Charter Communications, Inc.
Q2 2013 Earnings Call Transcript

Published: 6 Aug 2013

[Operator:]

Good morning. My name is Alicia, and I will be your conference operator today. At this time, I would like to welcome everyone to the Charter Communications Second Quarter Earnings Conference Call. [Operator Instructions] Thank you. I would now like to turn today's call over to our host, Mr. Stefan Anninger. Sir, you may begin.

[Stefan Anninger:]

Thanks, operator. Good morning, and welcome to Charter's 2013 second quarter earnings call. This morning, we issued a press release over PR Newswire at 8 a.m. Eastern Time detailing our results. Before we proceed, I would like to remind you that there are a number of risks factors and other cautionary statements contained in our SEC filings, including our most recent Forms 10-K and 10-Q. We will not review those risk factors and other cautionary statements on this call. However, we encourage you to read them carefully. Various remarks that we make on this call concerning expectations, predictions, plans and prospects constitute forward-looking statements. These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ from historical or anticipated results. Any forward-looking statements reflect management's current view only, and Charter undertakes no obligation to revise or update such statements or to make additional forward-looking statements in the future. During the course of today's call, we'll be referring to non-GAAP measures, as defined and reconciled in this morning's earnings release. These non-GAAP measures, as defined by Charter, may not be comparable to measures with similar titles used by other companies. Please also note that all 2012 growth rates noted on this call are pro forma for certain acquisitions and divestitures, as if they occurred on January 1, 2011. Joining me on today's call are Tom Rutledge, President and CEO; and Chris Winfrey, our CFO. The presentation that accompanies their comments can be found on our website, charter.com, under the Financial Information section of our Investor & News Center. The press release and trending schedules can be found at the same location. With that, I'll turn the call over to Tom.

[Thomas M. Rutledge:]

Thanks, Stefan. Charter's customer growth and recurring revenue growth accelerated in the second quarter. We've made significant progress in creating a superior product and service offering using our inherent network advantages and improved our execution on fundamentals. Our total revenue grew by 4.7% year-over-year. And excluding the impact of advertising revenue, second quarter 2013 revenue grew by 5.7% year-over-year. Our second quarter residential revenue growth rate was 4.3% versus growth of 2.6% last year, and our first half 2013 residential revenue growth rate was more than double the 2012 growth rate. Commercial services continue to perform very well, with over 20% revenue growth in the quarter, and our pipeline for future growth remains strong. Our total customer and PSU results improved this quarter, with year-over-year net add improvements in all residential and commercial categories. Total residential customer relationships grew by 5,000 during the quarter versus a loss of 17,000 a year ago. We also gained 38,000 residential PSUs during the quarter versus a loss of 31,000 during the same period last year. And expanded basic video customers grew by 23,000 in the quarter. Adjusted EBITDA was virtually flat year-over-year, and reflects the change in operating practices and upfront investments we are making to accelerate the growth of our business. So our short-term adjusted EBITDA results reflect our plan. More important is the operating progress we're making, which positions us to win market share and grow cash flow per home passed. Consistent with the strategy we outlined last year, we've made a number of changes to

[Christopher L. Winfrey:]

Thanks, Tom. When we implemented our new strategies last year, we articulated a sequence of how we would see success develop in our metrics. Let me again highlight that sequence and our status

[Thomas M. Rutledge:]

Thanks, Chris. Before moving on to Q&A, as Chris mentioned, last month, we closed on the acquisition of Bresnan from Cablevision. And the integration of Bresnan's customers and employees is going well. On a related note, clearly, we are aware of all the press surrounding M&A speculation, and we will not be answering any questions surrounding that speculation on this call, other than to generally say that we believe in the benefits of consolidation, including significant opportunities for cost and tax synergies, and more importantly, the ability to grow assets organically at a faster pace. And while I think these principles could be applied across a number of assets with very attractive returns, we remain focused on the core opportunity at Charter today, and we'll continue to be very disciplined around M&A opportunities when and if they arise. Operator, we're ready to take questions.

[Operator:]

[Operator Instructions] Your first question comes from the line of Jeff Wlodarczak of Pivotal Research Group.

[Jeffrey Duncan Wlodarczak:]

Jeff Wlodarczak. Part of the Charter EBITDA acceleration story is leveraging your improved product, customer service, triple-play to accelerate your RGUs. That's working very nicely. The next step seems to be raising prices, consumers coming off promotions. You feel like the more aggressive promotions from AT&T, in particular, as of late, have materially affected your ability to reprice consumers coming off promotional periods? And then I had one follow-up.

[Thomas M. Rutledge:]

Well, Jeff, this is Tom. We think that our pricing strategy is working, will work, and we don't see anything that's going to throw us off track with our pricing strategy in the marketplace currently.

[Jeffrey Duncan Wlodarczak:]

And then how much do you -- how much has AT&T expanded their U-verse service in your footprint and what are your expectations based on their public commentary about where they're going to get to in the future?

[Thomas M. Rutledge:]

Right. Well, we haven't really seen any evidence of any significance that they have expanded in our footprint. And so I've read their public comments and they're fairly convoluted. And their current overlap of our footprint is slightly less than 30%, and we still think that's the right number.

[Operator:]

Your next question comes from the line of Jason Bazinet of Citi.

[Jason B. Bazinet:]

I just had a question on the cost structure. You guys gave quite a bit of color commentary. But if you sort of roll it all up and you sort of think about the margin trajectory of the business, is it still reasonable to assume that the 3Q margins will probably compress a bit, as they always do seasonally, and then we sort of springboard off of -- from there? Is that sort of a reasonable expectation?

[Christopher L. Winfrey:]

Jason, this is Chris. Yes, Q3, you have typically all of the reconnect activity. So I think one way to think about things is sequentially, and it seems that you're thinking about it that way. The weighted average articulating cost structure is really more from a year-over-year comparability. And a lot of the activity, particularly the acceleration of the deferred plant maintenance, which started in Q3 of last year, has now leveled out. We're doing it more frequently. But at a minimum, from a -- in the short-term perspective, you shouldn't see the same type of acceleration that we've seen in the past. Not going go into margin forecast. We still have a number of changes that are ongoing, including in-sourcing. But all of these have a positive ROI attached to them. And the goal here is not only to return to margin over time, but to be able to provide a better service and product quality, such that you can actually lower the amount of transactions, which of course, over time, will reduce OpEx to provide those transactions. But you made a very good point about the sequential increase that always happens in Q3 for most cable operators as it relates to the back-to-school season, and then onto to the free connect activity that takes place there.

[Operator:]

Your next question comes from the line of John Hodulik of UBS.

[John C. Hodulik:]

Could you guys comment on the -- what kind of subscriber growth and revenue growth that you're seeing compared to the broader company in those Texas markets that you've done the all-digital transformation in? And then beyond that, can you give some -- I know you said that you'll be done with the all-digital strategy by the end of 2014. But can you give us a little bit more color on when some of those new markets come online? For instance, when is the next group of markets going to be all digital?

[Thomas M. Rutledge:]

John, this is Tom. The one thing I'll say about Texas is that Texas is growing again in every category of subscriber PSU, and that's the first time Texas has grown in years. So that's a good sign and that's coming as a result of the superior product that we have on the street now in Fort Worth. Additional markets this year will be Los Angeles area systems; Saginaw, Michigan; and Greenville, South Carolina. And then we'll go through the whole company next year.

[Operator:]

Your next question comes from the line of Craig Moffett of Moffett Research.

[Craig Moffett:]

Let me see if I can squeeze in an M&A question without asking you to comment on anything specific. But do you think you could discuss how you think about smaller transactions rather than larger transactions going forward? Is there a way that you can address the programming cost issues that you've highlighted in the -- in talking about M&A by doing a series of smaller deals? Or do you think it has to be something larger?

[Thomas M. Rutledge:]

Craig, when we looked at Bresnan, we looked at an opportunity to grow our market share, and that is the Charter opportunity, then it's the opportunity for the whole cable industry to take what, I think, is a superior infrastructure and to put products together in that infrastructure that create value for the consumer. And I think that the cable infrastructure that we have at Charter and the cable infrastructure that was in place at Bresnan before we purchased it allows us to do that. That's the single biggest economic driver that we have at our disposal. Beyond that, if you get to a certain scale, you have a different form of leverage in programming negotiations and you could argue about where that is. And it's not just scale, it's also willingness to use that scale to affect your outcome, and how much you need or how big you need to be is a difficult question to answer.

[Operator:]

Your next question comes from the line of Phil Cusick of JPMorgan.

[Philip Cusick:]

I guess 2. So I want to follow up. But first, can you give us a little more detail on your set-top box plans? You talked about the low-end product as sort of bridge. But what about the high-end box? And then second to follow up a little bit on Craig, given your comment on programming, is there a sense of urgency to do deals here? Or is this something that really could take some time? It feels like this industry needs to roll up, but it's felt that way for a long time.

[Thomas M. Rutledge:]

Well, our box strategy is designed to actually make our boxes a thin-client as opposed to a fat-client box. And the idea of using cloud-based user interfaces allows you to take a server-based architecture and feed existing boxes sophisticated guides that can be changed very inexpensively without changing out the hardware. And as part of our strategy, we received a waiver from the FCC to begin employing a new box that uses traditional, conditional access. And at the end of a 2-year period, we'll be switching to downloadable security, which allows us essentially to buy boxes from anywhere and any vendor and not be locked into legacy conditional access or security systems that are currently -- that currently limit the amount of vendors you can use in a cable system. That, in itself, will allow us to buy lower cost CPE, whether it's high-processing power CPE or low-processing power CPE. In the long run, with smart televisions and smart tablets, which essentially allow the TV or the tablet to operate as a set-top box and a TV combined, we think that incremental CPE will become less and less a factor in our overall capital structure. So we think capital intensity is coming out of CPE, and we have a strategy designed to ensure that happens.

[Philip Cusick:]

And in terms of urgency on M&A?

[Thomas M. Rutledge:]

I think, as I said to Craig, our big opportunity is to take advantage of our inherent strength and grow our share, and that's what we're focused on. In terms of timing on M&A, I think Charter can be extremely successful without it and potentially, with the right deal, be more -- even more successful.

[Operator:]

Your next question comes from the line of Ben Swinburne of Morgan Stanley.

[Benjamin Swinburne:]

Tom, just going back to the Dallas, Fort Worth and the Texas markets, can you talk a little bit about the ARPU benefits you're seeing? I know there are some FCC rules around how quickly you can start charging for boxes. And whether you're seeing any improvement in like operating expense trends, as you've gotten rid of analog and particularly around truck rolls? And then I have a follow-up for Chris.

[Thomas M. Rutledge:]

I don't want to break out Texas specifically. If we are performing better there, from a growth perspective and as a general proposition, Charter operating metrics are improving, service metrics are improving, including how customers perceive our service. And we expect those to exist in Texas. We do expect that the overall perception of quality by customers in an all-digital environment will be enhanced. But I don't have any data specifically to Texas that I want to share with you.

[Benjamin Swinburne:]

Okay. And then, Chris, just on the ARPU front, as we move into Q3, just wondering if you can remind us of the puts and takes that you have. The price increase, which, I think, has been fully implemented now, the 2.3% you called out in prior quarters, plus the beginning of the anniversary of last year's promotion. So maybe what are the other things we should be keeping in mind as we think about the sequencing from Q2 to Q3?

[Christopher L. Winfrey:]

You have -- so you -- let me just rehash what you said for the benefit of others. We did have the enterprise increase that was put through in March. So that's not fully baked in inside of Q2. You also have the fact that we're selling a better product today, which is more bundled. And then you have the anniversary of the first roll-offs, offset by the fact that we were doing roll-offs in the past. We did have promotions in the past. The difference here is that, by having a higher-quality product in the home and a higher amount of bundling and a better device -- and more of those devices, that the ability to retain net revenue, we expect, to be higher. And then the only really minor thing I would highlight is every Q3 is a back-to-school season. So on the margin, your connect volume and the bundle attach rate tends to reflect a little bit of that as well. But the first points I were mentioning, by far, are the most material.

[Operator:]

Your next question comes from the line of Doug Mitchelson of Deutsche Bank.

[Douglas D. Mitchelson:]

Just one for Tom and one for Chris. Tom on the cloud-based user interface, some engineers have told us there might be scaling issues with rolling out the thin-box version of a cloud-based service. Is that right? And if so, how do you grapple with that? You just roll it out to your customer base over time? Or do you think you can flip a switch and give it to everybody?

[Thomas M. Rutledge:]

Well, we -- we're still experimenting with our strategy, but we do acknowledge that there are scaling issues. And obviously, you have to overcome those to flip a switch. One of the things we've been thinking about and which we've had some success with trialing is a hybrid approach, where you put some of the guide infrastructure on the box and the existing boxes have guides on them. And you use that as a high-volume function aspect of the guide and put other parts of the guide in the cloud, so that there's less total demand on the scale of the cloud infrastructure. And we've been experimenting with that, and think that, that is an alternative to a complete cloud-based system. And so we'll see which way works best, but we think that we have a way to make it work and be, from a customer perspective, a high-value service.

[Douglas D. Mitchelson:]

Is there any kind of time frame at this point that you could put on when you think you might be able to get something out into the marketplace broadly?

[Thomas M. Rutledge:]

We're, at this point, still in the experimental and testing phase and don't have a launch date.

[Douglas D. Mitchelson:]

Fair enough. And then, Chris, if Charter issues shares in an acquisition or acquisitions over time, is there a ceiling above which Charter NOLs will be impacted? Or is there no issue since you already have that first change of control triggered by Liberty?

[Christopher L. Winfrey:]

Well, let me use the change of control that took place from a Section 382 tax perspective already as Liberty. I'd rather not get into scenarios that talk about us issuing additional shares because that's not what's on the plate today. But I think it's a good case when you take a look at what took place. We had over a 3-year period since the first ownership change took place when Charter emerged from bankruptcy, so the second ownership shift change, which when Liberty invested its 27% beneficial ownership, triggered us for the cumulative ownership change exceeding 50%. When that took place, it was happening at a share price value that was above when the first ownership test took place. And as a result of that we had an additional 382 limitation. That is offset by the fact that you have a recapture, effectively, through a higher amount of realized built-in gain that occurs very quickly over time. And because Charter is in a net operating loss position today, as we speak, builds up -- rebuilds very quickly and can use fully the amount of its NOLs over the coming years in the same way and fashion that we always were planning to do so. So as a result, the present value of our NOL and our NOL itself was unimpaired at the end of the day. And I think that's some color that you can think about, different ways where the tax assets remain extremely valuable in the context that you were discussing. In all forms at different M&A transactions, we think our tax assets are highly valuable.

[Douglas D. Mitchelson:]

Right. Because it depends on what you do with your balance sheet at the same time. I get it.

[Operator:]

Your next question comes from the line of Bryan Kraft of Evercore.

[Bryan D. Kraft:]

I just had 2 questions. Chris, following up on the cost comments, is there a percentage of revenue that you'd expect cost to serve customers to settle in at? Or were you trying say that in the back half of the year, we should start to see some improvement as a percentage of revenue in that line? And then secondly, just wanted to follow up on the limited basic losses. Do you mean that limited basic subs have actually disconnected? Or does it include the limited basic subs that upgraded to a full service package? And maybe there's no difference, but I just wanted to see if you could clarify that.

[Christopher L. Winfrey:]

So let me start with the second point. So limited basic losses includes both disconnects and as well as customers who have moved to expanded. And the first point is cost to serve. Obviously, we think a lot about this, but we're not here today to give the percentage of revenue guidance. What I'm -- what I think we are saying is that we've actually intentionally and in a very focused way made that percent of revenue higher in the short term by investing more cost per transaction, so that you can reduce the amount of follow-up transactions and that you can reduce truck rolls, phone calls, repeat truck rolls and ultimately, churn over time. If you can do that, you can significantly reduce the cost to serve as a percentage of revenue, not only from an expense standpoint but the whole model is driven to drive additional revenue per household. And by virtue of doing that, you almost get there organically, even without some of the benefits that I was describing.

[Operator:]

You have a question from the line of Frank Louthan of Raymond James.

[Frank G. Louthan:]

Can you comment a little bit on the commercial opportunity? It's a little better than we were expecting there. Is there anything, any particular markets you're seeing some economic strength or just overall execution? And then could you comment a little bit on Comcast's plan to sort of daisy-chain some WiFi hotspots throughout their neighborhood with some new CPE? I would think with your throughput you're putting a new network, that would be an interesting opportunity for you. Just conceptually, how do you think about that concept for your customer?

[Thomas M. Rutledge:]

Don Detampel is with us, who runs our commercial business. Do you want to speak to that, Don?

[Donald F. Detampel:]

Certainly, Tom. So in the commercial sector, we just ran our ninth consecutive quarter of 20%-plus growth. And as Tom mentioned or Chris, I guess, mentioned earlier, we believe we have about a $9.5 billion opportunity within our footprint. We're about $100 million -- or $800 million penetrated into it across all sectors. And we divide the commercial business into small, medium, large businesses, then of course, our carrier segment. We have great opportunity, I think, across all segments and have low penetration. So we see good running room ahead and see no reason why we can't continue to grow at substantial growth rates.

[Thomas M. Rutledge:]

And with regard to your WiFi question, I do think Comcast is doing the right thing with creating a dual SSID approach, which is what I think you're talking about, where the subscriber has their own and the company has another one, which can be used for other kinds of services. That is the opportunity of WiFi. I think the opportunity that the cable infrastructure lends itself to is small cell wireless services, which can have very high capacities. And that can be either unlicensed spectrum, like WiFi or licensed spectrum. And I think in the long run, there's a tremendous business opportunity there.

[Operator:]

Your next question comes from the line of Lance Vitanza of CRT Capital Group.

[Lance W. Vitanza:]

I just wanted to go back to the commercial for a second, because it is growing so well and the opportunity seems to be really big there. Can you give us a sense for what a reasonable market share objective might be and on what kind of time frame? And then what the incremental margin would be on the incremental revenues?

[Thomas M. Rutledge:]

I think we'd rather not.

[Lance W. Vitanza:]

Anything you can say about what your customers tend to look like? I mean, I know that you break them into different groups, but are you most active in guys that are at single locations or at multiple locations, mostly fewer than 20 employees, that type of stuff?

[Donald F. Detampel:]

This is Don Detampel. There are certain segments where we've done better traditionally. Certainly, the small business segment, those businesses that have less than 20 employees are very much a sweet spot for us and we can easily serve those customer requirements with our co-ax plan. But we've done very well in the large business segment as well, in certain sectors such as education, health care, government, that require more custom fiber networks between locations. Certainly, the carrier segment has been strong, fueled a lot by cell tower backhaul. And I would say that the segment that perhaps we have the most opportunity going forward is the medium business segment, those businesses that have between 20 and 200 employees, where we're now kind of fully building out our product set and going after that segment a bit more aggressively. But we see strong growth opportunity really across all segments.

[Lance W. Vitanza:]

And then just lastly, does this business tend to be more capital intensive then, as we think about your CapEx plans?

[Christopher L. Winfrey:]

I think it is. But there's very few places inside -- this is Chris. There's very few places inside the businesses that have delivered 20% area growth for the past 9 quarters. So it's going to be more capital hungry along the way. We also have been, along the way, investing in areas that may not initially reflect itself in the revenue. A good example of that is cell backhaul, which Don mentioned. So cell backhaul is about 10% of our revenue inside of commercial. It's about 20% of our revenue growth inside commercial, and it occupies about 1/3 of our capital expenditure. These are very long contracts and we'll be seeing the revenue benefit from that for a long time to come. And some of that comes in waves. And so the reality is commercial is spending more in capital, and they're doing better. And all of that's good. They're all positive ROI projects, irrespective of the segment which you're looking at.

[Operator:]

Your next question comes from the line of Michael Senno of Crédit Suisse.

[Michael Senno:]

Just curious, you've grown non-video subs quite a bit. And I was wondering what level of success you've had in converting some of those to double or triple play as you've changed the pricing and packaging and improved the product?

[Thomas M. Rutledge:]

Well, the -- I think the thing you should consider is that we're in the midst of a lot of change in terms of our subscriber base. But incrementally, the customers that we're adding are taking multiple product sets in greater numbers than they have historically. And the other interesting thing about our current growth is that our expanded basic subscriber growth is actually accelerating and positive. And what that means is, if you think about the multichannel universe, expanded basic is increasing market share of multichannel video. The limited basic service is a broadcast-only service and tends to be part of the historic packages that were put together, that were low-value, low-price packages, and we're transitioning those to high-value, high-quality, relatively high-priced products. And over time, as we move our customer base, the mix of customers taking all of our products, we expect to increase.

[Operator:]

Your next question comes from the line of Tuna Amobi of S&P Capital.

[Tuna N. Amobi:]

So first question for Chris, with regard to the -- to your base that's kind of migrating into the new structure, I'm just kind of wondering how high do you think that percentage can go. So I think you said you're now well over 50%. And I'm wondering, ultimately, do you expect your entire base to be fully migrated and over what period? And with regard to that specifically for existing subscribers, what is the trigger event that kind of triggers the migration of these subscribers to your new structure? And I have a follow-up.

[Christopher L. Winfrey:]

Thanks, Tuna. The reality is that you may never get over to 100% on the new pricing and package. There will come a point where certain customers are happy with where they're at. And despite the amount of direct mail that you get to get them to upgrade a product or taking [indiscernible] and wrap rate [ph] pricing. And if that's where they're satisfied, you may not get all the way to 100%. So I don't know if there's a terminal target to do so. And then your question, the second question was how are customers migrating. It's a combination of really seeing the offers that we have in the marketplace that provide a lot more value, more product, more boxes, higher speed. And so you get a call-in [ph] that's taking place there, as well as the retention process that -- at the historical legacy promotions, that as they rolled off, to have an opportunity to take a higher amount of ARPU from our perspective, but a higher bill price from their perspective. And in doing so, take a lot more product along the way and achieve the overall price increase that was originally intended for them to get more value along the way. So those are the kind of the 2-key methods in which people are migrating in.

[Tuna N. Amobi:]

That's very helpful. So a quick question for Tom. I did pick up on your comments that your commitment to video remains. And I guess, I was thinking along the lines of the recent comment by Jim Dolan. And clearly, I wanted to get your sense in terms of how the industry has evolved and as to the potential role that video might play over the long term. I presume your comment was related to the short term if -- or medium term. So some clarification along those lines vis-à-vis how the shift in the industry toward high-speed data potentially as the main product driver.

[Thomas M. Rutledge:]

So what I said was specifically, we're committed to a video product. It doesn't necessarily have to be the one that we currently have or structured the way it currently is. And I think Jim Dolan's comments are correct over some period of time, although the long run is often hard to predict. And how long the long run is, is hard to predict. I tell people the story about how, in 1980, people were talking about the death of broadcasting, and it's still here and we all knew that it would go through a major structural change. But 35 years later -- or 33 years later, yes, there's retransmission consents. But even that didn't occur until relatively recently. So I think that the video product will become an on-demand product over time, and that it will be delivered what looks like stream services today on the Internet. But how that's actually defined or what it -- how that's structured from a rights point of view, I think is open to interpretation and certainly in the control of content providers. So we're committed to a video product. We think that we have a role to play in that world, and we think that we have a network that allows us to follow the development of television wherever it may go.

[Stefan Anninger:]

Okay. Thanks, operator, and thanks for -- everybody for attending the call.

[Operator:]

This concludes today's conference call. You may now disconnect.