

I think since you are not providing that anymore, should we then assume that those markets are pretty much trending alongside your overall markets, or do you see anymore room to make some incremental gains in those markets? I have a follow-up.

Chase Carey

I guess I would -- I think it was actually probably more like a year-and-a-half ago since we closed at the end of ’04, but I think that is actually an area of opportunity. It is probably one that in many ways is sort of one of the examples of a case that is getting the right dealer network in place is the case in point. Clearly, changing the Pegasus deal helped. It turns up we used to have quarter on quarter declines, we have quarter on quarter growth. The reality is though we still do not have, with our subscribers in those regions, still do not equal what they were four or five years ago.

It is an area of opportunity that we have not taken advantage of to the degree we should have. I think it is an area that is uniquely tailored to the type -- complementary dealers that have unique strengths and geographic regions, I think that is a place that is probably as good an example as any.

We know because of the troubles with the Pegasus relationship, clearly we lost dealers, that those regions were not ones that we were effective selling and therefore we lost dealers. That is a place we really dedicated in the last -- we actually have plans very specifically to really focus on that as a target area of opportunity that we can really make some headway.

Some of these areas, like MDU, that again is another area that we have not, we do not get anything close to what we should be getting, and we have a solution and we do not have a dedicated approach.

Certainly the Pegasus agreement enabled us to turn what has been a continued loss of subs into something that grows the subs, but we are not where we should be or even relatively close to where we should be, from my perspective. It is a place that is a real opportunity for us to take advantage of in the next year and we are getting the right sales organizations and dealers in place to do so.

Tuna Amobi - Standard & Poor's

Okay, that is fair enough. Separately, Mike, I think this is probably a question for you. I am just trying to get a sense of how, or what opportunity you see in the -- incremental opportunity for HD DVR subscribers versus non-HD DVR? So as you think about in lifetime value of a subscriber. So let’s say we quantify that in terms of IRR per sub, which by my calculation, you were generating anywhere from 50% to 60% recently. So as you now rule out HD DVR, how do you quantify the opportunities here? Where do you see the greater upside in terms of the value per sub? Is that going to come from -- I know there is a combination of things, subscribers, SAC, churn, and ARPU. I am just trying to get a sense of where you see, how you see HD DVR affecting your lifetime value per subscriber.

Michael Palkovic

As we said, the ARPU and churn profile of both the DVR and HD universe is significant. So those investments are definitely worth taking half a point, seven-tenths of a point churn.

When you combine those two, you have your absolute best combination of services in the home, your highest ARPU profile, and arguably there has to be some lower-end of that churn spectrum, so even though there is a little bit more cash investment in the home, the return is significant. When you lay on top of that the fact that we have a lease model and we can recover all the hardware, which is the only difference in cost, it just makes the IRR go pretty high.

Yes, I think there is a view that you have to be in view and ultimately the customers that are going to resonate with one of those products is likely going to resonate with the other. That would probably be our best investment, is that customer going forward.

Tuna Amobi - Standard & Poor's

Does 50% look sustainable to you over the long-term?

Michael Palkovic

I think 50% is very conservative for the scenario you just said. I think that number is much higher for an HD DVR, particularly when you factor in recovery of the lease program on the small amount of customers that ultimately churn.

Tuna Amobi - Standard & Poor's

Thank you.


Thank you. Your next question is from Qaisar Hasan of Buckingham Research.

Qaisar Hasan - Buckingham Research

Thank you. I wanted to focus on your net add trends a little bit. I had a couple of questions on that.

One, if we can just talk about your RBOX partnerships a little bit. It looks like if we look at basic net adds for DIRECTV that have been reported by Verizon, BellSouth, Quest, it seems to be adding up to around 140,000 in the quarter, which is basically more than your entire net adds in the quarter. Am I doing that math right, because that would seem to imply that if you strip out your RBOX partnerships, the rest of your distribution channels are actually not adding subscribers, so maybe you could just help me out on that.

Also, how you feel about that exposure, as the RBOX are to move towards their own video offers.

The second question I had on net adds was just on the cable VoIP market. Have you guys done any analysis to look at what your net add and churn trend seems to be in markets where cable is rolled out a VoIP triple play offer as opposed to those where it has not?

Chase Carey

I guess on the first, I do not think you can look at the sale. I think you have to look at sales, gross sales. So the RBOX channel is part of the gross sales mix which was somewhere in the high hundred thousands in the quarter. I do not think you can look at it as truly all incremental subs. There are subscribers that may have come in and taken offers in different mix and matches. There are values, you get churn pay, you get churn reduction on the benefits from people attaching a deeper level of services, but I do not think you could match -- I think it would be quite wrong to end up assuming those customers, if you did not have an RBOX, ship you in there some other way.

We could either get those customers or have alternative ways to sort of try and address those customers. You may not get all those customers, but I believe there is a benefit from the RBOX, but I think you have -- you would be doing things differently in the market place, so I do not think you can take the real arc and just sort of pull out a piece of it and assume nothing happened to fill that vacuum. There would be an array of ways.

I do not think that is the way you can look at that.

I think in terms of SA development, I think realistically, we are developing as they are developing. I mean, I am not sure we are -- you know, they have got quite a long time frame and I think an array of questions that continue to exist, where they are going to go, and how successful they are going to be, and I think in many ways, our plans as we develop alternatives, I mean, the wireless broadband alternatives, you know, we actually announced that the wireless deal with Earthlink that we launched in Anaheim we are going to launch in a few other cities behind it.

There are an array of new initiatives for us that broaden and give us multiple opportunities to continue to address the broadband bundle. I think the reality of that is going to be the RBOX today are quite committed to our relationships, continue to, if anything, strengthen. I think they are building out their alternative, so I think that is a long-term process, and we are side by side looking to develop our alternatives to compete in the market place.

I do not remember the last -- do you remember the last question?

[Multiple Speakers]

If you look at bundles, in many ways I guess where there is more -- again, the bundle is a part of the competitive landscape, where you have a more aggressive bundle. It has probably more of an impact than margin. In many ways, probably to some degree, where we are able to compete that effectively, where we are working hard to have those, we actually compete pretty well that effectively where they are there.

That market is moving fast and people are adding those services on both levels. The reality is you are moving to a triple-play competition pretty quickly, so I think the focus on the two-play is probably in some ways more your focus, in many ways, assuming you are competing in a pretty reasonable time frame against the triple play bundle.


Thank you.

Qaisar Hasan - Buckingham Research

If I could just follow-up on your broadband comments, obviously one of the announcements that came out in addition to your results was the Sprint WiMAX announcement. Could you maybe just talk about that a little bit, to the extent that could help fill some of the gaps that you feel in your coverage right now, at all?

Chase Carey

I am not going to -- I guess would not comment on any specific entities. On an array of entities we are talking to, again, we may end up with the most -- we may end up finding there are an array of ways for us to approach the marketplace. I think clearly you have large players looking to aggressively build out a third play in the broadband world beyond the two wired ones. I think all of that is good, and all of it provides opportunity.

We are a natural fit with any of them, and to the degree those products are in the marketplace, I think it is a positive, and those products obviously bring a new feature in terms of portability, mobility and work that I think will put increasing premiums and importance on wireless services, I think are all positive and very compatible with us. I think it is -- I think as you get larger players committing larger resources and developing it, I think it all helps bring scale, bring size, bring investment dollars to really develop and build that third broadband alternative through multiple players. I think to some degree, the more the better for us.


Thank you. Your next question is from Thomas Eagan of Oppenheimer & Company.

Thomas Eagan - Oppenheimer & Co.

Thank you. Just a follow-up on the customer growth questions. If you could, Mike or Chase, talk a little bit on maybe some detail on the gross adds. For example, how many of them came from cable, how many came from new TV households, how many of them came from broadcast only, or at last how it was different from last year in terms of what proportions are different?

Then, a follow-up, your corporate cousin, BSkyB, launched essentially a 1 billion pound broadband service last month. I guess the bare case on that launch is that it is essentially an expensive program for retention. Chase, if you could talk a little bit about how much interest from News Corp there is, and you launching some kind of broadband service. If you can reiterate the strategy of how it can add value. Thank you.

Chase Carey

I do not think News Corp brings a different perspective than DIRECTV to this. I think clearly broadband is important part of the market place, support of the bundle is a part of the market place. The environment we are competing and I think that for all the reasons we said it is important, I think it is important to us and important to News Corp as a major shareholder of ours. I do not think there is a different perspective in terms of the importance of it from News Corp, but I think it is mostly one that is reflected through DIRECTV, the importance to the degree that we can find ways to take advantage of these developments and News Corp’s other Internet and broadband. Obviously they have broadband content arrangement is one that has been very successfully grown by News Corp. We could take advantage of working with them to find ways to compete using that relationship. That is certainly something we do, and to the degree there are opportunities to work with the other platforms around the world to find ways to create opportunities and synergies to develop broadband for the market place. There are certain things we will also do, but I do not think News Corp has a different perspective than the importance it has DIRECTV to compete in the market where clearly the bundle is going to be the center of the market place for competing. John.

John Hogan

On the first question, we do not typically give out specific source of where customers come from. It is obviously a fairly competitive number. We do track it, but we have not seen any significant shift over the course of the last year in terms of where customers are telling us they are coming from. It moves around a little bit, quarter to quarter, but that is probably as much as we are going to share on where the customers are coming from. As hopefully you can appreciate there is a little sensitivity there.

Thomas Eagan - Oppenheimer & Co.

Understood. Thank you.


Thank you. Your next question is from Jason Bazinet of Citigroup.

Jason Bazinet - Citigroup

Thank you so much. Just a follow-up question on your wireless plans, and please correct me if I am wrong here, but if I recall correctly, there were sort of three important points I think you have made historically. The first is whatever you do in wireless would certainly involve partners. The second is that you would limit the magnitude of capital you would commit to, around $1 billion, and the third was that you would not necessarily consolidate the revenues or expenses from this venture. I just wanted to re-test that all of those are still valid, regardless of which technical platform you pursue.

Chase Carey

I think those are probably an accurate reflection of where we are at, so I think the market is always moving, the players are always in different places, so I think that is how we are approaching the market and how we are looking at it. As I said, it may end up including things that are distribution arrangements, not -- investment and distribution, but I think we recognize on the one hand the challenges of building this and broadband could be a very competitive space. We think there are real opportunities there. We think the wireless ones have real advantages in terms of features of the wireless itself, as well as a set of costs that really give you an ability to compete quite aggressively, and an advantageous cost structure, and I think technology is continuing to improve, and so is the cost of developing of it.

I think it as a broad-based picture, I think that is an accurate picture. Again, I think that being said, you always have to sort of continue to see what the opportunities are in the market place and judge any particular one on its own merits.

Jason Bazinet - Citigroup

Thank you very much.


Thank you. Ladies and gentlemen, that concludes today’s call. Please disconnect your lines at this time, and have a great day.

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