Charter Communications, Inc.
Q4 2014 Earnings Call Transcript

Published: 5 Feb 2015

[Operator:]

Good morning. My name is Regina, and I will be your conference operator today. At this time, I would like to welcome everyone to the Charter Communications Fourth Quarter 2014 Earnings Conference Call. [Operator Instructions] I would now like to turn the conference over to Stefan Anninger. Sir, you may begin.

[Stefan Anninger:]

Good morning, and welcome to Charter's 2014 Fourth Quarter Earnings Call. The presentation that accompanies this call can be found on our website, ir.charter.com, under the Financial Information section. Before we proceed, I would like to remind you that there are a number of risk 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 will be referring to non-GAAP measures as defined and reconciled in our earnings materials. 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 on July 1, 2013, Charter completed its acquisition of Cablevision's Bresnan Broadband Holdings LLC and its subsidiaries also known as Bresnan. Unless otherwise specified, all customer and financial data referred to on this call are pro forma for the Bresnan transaction as if it had occurred on January 1, 2012. Please also note that all growth rates noted on this call and in the presentation are calculated on a year-over-year basis, unless otherwise specified. Joining me on today's call are Tom Rutledge, President and CEO; and Chris Winfrey, our CFO. With that, I'll turn the call over to Tom.

[Thomas M. Rutledge:]

Thanks, Stefan. 2014 was a transformative year for Charter. We successfully digitized our network on time and on plan and introduced a more advanced product called Charter Spectrum. And despite putting nearly all of our customers through an all-digital service transaction, we improved our underlying operating metrics, grew market share across all of our products and improved our financial performance. Our high-capacity network is now unburdened by analog signals, allowing us to offer superior products not replicated by the competition across virtually our entire footprint. Charter is now a very different company. We're delivering a video product with more HD channels than satellite with full Video On Demand functionality on every television outlet. And our network is now enabled to deliver an interactive IP-based video user interface. Our Internet product is faster than the competition in the vast majority of our footprint, with our slowest speed offering of between 60 megabits and 100 megabits. And over time, our speeds will get faster. We combined these superior video and Internet products with a fully featured voice product and sell it at highly competitive price points. That high value offering, combined with good service, is driving customer growth, market share and greater revenue per household. In turn, our revenue and EBITDA continue to grow, translating into higher EBITDA [indiscernible]. And with all-digital behind us, the capital intensity of our operations and our retained footprint will decline significantly in 2015, driving meaningful free cash flow growth. During the fourth quarter, we added 73,000 new residential customer relationships. Over the last 12 months, we've grown our residential customer base by 5%. Primary service units grew by 157,000, and we added 3,000 video customers. Over the last 12 months, we've grown our expanded basic video by 76,000. So we continue to grow video market share versus the competition. During the fourth quarter, we also added 104,000 broadband customers. And at year end, over 80% of our Internet customer base subscribed to tiers that provided 60 megabits or more. Fourth quarter revenue grew by 9.9% versus 5% for the same period last year with residential revenue growth of 8.3%. Our fourth quarter revenue growth accelerated both sequentially and on a year-over-year basis. And finally, adjusted EBITDA grew by 10.5% year-over-year. Our fourth quarter results demonstrate the growth potential of our operating strategy and early 2015 results will demonstrate Charter's free cash flow potential. As we move into the second half of 2015, we'll start the same process that we started here at Charter in 2012 on a new set of acquired assets with more scale and an enhanced footprint. As we start 2015, we remain focused on 3 key areas

[Christopher L. Winfrey:]

Thanks, Tom. Turning to Slide 7 of today's presentation. We grew residential PSUs by 157,000 during the fourth quarter, and we added 3,000 residential video customers. That includes approximately 5,000 bulk digital upgrades. In Residential Internet, we added 104,000 customers, and we grew residential voice customers by 50,000. As Tom mentioned, our residential customer base has now grown by 280,000 or 5% in the past year. And at the same time, fourth quarter residential ARPU rose by 3.1% year-over-year, driven by higher-product sell-in and increase to our retrans pass-through in September, partially offset by the continued sell-in of single-play Internet and a larger digital bulk upgrade base. As Slide 9 shows our customer growth combined with our ARPU growth resulted in year-over-year residential revenue growth of 8.3%. Even without the benefit of the September retrans rate adjustment, residential revenue grew by 7.3%. That accelerated year-over-year and sequentially. Looking at commercial, we added 14,000 PSUs. Commercial revenue grew by 16% driven primarily by small and medium businesses. Excluding the lower growth hospitality video base, business telecom revenue grew by 19%. As Tom mentioned, we have a large, underpenetrated business telecoms market opportunity in the Charter footprint today, and we've recently made some go-to-market changes in advance of closing the transactions to better take advantage of what we believe is a long runway for growth and a larger pro forma footprint. Our advertising business also had a strong quarter growing 29% year-over-year. While fourth quarter political played a big part, advertising revenue growth, excluding political, remained strong, roughly 9% year-over-year and 5% for the full year. In total, revenue was up by 9.9% in Q4 versus last year. And excluding the impact of political and the higher retrans pass-through, total revenue still grew by 8.3%. Turning to operating expenses and adjusted EBITDA on Slide 10. Total operating expenses grew by $131 million or 9.6% year-over-year. Note that transition cost related to our transactions with Comcast were included in that number and accounted for about $11 million of the $131 million. And that expense is captured in cost-to-service customers and other operating costs. Total programming expense grew by $64 million, accounting for about half the increase in total operating expense versus Q4 '13. The 11.6% increase in programming was driven by contractual rate increases, 1.9% growth in our expanded video customer base over the last year and higher penetration of our tiers, broader carriage and the launch of new channels like the SEC channel. Cost-to-service customers, which includes field operations, customer care, and network operations costs, grew by about 7% year-over-year on higher customer and revenue growth. Other costs grew by $37 million or 20% year-over-year, driven by higher labor costs to support commercial and the in-sourcing of IT, engineering and product functions, also some additional administrative and advertising labor expense and transition cost related to the transactions. So in total, adjusted EBITDA grew by $81 million or 10.5% year-over-year and 8.2% for the full year. I'm not going to get into a detailed line-by-line waterfall, but if you exclude the fourth quarter impact of political advertising revenue and exclude M&A transition expenses, our fourth quarter adjusted EBITDA still grew by about 10%. If you were to further exclude the Q4 effects of the retrans pass-through increase in September, which is in fact, a recurring benefit, EBITDA grew about 8%. So thinking about growth with a lower level of rate increase is more of a forward-looking comment, which I'll come back to in just a moment. Moving to Slide 12, fourth quarter capital expenditures totaled $543 million. About 1/3 of that spend was driven by CPE. And of our total CapEx this quarter, only $42 million was directly attributable to our all-digital initiative with most of that spend inside CPE. For the full year, we spent $2.2 billion in total capital expenditure with about $400 million for all-digital in plan with previous estimates and including $27 million of transition capital relating to the pending transactions. We generated $89 million of free cash flow in the fourth quarter compared to $84 million during the same period last year. So our higher year-over-year EBITDA and lower CapEx in the fourth quarter was mostly offset by the transaction and transition cost for our deal with Comcast. That includes $52 million of higher cash interest for the $7 billion of escrow debt financing. So we're incentivized to close on the transaction with Comcast, not only to get going, but to gain access to the operating cash flow associated with the interest payments and the transaction costs. As a reminder, our weighted average borrowing cost is 5.6% today and 5.4% pro forma for the transactions. And our current leverage ratio is 4.4x on an LTM basis. We also had a big quarter for warrant exercises for $79 million of proceeds in the quarter for the cash settlement portion. And as you can see on Slide 22, we no longer have any warrants outstanding. Of course, as Slide 14 shows, we continue to benefit from our outsized tax basis and NOLs from a free cash flow perspective. Our total tax basis at year end was $9.1 billion, and our NOL is now $9.5 billion. And we don't expect to be a significant cash taxpayer until at least after 2020. So all in all, we're pleased with our fourth quarter and full year results, and we're well positioned for 2015. Our systems are poised for continued market share, revenue and EBITDA growth without having to take significant price increases, despite the obvious programming headwinds. While annual rate increases have not been the primary driver of revenue -- for growth for us, in Q1 of this year, we're taking an even smaller rate increase than prior years. That may appear to slow our short-term year-over-year growth rate, at least relative to this past quarter, but our goal is to grow market share now with superior products while competitors take larger rate increases. We also want to minimize customer disruption in the face of closing and integrating a complicated set of M&A transactions with Comcast and the teams at TWC in GreatLand. Absent the transactions with Comcast, we expect to spend approximately $1.7 billion of capital expenditure in 2015. That's a full $500 million less than 2014, which falls straight to free cash flow. That estimate still includes ongoing expenditure to continue in-sourcing our labor force with the purchase of facilities, trucks, tools and test equipment, in-sourcing IT and network platforms to provide better end-to-end service and accelerate our time-to-market and to fund new product development in the areas Tom mentioned, like downloadable security and the Spectrum Guide rollouts. The $1.7 billion also includes our assumption for continued customer growth. As we get closer to closing, we'll continue to have onetime operating and capital expenditures to prepare the company to double the number of customers we serve. That type of expenditure will continue for a period after close, as well as transition service cost going both ways between us and Comcast as we migrate customers off each other's platforms. So it'll be noisy, but as we have during the past 2 quarters, we intend to continue to highlight this transition cost -- transaction cost and escrow interest to provide visibility to the underlying results, including free cash flow. So we provided significant color on how we think our underlying financial trends will develop post-closing both on previous calls and our S-4 filings, so I won't repeat that here other than to say that we're confident in the operating strategy, our ability to integrate the new assets well and how that translates into a long-term growth strategy, which translates into free cash flow. With that, I'll hand it back to the operator for Q&A.

[Operator:]

[Operator Instructions] And our first question will come from the line of Vijay Jayant with Evercore ISI.

[Vijay A. Jayant:]

Tom, I just want to understand with this transition that you have to do with the Time Warner Cable properties, can you sort of compare and contrast what -- since you've already done that on the heritage Charter properties, what the real challenges are? What the properties? How different are they in terms of pricing promotion and just the operational structure? Obviously, it probably seems to be an easier transition than you had.

[Thomas M. Rutledge:]

Yes, Vijay, I think that there are many things that are similar in the transition in terms of product strategy and pricing strategy that we'll want to implement. But these assets are in different shape relative to what Charter was in 3 years ago in terms of the maintenance that's been done on the plant has been better. The trucks, tools, test equipment and the employee base is better. And so the amount of total investment should be lower, although we haven't done the deal. We haven't gotten in and started to formulate a detailed plan. But our CPE strategy, which we developed will allow us to have a lower cost of capital to do the kind of product development that we've done at Charter. And so net-net, I think it's more complex from a transition services perspective. We're going to be taking new assets in and having to migrate them off Time Warner and Comcast platforms. That's actually quite complicated. The business has become much more cloud-based or national. So the email systems, the billing systems, the provisioning systems, those are all national kind of infrastructures that each company has that are unique. And the same will be reciprocated in our assets going to Comcast. There's a complex transition process that we've been working through with Comcast, and we have the transition services agreement developed. So we have that to deal with, but in terms of the assets themselves and integrating them and making them work the way we want from a product perspective. We think they're better than what Charter was 3 years ago.

[Vijay A. Jayant:]

If I can just have a quick follow-up, obviously, it looks like Title II will rate for variance [ph] is probably going to happen in some form. Does anything change in your pricing investment or M&A strategy just broadly?

[Thomas M. Rutledge:]

Well, I mean the issue with Title II is that as it's currently described, it doesn't look like it changes anything. Our concern is that it increases the power of a regulatory body in an unnecessary way. We've had a very successful experience in putting private capital to work and developing high-speed Internet service. And as you see, what we've done over the last 3 years, we've quadrupled the speed of our average Internet service. And it seems to me to be an excessive approach, but it -- and so we're opposed to it, but it does look like it's going to be, in fact, the law of the land.

[Operator:]

Your next question will come from the line of Marci Ryvicker with Wells Fargo.

[Marci Ryvicker:]

I guess kind of a similar question. What are your thoughts on this new definition of broadband? Do you think that that's going to have any impact on the regulatory environment? Anything that you can comment on there.

[Thomas M. Rutledge:]

Well, I'd say this, we have -- we've never had a problem actually with net neutrality. That is the business model that we operate in and have operated in. To my knowledge, no ISP. I've never been asked to prioritize content by any website. So I've never actually had a personal business experience where net neutrality was an issue. And so I didn't think previously that we even needed net neutrality regulation, but because it was our business model and because it was essentially not a problem, I signed up for the light touch net neutrality regulation previously. And I think it was working just fine. It got overturned by the courts, but I think we have a heavy-handed regulatory solution for a problem that doesn't exist. And while it doesn't change the status quo in any way, it's -- somebody has a bazooka aimed at you, and that's an uncomfortable situation.

[Operator:]

Your next question will come from the line of Phil Cusick with JPMorgan.

[Philip Cusick:]

Tom, you talked about the sort of volume versus price strategy for quite a while, and it's working out well. I'm just curious, given the pretty substantial price increases from your competitors, call it, 5% and roughly 10% increase in programming cost, does it not make sense to take a decent price increase? And can you expand on that? And then also, does that mean that margins on a stand-alone basis drag a little bit this year?

[Thomas M. Rutledge:]

Well, we've actually taken a moderate price increase, a very moderate price increase. And we think that we can continue to grow our market share faster than we would otherwise by taking a larger increase. But in the long run, pricing power comes from having superior products. And our strategy is to put superior products in front of customers, have them recognize that they're superior and to have a long-term relationship with that customer and to the extent that the customer perceives us as more valuable, ultimately, we can get the price. And so how and when you take it is a part of the marketing strategy.

[Philip Cusick:]

Okay. And can you expand a little bit on what the, you said moderate, what those price increases have been?

[Thomas M. Rutledge:]

The rate increase part of our price strategy has been less than 2% the last couple of years. And it's going to be even less than that going forward. So most of our rate growth is coming from subscriber growth; and secondly, by selling more valuable products incrementally.

[Christopher L. Winfrey:]

So Phil, the impact of what I was describing is that if you take a lower amount of rate increase in the first quarter of this year, which we have for the reasons that we described versus a higher level of what was done last year, it has the effect of artificially and temporarily impacting the year-over-year growth rate. But it's done so in a way that's designed to increase your longer-term revenue and EBITDA growth rate and your margins.

[Operator:]

Your next question comes from the line of Craig Moffett with MoffettNathanson.

[Craig Moffett:]

I wonder if I could go back to this -- the Title II question for a second. In the event that the -- well, first, do you think that the Title II developments yesterday have any bearing on the review of the transactions that you and Comcast have in front of the SEC and DOJ right now? And then second, if that deal is blocked for any reason, does Title II affect your appetite for further expansion in the category at all?

[Thomas M. Rutledge:]

Well, we haven't seen the order, Craig. So I only know what is in blogs, and we would rather not have Title II than have it. There's going to be -- it appears to be a long period of litigation and uncertainty about what the actual rules are. And we're going to have to operate during that period of uncertainty. I don't know how it affects the transaction. I haven't heard directly from a regulator about the transaction or their point of view about the transaction. So I don't -- I really don't know what its impact would be. And we, as a company, are interested in acquisitions because we strongly believe that the cable business, as we see it, is a good business and that it has potential for growth that the assets that we manage are superior assets and that we can compete. And so any platform out there that's available that would allow us to take advantage of scale and unsold passings is attractive to us at the right price. So if Time Warner were to fall under that position again, obviously, we'd be interested, but there's a lot of ifs there. And all of our energy and expectation is that the deal will close. And that's what we're working on, and that's what we're doing.

[Operator:]

Your next question comes from the line of Jonathan Chaplin with New Street Research. Your next question will come from the line of Mike McCormack with Jefferies.

[Michael McCormack:]

Tom, maybe just a quick comment. I know AT&T has sort of pulled back on the U-verse front a bit. Maybe just comment on the competitive landscape from a pricing standpoint, and then maybe just a quick comment on the AT&T stuff. And then, I guess not to get too detailed, but you talked about progress on the regulatory front in the prepared remarks. Just trying to get a sense for what you sort of meant by that?

[Thomas M. Rutledge:]

Well, on the regulatory front, all of the -- most of the, if not all the LFAs have approved the transactions that we're doing. So the vast majority are approved. That's been logistically complex. We've been working on that, and it's pretty much done. And the FCC Shot Clock is moving along. And they've asked for information, and we've provided all the information requested by DOJ and by FCC. And as I've just said to Craig, I don't have any direct feedback, positive or negative, from federal regulatory authorities.

[Michael McCormack:]

And Tom, just on that front, would you -- if there's a process by which the FCC is negotiating conditions with Comcast, is that something that Charter would be involved with from the start?

[Thomas M. Rutledge:]

I don't know how the FCC will choose to negotiate with us. But we have been included so far in all the discussions.

[Operator:]

Your next question will come from the line of Ben Swinburne with Morgan Stanley.

[Benjamin Swinburne:]

A couple of questions for either of you guys, maybe first on commercial. That growth has slowed a bit. I'm wondering if you think that's going to accelerate going forward and how the Time Warner Cable deal might impact that. And I think you mentioned some new pricing and packaging. So any color on how you're going to attack small business going forward would be helpful. And then maybe for Chris on the outlook, you put in this broadcast fee increase in the fourth quarter, which obviously will ripple through '15. I know you're raising rates less in Q1 '15 than the prior year. I guess I'm just trying to understand, if we step back from the kind of quarterly movements, are you suggesting that for '15, you'll have less benefit of ARPU growth than '14? Or are you focusing us more on just Q1?

[Christopher L. Winfrey:]

The answer to that question is yes. We'll have less benefit in '15 of flow-through rate increase from annualized rate increases, whether you include that retrans pass-through or not.

[Operator:]

Your next question will come from the line of James Ratcliffe...

[Thomas M. Rutledge:]

Wait a minute.

[Christopher L. Winfrey:]

We had one other point that Ben wanted...

[Thomas M. Rutledge:]

Yes, Ben wanted me to answer the question about commercial. Yes, it has slowed sequentially and part of that is due to the cell tower business, which we have had a successful run with but has slowed. And yes, we think that new product and pricing can accelerate small business growth, which is the biggest piece of that business today. And similarly to our residential strategy, we think that having superior properly priced products in the small business space, well marketed from a value proposition perspective can accelerate growth. And so that's part of our operating strategy there. And then with regard to the transaction, we're going to have a much better footprint going forward for commercial service marketing and operations because we'll have a better DMA coverage proposition than we currently do. And as a result of that, we think that we can accelerate growth in our -- this is over the long term, in our commercial space and stand up better products and compete more effectively.

[Operator:]

Your next question will come from the line of James Ratcliffe with Buckingham.

[James Maxwell Ratcliffe:]

Two, if I could. First of all, following up on the question regarding 25 megabit service. I know you have a de minimis FiOS overlap, but do you have a read on what share of your footprint has a telco offering of 25 megs or more available? And second, on the M&A front, clearly, you're interested in doing things beyond the TWC-Comcast transaction. But how do we think about the sequencing of that? Do you have to get Comcast-TWC done before you can work on other opportunities? Or can they all happen in parallel?

[Thomas M. Rutledge:]

I'm not sure what the 25 megabit footprint is going forward relatively. Today, U-verse's average customer is 6, and ours is 60-plus. And FiOS overlap with us is less than 4%. So -- but what I don't know is how much of U-verse is capable of 25 megabits inside our footprint. But from a practical point of view today, we are dramatically different than they are. Maybe our marketing strategy should be to say, AT&T doesn't sell broadband, but we haven't decided to do that. What was...

[Christopher L. Winfrey:]

James, the second part of your question was...

[James Maxwell Ratcliffe:]

On M&A, whether other opportunities need to wait for completing the Comcast-TWC transaction? Or if you can work on them in parallel?

[Thomas M. Rutledge:]

We're good at multitasking, but we take our M&A opportunities when they arise.

[Operator:]

Your next question will come from the line of Frank Louthan with Raymond James.

[Frank G. Louthan:]

On your Spectrum Guide, you made a significant investment there. How confident are you on how transferable that will be to customers in the properties, post the Comcast transaction? And then on the -- additionally, on the transaction, are you still fielding active calls and inquiries from DOJ? Or is it -- are you mostly done with that and it's pretty much the FCC inquiries at this point?

[Thomas M. Rutledge:]

The last part of your question, DOJ inquiry is still going on. And with regard to our user interface, the whole purpose of that user interface is to be able to make it work on additional assets without having to change those assets out, meaning all the existing boxes in the Time Warner footprint would be capable -- all the existing two-way boxes in both the Time Warner and Comcast footprints would be capable of using that user interface. It is not capable of being put on to a D-to-A, which is very inexpensive one-way product that exists in both Time Warner and Comcast. But generally, the answer to your question is yes, it can be done quite easily.

[Operator:]

Your next question comes from the line of Kannan Venkateshwar with Barclays.

[Kannan Venkateshwar:]

Just a couple of questions. The first is, from a Title II perspective, if the FCC was to put that into the consent decree, is that something that would make you reconsider the M&A trend line and what you plan to do in that market? And the second component of...

[Thomas M. Rutledge:]

[indiscernible] Go ahead, sorry, the second question.

[Kannan Venkateshwar:]

And the second question was more in terms of the competitive landscape. I mean DirecTV and DISH have basically been saying that they're managing their customer base for -- more for cash. And they're letting go of the low-credit-quality customers and so on. So when you -- given that you overlap with the satellite operators significantly, in terms of the quality of customers that you're getting and the churn rates and so on, have you seen any trends which could help us in terms of what the new subscriber base looks like versus what you had historically?

[Thomas M. Rutledge:]

Well, on the first part of your question on Title II, I answered that previously. We haven't seen the order. If it's the status quo, that's one thing; if it's -- and obviously, it's going to -- it's creating confusion and uncertainty. And we'll have to deal with that. With regard to the quality of customers, look, we think that we're a superior service to satellite, and our whole investment thesis has been to turn our two-way platform, to turn our video product into something that can't be replicated by satellite and to take their customers away from them. And we are growing our business. We've got a long way to go. Satellite -- we successfully took cable customers for 20 years and got to 35% penetration. I think there's an opportunity for us to grow our business at their expense slowly. And I think that their highest-quality customers would be best served by our superior products. But we're interested in all customers, and we think we can serve all customers effectively.

[Operator:]

Our final question will come from the line of Tom Eagan with Telsey Advisors.

[Thomas William Eagan:]

Tom, you mentioned last quarter that there may be some benefit of packages that are smaller and at a lower price. What have you seen regarding your customers, regarding their price elasticity? And how many cable networks do you think that you guys could drop without lifting subs?

[Thomas M. Rutledge:]

That's a good question. Price elasticity is a problem. The biggest problem in video is that it costs too much, and there's been a lot of price pressure because of the programmers' ability to pass through pricing in the bundle. And selling a more tailored product that was compelling would be a very attractive thing. The problem is that last concept of compelling. Do you have enough to make it worthwhile? And we haven't been able to put a package, a small package together yet that would cost less and still satisfy what most people want out of television. So that's a real dilemma. And we would be interested in developing it. We are working with programmers where we can to do it. And you've seen the sling product. I'm not sure that alone, as it's currently defined, is a breakthrough product. But it's certainly possible to imagine a much more tailored product environment where customers would be satisfied and would be able to afford the product. But that has major implications to the video business ecosystem.

[Operator:]

Ladies and gentlemen, this does conclude today's conference call. Thank you, all, for joining. And you may now disconnect.