康卡斯特 (CMCSA) 2004 Q2 法說會逐字稿

Good morning and welcome to the Comcast second quarter earnings release conference call.

Today's call is being recorded.

At this time for opening remarks and introductions I would like to turn the call over to Executive Vice President, Treasurer and Co-CFO, Mr. John Alchin.

Please go ahead, sir.

Thank you, Operator and welcome everybody to our second quarter 2004 earnings call.

Today's call is accompanied by slides which are available on our Investor Relation Web site and I'd encourage you to click through those as we go through the presentation.

Before we proceed, I need to refer everybody to our Safe Harbor disclaimer and remind you that this conference call may contain forward-looking statements subject to risks and uncertainties which we outlined in our recently filed 10-Q and other SEC documents.

Also, please refer to the Investor Relations Web site for a reconciliation of non-GAAP financial measures.

Well, the second quarter was another quarter of outstanding results.

On a consolidated basis revenue grew 10.3% to 5.1 billion, while consolidated operating cash flow grew a substantial 21% to 1.95 billion.

Cable revenue grew 10.4% to 4.8 billion and cable operating cash flow increased 20.1% to 1.9 billion.

Our very strong first-half performance gives us a high degree of confidence in the second half results, and accordingly we're increasing cable operating cash flow guidance to approximately 7.5 billion, or approximately 18% growth.

And while the absolute numbers are smaller, the growth in our content division is also outstanding.

Content revenue grew 25% to 199 million and operating cash flow almost 38% to 77 million.

So we're reaffirming guidance for revenue growth in the content division of at least 20% and operating cash flow growth of 30%.

With both the Masters and the Open on schedule, the second quarter is always a high point for the Golf Channel.

Primetime viewership was up 33%.

Primetime viewership for the Masters up 57%.

And during the second quarter OLN prepared its viewers for the Tour de France with a marathon of tour-related programming, and strong viewership ratings were recorded amongst just about every category of male viewers 25 to 54, 18 to 34, and so on.

But Sunday, with Lance Armstrong winning his sixth consecutive Tour de France race, OLN recorded its highest ever day rating, and in July, OLN also recorded its highest ever one week rating and one month rating.

But moving on through the remainder of the consolidated results, consolidated operating income more than doubled to 852 million, up from 425 in the second quarter of 2003, cable operating income was 877 million, driven by strong top-line growth and improving margins.

As a result, the company reported consolidated net income of 262 million, or 12 cents a share compared to a net loss from continuing operations, excluding QVC, of 93 million, or 4 cents a share in the second quarter of 2003.

So if you would turn to the slide that highlights the various categories of cable revenue growth.

Let's drill in to the cable results beginning with revenue.

Excluding our phone business, we're reporting fully 11.6% revenue growth for the quarter.

And I'll say more about the phone business at the end of this particular slide.

Looking at the various components, total video revenue from both analog and digital service was up 6.9%, to $3.2 billion.

This was the result of several key factors.

First of all, about a 5.7% increase in average revenue per basic subscriber is recorded as a result of increases that were taken earlier in the year.

Basic subs are flat year-over-year, but the 96,000 loss for the quarter reflects primarily seasonality and moderately lower gross adds.

Steve will have more color on the seasonality and the outlook for the remainder of the year that will result in our gaining subs in the second half of the year to finish the year flat at about 21.5 million subscribers.

Don't forget that the third quarter is also seasonal as we have the seasonality influence of July and August offset by snow birds returning, and results increasing as we get into September and into the fourth quarter.

The second factor was a 21% increase in digital revenue, the result of a higher number of digital subscribers.

We now have over 8 million digital subscribers, and added over 206,000 in the second quarter, giving us 1.1 million net adds for the last year.

We continue to be successful in increasing the uptake of digital.

Now digital sell-in rate is now 57%, up from under 51% in the second quarter a year ago.

Digital revenue growth also reflects the increased take rate of new digital features such as Comcast ON DEMAND, high-definition television and DVRs.

At the end of the second quarter we had nearly 600,000 high-def TV boxes.

Digital features such as ON DEMAND and high-def not only contribute to the video revenue growth, but also they help reduce churn.

Markets with our ON DEMAND service have digital and basic churn rates that are 20 to 30% lower than market that don't have Comcast ON DEMAND.

At the same time, we saw pay-per-view revenue increase over 26% driven by higher movie take rates for those places that have the ON DEMAND service.

And another key factor in driving the cable revenue growth is our high-speed data service.

Revenue for this service up over 39% for the quarter to over $760 million, an annualized run rate in excess of $3 billion.

So we continue to balance unit growth and ARPU.

High-speed Internet selling rate is now 31%, up from 27% from the first quarter, a sequential increase of 4 percentage points, very dramatic in that short period of time.

This product still has very significant upside as we're still only reporting 16% penetration and we have growing appeal through the new applications and features that we're loading on to the service.

Not unexpectedly, telephone revenue declined about 13.8%.

This is a result of our continued focus on profitability of the circuit switch business and not on unit growth as we prepare to move into the VoIP platform in 2005.

Our VoIP trials in three markets are going according to plan.

We lost 20,000 subscribers in the second quarter, and expect that level of quarterly sub loss as we continue into the second half of the year.

Accordingly, we've adjusted our guidance down slightly from up about 50,000 to a loss of about 100,000.

Finally, advertising revenue very healthy.

Steve will have more to say about this in his part of the presentation, but revenue up 15% for the quarter.

If you turn to the next slide, we give you an insight here into the cash flow growth, moving down to free cash flow.

As you can see, the combination of double-digit revenue growth and slower expense growth of 4.8%, produced operating cash flow of 1.9 billion for the quarter, up 20%.

As a result of this strong performance in the first half of the year, as I said before, we're increasing guidance for the full year.

As Steve will detail, the improved operating cash flow is driven not only by top-line growth of 10.4% that we're reporting, but equally importantly we continue to report meaningful and sustainable expense reductions across a number of categories, from headcount reductions inefficiencies, reductions in customer service expense, reductions in network costs for high-speed data and phone, and a significant reduction in the rate of programming expense growth.

But let me focus for a minute on how this increased operating cash flow translates into dramatic increases in system-free cash flow and ultimately consolidated free cash flow growth.

If you annualize the quarterly operating cash flow per sub, we generated on an annualized basis about $350 of cash flow per sub from the second quarter.

This compares to about $167 that was being generated by the AT&T Broadband systems when we acquired them.

So doing the comparison for our entire footprint of 21.5 million subs, we're now generating twice the amount of operating cash flow per sub that we were at the time that we closed the AT&T Broadband deal.

And with the completion of the rebuilds, capital investment is declining, which drives higher system free cash flow, which we define on table five of the press release as operating cash flow net of capital expenditures.

So as we've said a number of times before, we see our business model averaging approximately 10% revenue growth converting to approximately 10 to 15% operating cash flow growth, which in turn should convert to approximately 20 to 30% free cash flow growth.

At the consolidated level on the next slide, we're looking at combined operating consolidated Cap Ex relating to the rebuilds coming down significantly quarter-to-quarter.

We're looking at free cash flow generation of approximately $500 million.

This is directly in line with our full-year guidance for free cash flow at the consolidated level of about $2 billion.

This quarter we received a tax refund of $536 million, a one-time item that we're not including in our free cash flow calculation, but this amount is specifically footnoted and included in the free cash flow reconciliation Table 6B of our press release.

Sequentially, you're seeing a $79 million increase in Cap Ex quarter-to-quarter, up to $893 million in the second quarter.

This is a result of two factors: The accelerated rebuild, we now have 75% of our rebuild capital for the year already spent and, secondly, slightly higher variable Cap Ex as a result of the rollout of digital, high-def, DVRs, and VODs.

At the end of the second quarter, we're 97% rebuild, we see no need for rebuild investment going forward, and, therefore, expect rebuild capital expenditures to decline for the remainder of this year and going into 2005.

As this slide shows, at the six-month mark, year-over-year Cap Ex declined 15% versus last year, and this is in line to meet our guidance of 3.3 to 3.4 billion for capital investment in cable for the year.

Capital investment for the second half of the year will be roughly equal to what was spent in the first half, with upgrade capital continuing to decline, while success-related variable capital will increase due to digital activity, high-def, DVR, and VOD deployment.

As we've said before we expect Cap Ex in 2005 to decline further, as upgrade capital declines significantly from the $800 million level that we expect this year, which should result in 2005 capital investment being within 10% of about a $2.5 billion level.

So, all in all, we're confident with our guidance of $2 billion of free cash flow for this year that takes into account interest expense of approximately 1.8 to 1.9 billion, and a tax estimate of approximately 200 to $300 million.

Brian will cover the stock buy back program and the activity that we've had in that program, but let me highlight the elimination that we've created of the issuance of approximately 15 million shares that would otherwise have been issued by redeeming early two issues of notes exchangeable into Comcast shares and redeeming those issues for cash.

Through the combination of our stock repurchase program, and the cash redemption of the Comcast stock related securities, this results in a positive impact on float of almost 42 million shares.

At the same time, we continue to achieve tax efficient monetization of our non-strategic assets.

Last week we announced the exchange of 120 million shares of Liberty Media for 100% ownership of the International Channel, $545 million in cash, and the 10% ownership interest that Liberty had in E!

Entertainment.

In his closing remarks, Brian will highlight other uses of free cash flow when he reviews a number of other key acquisitions and investments that were made during the quarter.

So not only were we able to report terrific operating results but we also have a very strong financial base that still includes non-strategic assets with an estimated value of approximately $10 billion.

On the next slides we highlight the guidance.

We're reaffirming all other guidance that I haven't already referred to, but now let me pass to our Chief Operating Officer, Steve Burke to give us color on the cable results.

Thank you, John.

I think it was clearly another strong quarter for Comcast Cable.

What I'd like to do today in the interest of brevity is highlight five areas: First operating cash flow and our progress improving our margins, secondly, programming expenses, third, basic subscribers, fourth, the high-speed data business, and fifth, ad sales.

If you turn to slide ten, starting with operating cash flow growth, we're very pleased with our margin performance this quarter, coming very close to 40% within 18 months of the AT&T deal.

As those of you who have followed the company know, reaching a 40% margin was a key benchmark of ours when we did the deal, and it represents a major improvement versus AT&T Broadband margins of roughly 20%.

Importantly, the improvement in our margins came from many areas of the P&L.

And I'd just like to highlight a few.

Headcount is down about 2,000 people from a year ago, despite the fact that we have over 2.6 million more RGUs.

And what that means is the efficiency see of our business is continuing to improve as the number of RGUs increase and employee headcount actually declines.

What's particularly impressive is that this headcount reduction has come despite the fact that we've actually added in some areas such as in-house customer service.

Our high-speed data network costs are continuing to fall, they're down 30% on a per-sub basis versus last year.

Our phone network expenses are down 23% versus one year ago, and I think it's important to note that all of these improvements are sustainable improvements.

Moving on to our next highlight area on the next slide we come to programming.

We spend about $4 billion a year on programming.

It's by far our largest expense item, and traditionally it's been growing too rapidly, in the 13 to 15% range.

Our initial expectation for 2004 was that program would grow roughly 10%, the result of 8% cost increases, and another 2% from new channel adds.

In the first half of 2004, our programming expenses grew around 5%.

While there are still some negotiations in progress, we think for the full year it's now safe to assume we'll be in the 5 to 6% programming cost increase range, which is significantly lower than we had thought just six months ago.

Longer term, we think the prognosis is good to get total programming costs growth down even further, so that our total programming costs grow at roughly the rate of inflation, be that 3%, or wherever inflation ends up.

So I think at this point it's safe to say that the advantages of scale, as it relates to programming, are greater than we forecast when we did the deal and should clearly continue in the future.

Moving on to slide 12, basic subscribers, we lost 96,000 basic subscribers during the second quarter.

Now the second quarter is a seasonally slow quarter, and we and other cable companies have traditionally lost subs in the second quarter as people leave areas such as Florida and schools get out of session.

This quarter we actually had fewer disconnects than we did the same quarter last year.

The drop in basic subs was due to the fact that we had less connects than we anticipated.

We plan to be more aggressive with marketing and promotion in the second half of 2004, in particular with field sales and dish win backs.

Now that our margins are where they should be, we will increase our focus and spend a little bit more in terms of marketing to gain basic subscribers in the second half of the year.

Importantly, we expect to gain subscribers in the second half and gain subscribers for the full year.

Moving on to high-speed data, we added 326,000 units during the quarter and now have just over 6 million subscribers.

Like the first quarter, this represents 93 to 94% of last year's quarterly net adds.

The second half of this year should pick up with back-to-school and Christmas, like did it last year, when the second half of the year represented 54% of the total year.

So we're right in line for 1.5 to 1.6 million net adds during 2004.

ARPU was up significantly to $43.52, versus $42.45 in the first quarter of '04.

We would expect this ARPU to come down closer to $42 in the second half of the year as we get more aggressive with seasonal promotions.

According to Nielsen, Comcast.net is now the number one broadband portal in the country and we're working hard to make it even better.

We've added video e-mail, new content for our Fan, recently announced a deal with Disney and ABC, we've added a 4Meg product, the 5295 4Meg product Games ON DEMAND and expanded e-mail.

This is a fantastic business and it's shaping up to be a very strong year for high-speed data.

Moving on to ad sales, on the next slide you'll see that our ad sales grew about 15% in the quarter up slightly from 14% growth in the first quarter.

And this growth is really being powered by our interconnect strategy which really continues to drive the growth rate.

Our local business was up about 5% for the quarter, but our regional and national business were each up over 20%.

We have very strong trends going into the second half of the year with the Olympics and political spending.

We continue to be big believers in the ad sales business and our role in it, now that we have a presence in 21 of the top 25 markets.

So in sum, it was another strong quarter and it's shaping up to be another great year.

The good news is, we've now achieved most of the goals we set for ourselves when we bought AT&T Broadband.

Our margins are where they should be, our plant is rebuilt, we're rolling out more new products, and we're looking forward to a strong second half of 2004.

Brian?

Thank you, Steve.

This, I don't want to drive the point too much, but we're upbeat about the business because of 20% plus cash flow results for the second straight quarter, and hence we're upping our guidance and that's probably the big headline.

But I think as you drill into it, the quality of the revenue growth, that's diversified among a bunch of new initiatives, and they're all starting to pay off, obviously high-speed data as Steve just said, we are really quite bullish, the ARPU increase in high-speed data, we're trying to get the balance right on how many net adds versus revenue, but the market looks deep and sustainable and we're very confident of the full year results and very pleased with how high-speed data is going and the trends we're seeing there.

I think on the video product, we are pushing ahead with trying to differentiate cable from satellite.

We're at a moment in time, we're getting our digital video recorders, DVRs, deployed by the end of the year.

That is not yet a meaningful impact in our numbers.

High-def, you can see how quickly that is beginning to be a differentiator.

We are launching regional sports in high-def all over the country in high-def, we are doing video ON DEMAND in high-def.

And we again, once you get there, you can begin the marketers take over and find ways to enhance the product.

And so it goes, we're obviously excited about where we're going in Voice Over IP, and we're excited about where the platform takes us with each one of our product categories.

So, you know, big picture, let me just give you an example of what happens when we continue to improve the content on ON DEMAND.

In 2003, in June, we were 50%, or in 2004 we're 50% higher than we were in 2003 in 75% of our customers using the ON DEMAND product in Philadelphia and virtually the same results in the Boston market.

Three-fourths of our customers are using the product in the 90-day period.

We are finding that the average home, as we've said, takes it, uses it more than 20 times a month, and every single content deal that Steve and we and Matt Bond are doing, and Amy Vance, all include video ON DEMAND.

Every new initiative in this company is to figure out how to make Comcast's version of television better than anywhere else you could go.

Same philosophy applies to our high-speed Internet product.

And what we have said, if you turn to the next slide, is that when you put that together, as you have a state-of-the-art network, and a growing stable cash flow business, I mean we can't go 20% forever, we're saying 18% for the full year, but the operations team is fantastic, that you're generating free cash flow at unprecedented levels for our company and so we are today announcing a $1 billion increase in our stock buy back authorization.

John reported on how much we've already been buying.

We, at the same time, are able with the nearly $2 billion of free cash flow that we expect to generate this year, and more next year, and hopefully for many years to come, that we're able to reinvest in the business with new strategic initiatives, focused on making Comcast a better and more valuable company.

And three of those deals that I'll just quickly highlight were, one was our purchase of TechTV that was married with G4.

We think G4 TechTV, in effect video games and high-tech fun for, particularly young males, will be the potential to be the next MTV-type breakthrough channel for that very, very attractive advertising demo.

And to pick up nearly 25, 30 million more households right on for this channel has taken, you know, a five-year or more acceleration for this programming channel, and that will compliment E! and OLN and Golf, and our major channels, the Style, that have hit the 40 plus, 50 plus million home mark which is where you start to make cash flow.

We never spend enough time on these calls talking about our programming channels, but, John, it was nice of you to single out each one of our networks as having fantastic results and continue to be the fastest growing part of Comcast.

In the cable business we made two strategic announcements.

We spent approximately $250 million, we spent about $300 million on TechTV, give or take, 250 million or so for the Gemstar TV Guide relationship.

This allows Comcast now working with all the work that's been accomplished at TV Guide to have a managing partner role in developing the guide for our future technology platforms, our current platforms and our go-forward platforms.

All the intellectual property and all of the people who are working on TV Guide's products are now being directed by the Comcast team.

Tremendously important as we want ON DEMAND to be fully integrated and PBR functionality fully integrated in a fun and easy way for consumers to access.

We don't have to say, well, that's somebody else's Guide.

We are looking to be responsible, and therefore opportunistic, on the entire end-to-end experience that our consumers get.

And equally, we didn't want to have all of our eggs in one basket, and we want to begin to drive innovation toward cable software, which is a whole new business for cable, and so we consummated a deal with Microsoft where we purchased from Microsoft their TV foundation platform and we intend to roll out both these products.

We have so many homes that we want to run both.

Their platform is very fast when you change channels it moves right away, when you want to play games on your set-top box, and they will build a platform that will be available and open as part of our deal to third-party developers to help drive some of the uses on this foundation platform much the way they've done with other platforms around the world.

So, again, all of this is designed to try to, you know, take advantage of free cash flow, find places where we can grow asset values like G4 TechTV, at the same time return money to shareholders and basically shore up all of our credit ratios as they have just in the last 24 months made such a dramatic turnaround.

So very excited, happy to take questions for any of us.

And with that, Operator, we'll kick it back to you.

Operator, we're ready for Q&A.

Thank you, sir.

Investors wishing to ask a question may signal us by pressing star one on your touch-tone telephone.

If your question has been answered and you wish to be removed from the queue, please press the pound sign.

If you are using a speaker-phone, please pick up the handset before pressing the numbers.

Our first question is from Kathy Styponias from Prudential Equity Securities.

Please ask your question.

Hi, thank you.

I guess a question for Brian and for John.

With the increase in your authorization and the money coming in from Liberty Media, it looks like you still have a little North of a billion dollars that would be left over from free cash flow generation this year.

Was wondering if you can kind of outline what the priorities are for that free cash flow other than share repurchases?

Thank you.

Just before Brian answers that Kathy, let me highlight that the three deals that Brian just referred to involved an investment of over $600 million, and so, you know, that in conjunction with other debt maturities and redemptions that we have would go towards offsetting the inflows that are otherwise there.

Brian?

I don't know that we have a specific answer on that at this point.

I think it is our job to continue to scour every possible opportunity and ultimately try to find the balance between new initiatives and in our case being, we hope, opportunistic in buying back shares and returning the money to shareholders.

That way, and we are, at this point I don't think there's any plans.

Thank you.

Next question, Operator.

Our next question is from Douglas Shapiro from Banc of America Securities.

Please state your question.

Thanks.

Two quick things.

I was just wondering if you could talk about the gross add and churn dynamics in the data business and specifically what you're seeing in terms of gross addition growth?

And then the second thing, John, just to clarify what you said about basic video ARPU, was the 5.7% growth driven solely by price increases or was there something else going on there?

The 5.7 the primarily the price increase flowing through because year-over-year there's virtually no change to the basic sub count.

And Steve do you want to talk about the high-speed data?

Well, I think the real headline on high-speed data is that the churn continues to remain very, very low.

No increase in churn whatsoever, and so what's really happening is, as our business gets bigger, we do have more customers churning off just because the business is bigger, but the churn itself is very stable and gross adds are growing much faster than the customers that are leaving us.

Next question, Operator.

The next question is from Jessica Reif Cohen from Merrill Lynch.

Please state your question.

Good morning.

I have two questions.

One on the Liberty transaction.

Now that you're own 60% of E!, could you just review, is there a path to control the balance, the other 40% of E!?

And secondly, on the basic subs, with penetration of only 53% could you just go into a little more detail of where you ultimately expect to wind up in terms of basic penetration?

I'll answer the E!, Steve maybe we can talk about the video penetration.

On E!, the way the partnership agreement works, we are the managing partner, and at various times or anytime when we choose to, you know, there's no call, and Disney can exit through or begin an exit process that gives us the option whether to buy or sell.

So at this point there's nothing to talk about.

It certainly, we own 100% of all of our other programming assets, or virtually 100%, so that's some day a logical possibility, and we did buy the Liberty stake directly so our ownership has been going up.

We like the asset, but we have no prospect at the moment that that's going to change to be 100%.

Regarding the penetration, Jessica, I think the key thing to remember with our video business is these are very stable, mature businesses at this point and I think it would be unreasonable.

We would certainly shoot for it and love if we could get a number of product differentiations that allowed us to increase penetration, but I think the more likely scenario is that we're at a real equilibrium point and the penetration is likely to remain pretty much where it is.

I have to tell you that I don't think you focus on penetration, per se, because there's, you know, so many products now, and our view is now trying to figure out where the high-value product customers are.

It's not one-size-fits-all anymore, like the good old days, so to speak.

And in fact, as we analyze for ourselves some customers are paying us $100, versus customers in that some cases are paying us $10, who are B-1 only.

Your trick here is, how do you make sure you keep and retain and get the better customers.

So it's more complicated than just that one stat, particularly with multiple product lines as we go into telephony and DVRs, ON DEMAND usage rates, and so I again, personally think you've got to look at the health of the underlying business.

Revenue growth.

We said last year one of the reasons revenue didn't grow faster was telephony, and we are ramping up the new product sales and you're seeing the success of that in this year with really 11% revenue growth if you back out telephony.

And we're making that investment again right now with the high-speed data growth and eventually voice over IP, and again our view on voice over IP again, will not be penetration, penetration, penetration, it's going to be high quality revenue and cash flow coming from those subs.

So it's obviously a statistic that matters, but in the full context, I think you've got to look at the overall health.

And when you add it all up and you get 21%, or 20.3% growth, or 20.1% growth, thank you John, we're just thrilled with where this quarter's at.

Also, last point, as Steve kind of said it, I just want to make sure everybody really focused on it.

Programming costs has got to be one of highlights for this quarter and our ability to now have taken this platform and quietly gone about our business and tried to reduce the rate of increase, in not just a one-quarter way, but in a meaningful, sustainable way, while at the same time getting video ON DEMAND content thousands of hours that we're now making available to our customers that no other platform is doing.

Next question, please, Operator.

Our next question is from Richard Bilotti from Morgan Stanley.

Please state your question.

Good morning.

Thinking a bit about the TV Guide deal and what it could mean, two inter-related questions.

One, does that allow you to play offense in terms of forcing a conclusion once and for all to outcap on a two-way device so that you can get more than one set-top manufacturer to work in a given system?

And the second inter-related piece is, does it give you the ability to start to make an offer of three or four boxes per digital household to match the DBS players, and is that even a crucial capability to be able to offer three or four boxes?

Because they seem to have thrown that down as their next anti-chip.

Why don't I start and, Brian, you can jump in.

I think the key way to think about the TV Guide deal is, we are now in control of our own destiny.

There was a time when that deal was exclusive, and so therefore, every one of our digital customers, anytime they turned on the television set were dealing with, in effect, a portal that we did not control, and now we are driving the development of that portal and are coming out with a new revision in the next 30 to 60 days which is fantastic which is going to make video ON DEMAND navigation much more simple.

And then as we go into the future and have lower cost digital set-top boxes, and drive our penetration much higher than it is today in terms of digital footprint, we're going to be able to use this Guide and the ability to control this Guide and develop it in a way that's going to advantage us, both economically and also creatively.

So I think it really removes, if you will, TV Guide from being a barrier to driving the company in a lot of ways that are very positive to us, including having multiple sets in the home, multiple digital receivers in the home and other things.

Agree with that.

Next question, please, Operator.

The next question is from Niraj Gupta from Smith Barney.

Please state your question.

Thank you and good morning.

At last year's analyst meeting.

I believe Steve talked about targeting a phone margin of around 25% in 2004.

Could you talk about, you know, where you see profitability in that regard, Steve, and I guess looking out to 2005, given the fairly aggressive IP telephony launch plans, do you think you can actually improve upon that profitability as you go through an aggressive IP telephony launch?

Just some color would be helpful.

Thanks.

Well we, right now, we're traveling in excess of a 25% margin in the legacy circuit switch phone business.

I think it's obviously too early to predict exactly where the margin's going to shake out with voice over IP, but we would hope that it would be higher than a 25% margin.

We very much are going into this business to make money.

Our whole strategy is to have a differentiated product and not to compete solely on the basis of price.

Obviously we want to bundle the product with our high-speed data offering and video and everything else, but we fully anticipate having it be a profitable business.

Whether that means a margin of 25, 35, or it's, I think, too early to say.

But as to the circuit switch business we are traveling at a margin in excess of 25% now.

Next question please, Operator.

Our next question is from Tom Eagan from Oppenheimer and Company.

Please state your question.

Thank you.

If I could follow-up on the basic sub losses in the quarter, could you compare how those subs fared in the historical systems of Comcast versus the ones that are the former AT&T systems?

Thanks.

Why don't I take that one.

I think the short answer is, the performance right now of old Comcast and new Comcast as we call them, are roughly equivalent.

And what you saw last year in the second quarter, we actually gained subscribers in the second quarter last year, which surprised us.

And that was because there was so much to do in the new Comcast, i.e. the AT&T Broadband systems.

Most of those systems now are performing roughly the same as the Comcast side.

And I think what you really see in the second quarter is, with our footprint, we should lose somewhere around 50 to 75,000 subscribers in the second quarter.

We have lots of subscribers in Florida, we happen to have lots of college towns where people leave in the sort of springtime.

We lost a little bit more than we anticipated.

I think part of that is because we've had such a focus on driving margins and launching new products and obviously competition is stronger than ever.

But we're going to sort of redouble our efforts and try to concentrate on the second half and get the growth that we plan and would fully assume.

But when you think of the new systems and the old systems, right now the performance is more similar than dissimilar.

When we took over 18 months ago that was not the case, but I think the company is operating right now, more similarly than dissimilarly.

Next question, please, Operator.

Our next question is from Doug Mitchelson from Deutsche Bank.

Please state your question.

Thanks.

Just, you know the [RBOK's] obviously have been making a lot of noise about their different plants for fiber, and as you continue to invest in your business here, especially the video side, is there, do you think those plans for fiber are going to really happen and how do you prepare your business for that eventuality?

Well, it's not our job to comment on what they may or may not do.

I think it is our job to try to plan.

But can't help but say that it's a long process if they were to do everything that people have written about, just physically and dollar-wise.

I think wireless networks appear to be powering the revenue side of their business as we continue to watch, and watch where they're making acquisitions.

So it's a business that all we can do, we're in a competitive business already.

You can go out today for $25 and get 50 television channels.

So whether it's called an [RBOK] or whether it's called satellite, or whether it's called satellite via an [RBOK], there is plenty of competition in this business, and that has motivated many dramatic changes in the way we run Comcast.

The people that we have, the way we're pushing new technology, the way we want to be in control of the consumer experiences we talked about, and, frankly, it shouldn't over-react in causing us to herky-jerky around on strategy.

And so I think we've been very consistent that we want to differentiate our products, we want to give good value, and most of all we want to give great service.

And to that end, we are opening call centers, we're retooling AT&T's operations to look like our own, and I just want to step back for one second because it gets lost, and this may be the last time we do this, but when we bought this business the combined company had 4.9 billion of EBITDA two years ago, and we're now saying 7.5 billion, fully a 50% increase in two years, or less.

We bought with it two-thirds of the customers able to access new products, today we're at 97, 98%.

And so our strategy has been drive the margin to 40%.

We did that.

We originally said we'd only get to 35.

Use the scale, not just to cut programming costs, but to get more value from programming relationships so that we can have products that our competitors don't have, and, of course, along comes high-speed data and really step on the peddle there.

Yes, we've got competition, but again, let's be the premier provider.

And once again, I think we had more net adds than any other distributor here but it's pushing us, it's motivating us.

We're realistic about the competition but when you add it up you still have 21% cash flow growth that enables you to have free cash flow that's going to grow even faster than that.

So, at the moment we're not changing strategy, but we're realistic that it's a competitive landscape that we live in.

Next question, please, Operator.

Your next question is from Laurel Werner from Credit Suisse First Boston.

Please state your question.

Great.

Thanks.

Good morning.

Just to clarify, Brian, you talked a little bit about focusing on high value customers and you're rolling out HD, digital VOD.

How have you thought about protecting the lower end side of the base?

Or should we continue to maybe expect that, you know, some of those lower end customers are allowed to leave?

And just the second question, I just want to be clear because I'm a little confused.

Are you planning on doing an aggressive voice over IP rollout or are you planning on doing a measured voice over IP rollout?

If you could just clarify what your plans are at this point that would be great.

We're measuredly aggressive.

Not to be cute, we're doing three trials this year.

I think we've been very consistent that we are enabling the platform because we're enabling it with the rebuild with high-speed data, that then is able to go ahead and do voice over IP as that product ripens.

But it is not so aggressive at all compared to whatever your standard is.

In my opinion, because we want to make money, and we want to be differentiated and we don't view it as a race.

We want to get it right, we want to make it where the seamless for the consumer and that we've talked about to the people that follow the technology and the plumbing side of this, one of Dave Fellows' big initiatives is how to have an architecture that all of our networks can be provisioned, all of our products can be provisioned with one software system, and that is being developed as we speak.

But let me go to a very fair question you asked.

No, we don't want to sacrifice the bottom end of the market, and surrender it.

And I think if anything, I would personally say that is an area that we have to go more aggressively and faster on than we have in the past.

And I think what we've been trying to signal is that the all-digital, what we called all-digital, or simulcast all-digital, or whatever technology, the purpose of that product, when you get a lower cost digital box, $75 or less, some say $50 or less, some have even said it will get cheaper that that.

But that's going to allow us to put into every single home that wants it, perhaps some day every single home, but certainly every single home that wants it, a level of whether it's tiers of service, so you don't have to take all the channels, whether it allows you to get all digital pictures, not an analog picture, whether it allows you to get a video ON DEMAND product, maybe a different version of VOD than the other digital customers.

All of those products become enabled, all designed to help not just the people who are the full digital customers, but the 65% that are not digital customers today.

Steve, you want to add to that?

Well, I think the interesting thing about our business, if you look over the last year, we've added 2.5 million new RGUs.

So what we've really done is financially made the top end of our business that much more valuable.

And what we're trying to do is say, we want to gain subscribers, we don't want to lose subscribers, but what we really are all about is trying to differentiate and get the top part of our business to be more and more segmented and make more and more money for us and be more and more sticky, and be more and more loyal to our company.

And I think we've done a pretty good job of that.

You don't want to advocate any segment but what you really want to do is concentrate on the segments where you're really making money which is why VOD and high-def and PDRs and of course, high-speed data are so important to our business.

Next question please, Operator.

Out next question is from Richard Greenfield from Fulcrum Global Partners.

Please state your question.

Hi.

Good morning.

Question on free cash flow.

I know you all define it as before working capital.

I just want to understand for the first six months of the year you reported $900 million of free cash flow with working capital, but that had a $536 million non-recurring tax refund so your real free cash flow on a recurring basis was like 364.

You've said before that your working capital works itself out over the course of the full year, yet you're running at a $530-ish million deficit for the first six months.

Should we expect in modeling out that that reverses itself in the back six months of the year?

Thanks.

Rich, I'm not sure where you're coming up with that number, but that's not the correct number.

We have backed out and we do show on Table 6B the impact of that tax refund.

All we're suggesting is that that is a non-recurring item, we report it on that table if you want to take it into account, But we do feel comfortable with the $2 billion number for the full year.

Next question, please, Operator.

Our last question is from Aryeh Bourkoff from UBS.

Please go ahead.

Thank you.

Just two quick questions.

One, a little bit of a follow-up on the last one.

You increased the EBITDA nicely on the programming, cost savings versus the initial model, but not the free cash flow.

Can you just reconcile that?

Is that because Cap Ex is a little bit higher than expected on the high end of the guidance, or is that interest savings because of the buy back?

And the second question is, given the programming cost increases you're talking about of 5 to 6% now or 3% in the long-term, which is a nice improvement, does that at all change your view on the content business and the attractiveness of that business given those programming cost savings?

Let me speak to the free cash flow first, Aryeh, that has to do with the ranges depending on whether we come in at the high or the low end of the Cap Ex, or the tax ranges or the interest, that all has to do with just leaving the free cash flow number at approximately $2 billion.

So we feel very comfortable with that number and it's only the range that dictates where we come in around that number.

And then on the other one, Steve, do you want to --

Brian, do you want to comment on the --

My sense is that programming is, you know, our results are fantastic, we are looking at programming as an integrated part of the cable company, so one of the things we did this quarter is, Steve Burke is now Chief Operating Officer of the company, having responsibility for content as well as distribution.

So we're looking at new initiatives, whether it's TV-1 or G4 or other potential alliances with others, both as how do we create value and how do we do so in a way that is good for the Comcast cable customers as well.

And, you know, on one side programming costs slow down, that may have valuation impacts to content companies, but hopefully we're also creating value for the cable companies with things like video ON DEMAND and that's going to create value for the content companies.

So it's again, we've never tried to say it's one or the other.

Both are very good businesses.

And there's no reason that we can't look and be part of both.

And by having one person responsible for the operations of both I think is the right structure and helps us, you know, helps us at least, you know, think about how we can help both parts of the company when we're looking at new initiatives.

Well, thank you all.

This has been a terrific quarter, and we're here to take any follow-up questions.

Thanks.

We have no further questions at this time.

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Once again, the number for the replay is, 630-652-3000, and the passcode is 9196739.

A recording of the conference call will also be available on the company's Web site beginning at 12:30 p.m. today.

This concludes today's teleconference.

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