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Net Serviços de Comunicação S.A. (NETC)
Q3 2007 Earnings Call
October 18, 2007, 10:00 AM ET

Executives

João Adalberto Elek, Jr. - CFO and IR Officer

Analysts

Andrew T. Campbell - Credit Suisse
Peter Lyons - Oscar Gruss
Fernando Ramos - JP Morgan Securities

Presentation


Operator

Good morning, ladies and gentlemen. At this time we would like to welcome everyone to Net Serviços conference call to discuss its third quarter 2007 results. The audio for the conference is being broadcast simultaneously through the internet at the website www.ri.netservicos.com.br. We inform that all participants will only be able to listen to the conference during the company's presentation. After the company's remarks are over, there will be a question and answer section. At that time, further instructions will be given. [Operator Instructions].

Before proceeding, let me mention that forward-looking statements are being made under the Safe Harbor of the Securities Litigation Reform Act of 1996. Forward-looking statements are based on the beliefs and assumptions of our management and on information currently available to the company. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions because they relate to future events and therefore depend on circumstances that may or may not occur in the future. Investors should understand that general economic conditions, industry conditions and other operating factors could also affect the future results of Net Serviços and could cause results to differ materially from those expressed in such forward-looking statements.

Now I will turn the conference over to Mr. João Elek, CFO and Investor Relations Officer. Mr. Elek, you may begin your conference.

João Adalberto Elek, Jr. - Chief Financial Officer and Investor Relations Officer

Thank you. Good morning to all of you participating in this conference call. Today I have with me Francisco Valim, our CEO, and several members of our management team. I will comment briefly on the main highlights of the third quarter and then open to the question and answer session.

Remember that the figures I will give you include the results of Vivax, which became a wholly-owned subsidiary of Net on June 11th. To provide a better analysis of performance, comparisons will be presented on a pro forma basis for Net and Vivax for the quarter ended through September 2006. Beginning with our operating performance, note that the growth proposal is being achieved in line with the strategy presented by the company. Not only the pay-TV, but also broadband and telephone are registering consistent growth in the subscriber base, materializing the opportunities that exist in the potential markets.

In the third quarter, our pay TV base grew by almost 100,000 subscribers while the broadband base expended by nearly 170,000 and the telephone base by 115,000. We continue believing that our range of sales channels combined with the differentiated offerings of our high-speed broadband and our ability to create value for consumers by bundling products in our NET Combo packages has enabled us to capture a substantial share of new broadband users, driving the company's overall growth.

After all, Vivax had slightly higher churn rate than Net. Therefore we consolidated the two subscriber bases. Churn rates in both pay TV and broadband increased slightly. The pay TV churn rate was 14.3% while the broadband churn rate was 15.9%, although still close to the 15% ceiling guidance given by the company.

We are analyzing the reasons for this difference in churn rates and studying whether implementing the processes of Net and also of Combo products could really bring up churn rate closer to the one of Net's.

Now let's talk a little bit about liquidity and financial performance. Growth revenue rose 29% in relation to the third quarter of 2006 from 751 million reais to 968 million reais, driven by subscriber growth in pay TV, broadband and voice. Client ARPU which is the sum of gross revenue from monthly fees, pay per view, and other services, divided by the average number of pay TV customers and exclusive voice and broadband customers, rose 7% from 190 reais to 129 reais. The ARPU growth shows that the company is reaching the objective of delivering more products to different clients and also selling higher added value products, while operating [ph] has remained stable.

Operating cost grew to 363.7 million reais, 35.8% higher than the 267.7 million recorded in the third quarter of '06. The main items driving this increase were the internet link and the call center, which is expansion of the subscriber base. Note, however, that the increase in link expenses was also due to another equally important factor; more customers are using faster connections, which has played a major role in this product's growth.

As for the call center, there is also another factor explaining the high expense -- the company's constant concern in service quality. As a result, the call center was expanded and reorganized so that the complexity of the new services and products can be adequately explained to the customers.

Selling, general, and administrative expenses totaled 168.2 million reais, 14.4% higher than the 147.1 million recorded a year ago, mainly due to more sales. Excluding selling expenses, G&A rose 5%, showing how this expense line is fully under control. Selling expenses grew by 23% year-on-year to 68 million reais, in line with the growth strategy. Selling expenses, which includes advertising campaign and sales commission should remain at current levels as a percentage of net revenues.

Consolidated EBITDA closed the quarter at 203.2 million reais, up 28.4% from the 158.2 million reported in the last year, showing that the company's accelerated organic growth has been executed in a way to generate profitability levels compatible with the company's designed strategy.

Consolidated EBITDA margin was 27.3%. As anticipated by the company, the EBITDA margins exclude the strong [indiscernible] region, selling expenses should remain at high levels. Together with our concern with the quality of customer program, given the complexity of the range of services should remain between 96% and 98%. Net financial income was an expense of 30 million reais, versus an expense of 44 million reais in the third quarter of 2006.

We registered a foreign exchange gain due to the impact of real appreciation on the perpetual bond and also lower interest expenses, given [ph] refinancing operations from November of last year, which lowered our bad costs.

CapEx was $185.9 million reais, which is... of which 33.6 million was allocated to the bidirectional and digitalization project and the remaining $152.3 million to the company's current investments. Of these, approximately 92% was variable and related to subscriber connection, internal network, break nodes [ph] and the broadband center.

The company's liquidity situation remains good with cash and cash equivalents totaling 625 million reais, which is enough to cover 100% of all current liabilities.

Net debt stood at 553.5 million reais at the end of the quarter, up 8.9% in relation to the $508.3 million recorded at the end of last quarter of 2006.

The 12-month net debt to EBITDA ratio fell from 0.84 to 0.73. The company's shares traded at 30.06 reais under Bovespa for a gain of 54% against the third quarter of the last year. Our average daily trading volume under Bovespa remains strong at 63 million reais in the third quarter of this year, up 151% versus the same period of last year. On the Nasdaq, our average daily trading volumes of ADRs rose significantly last quarter from $704,000 in the third quarter of 2006 to $8.1 million in the third quarter of this year.

After analyzing our markets at this time, we did not identify any significant developments that should mirror [ph] to change our strategy of accelerated growth for the coming year. The broadband market continues to pose consistent quarterly growth and the current level of the pay TV subscriber base fully indicates that there are opportunities to explore our services for increasing penetration. Even though the fixed telephony market is not much more being penetrated [ph] in that form by offering an alternative to the current dominance [indiscernible] has found room to grow in the market while customers speak a good balance between cost and quality. And the issue of quality matches the company that speaks to the needs and expectations of each customer. That is why in 2008 we will not only continue to invest but will also increase investment in the issue of service quality which aligns with customers' expectation.

Given our high quality services and our sales strategy of sustaining the company's robust and consistent growth, we will maintain our expectation of generating EBITDA margin between 26% and 28%, not only in 2007 but also in 2008. To the extent that the year is now coming to a close, I would like to underscore that we remain focused on growth in profitability and added great returns for shareholders. Therefore in this last earnings conference call of the year, I would like to express our gratitude to everyone who has worked with us upon standing out performance and especially those who have regularly helped by providing excellent feedback so that we can continue to improve our work. Thank you very much and now let's move on to the question and answer session.

Question And Answer

Operator

Thank you, the floor is now open for questions. [Operator Instructions]. Our first question is coming from Andrew Campbell of Credit Suisse, please go ahead.

Andrew T. Campbell - Credit Suisse

Yes, hi João. I had two questions for you. My first question is on programming expenses and I noticed that your programming expenses increased basically the same percentage as the increase in your subscriber base over the past year and I was wondering if perhaps with the company achieving its greatest scale, if you might be getting close to a point where you could receive some lower price per subscriber so that we could actually see at some point programming cost growing at a slower pace than the growth in the subscriber base?

João Adalberto Elek, Jr. - Chief Financial Officer and Investor Relations Officer

Thank you, Andrew. Well, basically what we are experimenting when we compare year-over-year our programming costs is that well, they grew kind of the same level of our customer base and we also had a difference in our mix, given that we have not only a regular programming cost, but also the pay per view which has been growing pretty significantly. So, this mix is indicating this level of number that you reach, but especially when you talk about some scale gains, that's true, it is built in our contract that as long as we increase our customer base, we have drive for certain discounts for incremental acquisition. But the mix of the programming that we have this quarter versus the same quarter of the previous year resulted in this effect.

Andrew T. Campbell - Credit Suisse

Okay, I understand. And if I could just ask a second question; on the balance sheet I noticed that your judicial deposits went down pretty significantly in the quarter. And that looks like may be one of the reasons why your net debt decreased in the quarter. Was there some kind of legal resolution on a certain litigation or something, or can you just explain why that decreased so much?

João Adalberto Elek, Jr. - Chief Financial Officer and Investor Relations Officer

It was a good guess, but actually this was an accounting change... [indiscernible] accounting change. So, we had to re-class the judicial deposits to net and against the liabilities against which we made the deposits. So, it's no longer in our asset side of the balance sheet, it's moved to the liability side.

Andrew T. Campbell - Credit Suisse

Okay. So, the net impact on cash was zero... was zero from that?

João Adalberto Elek, Jr. - Chief Financial Officer and Investor Relations Officer

That's correct. That's correct.

Andrew T. Campbell - Credit Suisse

Okay. Thank you very much.

João Adalberto Elek, Jr. - Chief Financial Officer and Investor Relations Officer

Thank you, Andrew.

Operator

Thank you. Our next question is coming form Peter Lyons of Oscar Gruss. Please go ahead.

Peter Lyons - Oscar Gruss

Hi João. I had a question on the other cost in the direct operating expense line. If you could just describe what was the component of this? I think you mentioned that there was some reorganization of call center earlier. So, if you could address the other cost line and also depreciation, amortization, it seemed a lower than I would have expected given the levels of the last quarter. Thanks.

João Adalberto Elek, Jr. - Chief Financial Officer and Investor Relations Officer

Well, basically, we... the components of these expense lines... we have not only the call center... the customer service part, but we also had the need to connect our customers to the internet. So, these are the two of the components. And they have been going to the extent that we have customers seeking for higher speed connection, and also the complexity of our mobile services require a more... more sophisticated call center. So, we are investing in these two items, at least to provide or maintain the high speed connection and to sustain the quality of our customer service.

Peter Lyons - Oscar Gruss

Okay. And now looking forward to the next few quarters, is this reorganization of the call center largely complete, or can we expect additional costs associated with this at that line item?

João Adalberto Elek, Jr. - Chief Financial Officer and Investor Relations Officer

Well, the reorganization is complete, but to the extent that you have, we increased our subscriber base. We may eventually have to adequate the size of the call center and eventually bring in more people and also, we will have to invest in training them.

Peter Lyons - Oscar Gruss

Okay.

João Adalberto Elek, Jr. - Chief Financial Officer and Investor Relations Officer

So, that's an ongoing process to maintain the quality of the service.

Peter Lyons - Oscar Gruss

Okay. So that's basically linked to the subscriber growth, to the broadband subscriber growth especially, proportional?

João Adalberto Elek, Jr. - Chief Financial Officer and Investor Relations Officer

Yes, yes.

Peter Lyons - Oscar Gruss

Okay. And then if you could just... because you addressed depreciation, amortization at 104 versus 144, I believe, in the last quarter?

João Adalberto Elek, Jr. - Chief Financial Officer and Investor Relations Officer

Well, in the last quarter we had to... what was happened in the last quarter was the following. With the incorporation of the Vivax, we adjusted the amortization... the depreciation ratio of the fixed assets... assets of Vivax to bring them within the same page as we have... what we have here in hand. So we had to make a one-time adjustment, which increased the depreciation of Vivax. Now when you see this 104, that's what the... our ongoing and recurring level of depreciation.

Peter Lyons - Oscar Gruss

Okay. So, looking forward then, I guess, we can expect more levels like we have in this quarter, and before the Vivax acquisition?

João Adalberto Elek, Jr. - Chief Financial Officer and Investor Relations Officer

Yes, will be closer to this quarter.

Peter Lyons - Oscar Gruss

Okay, great. Thank you very much.

João Adalberto Elek, Jr. - Chief Financial Officer and Investor Relations Officer

You are welcome.

Operator

Thank you. [Operator Instructions]. Our next question is coming from Fernando Ramos of JPM Securities. Please go ahead

Fernando Ramos - JP Morgan Securities

Good morning. I was wondering if you could give us some feedback on the status of your bidirectional project, probably a little bit regarding how much more you are planning on investing on this project and then sort of when?

João Adalberto Elek, Jr. - Chief Financial Officer and Investor Relations Officer

Well, thank you Fernando. The de-rationalization project is almost complete. Our target is to reach 6.3 million households with this bidirectional network. And in the third quarter we reached 6.1 million. So we are almost finalizing the target. And the investments that we announced earlier this year that we will be investing 200 million reais for this project [indiscernible] and digitalization. They are both in line with our expectation. And moving forward, we believe that this level of bidirectional network is, obviously we have no plans to further invest in this regard. As for the digitalization of the network, which mean to replace the set-top box with digital, the analog ones with digital boxes, these efforts will continue next year.

Fernando Ramos - JP Morgan Securities

Okay. Thank you

João Adalberto Elek, Jr. - Chief Financial Officer and Investor Relations Officer

You're welcome.

Operator

Thank you. [Operator Instructions]. Our next question is coming from Andrew Campbell of Credit Suisse. Please go ahead.

Andrew T. Campbell - Credit Suisse

Yes, thanks for taking my follow-up. My question has to do with the Vivax subscribers, and where you guys stand in terms of rolling out the Net programming to them in terms of global pay channel? How far along are you in that process, and when do you expect to complete that?

João Adalberto Elek, Jr. - Chief Financial Officer and Investor Relations Officer

Andrew, our expectation is that in November we will begin the rollout of Net packages for the Vivax base. We are integrating the systems. We are finalizing that from the address sign. I mean, in November, that's when we believe we will be beginning the rollout of our products. Just to complement a little bit about the integration of Vivax, let met stress these areas; the systems are fully integrated and that means processes [ph] are totally integrated with Net.

Andrew T. Campbell - Credit Suisse

Okay, great. And so that will, I guess the customers have to... the customers can migrate to the new content. They have to do it voluntarily, is that correct?

João Adalberto Elek, Jr. - Chief Financial Officer and Investor Relations Officer

We will make an offer for them. And we hope that all of them will accept, but naturally those that are not willing to migrate, they will be maintained in the package they have today. Please go ahead.

Andrew T. Campbell - Credit Suisse

No, that's great. That's perfect. Thank you.

João Adalberto Elek, Jr. - Chief Financial Officer and Investor Relations Officer

You're welcome.

Operator

Thank you. Now, I would like to turn the floor back over to Mr. Elek for his final consideration.

João Adalberto Elek, Jr. - Chief Financial Officer and Investor Relations Officer

I want to take this opportunity to thank you all very much for the support you have given us along these years. It was a very intense year. And I believe that next year we'll have a lot of good news for our investors, for the analysts, and we're looking forward for that. So, thank you very much and all the best for you guys.

Operator

Thank you. This concludes the Net Serviços third quarter 2007 results conference call. You may disconnect your lines at this time and have a wonderful day.


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