Charter Communications, Inc.
Q1 2015 Earnings Call Transcript

Published: 1 May 2015

[Operator:]

Good morning. My name is Tia, and I will be the conference operator today. At this time, I would like to welcome everyone to the Charter Communications’ First Quarter 2015 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. At this time, I would like to turn the conference over to Mr. Stefan Anninger. Sir, you may begin.

[Stefan Anninger:]

Good morning, and welcome to Charter's First Quarter 2015 Investor 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. Unless otherwise specified, 2014 growth rates 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. And with that, I'll turn the call over to Tom.

[Tom Rutledge:]

Thanks Stefan. Our strategy to deliver superior products at attractive prices continues to resonate with consumers. Charter’s Spectrum products are now in over 85% of our customers’ households. The continued strength in our customer relationship revenue and cash flow growth reflects the success of our product. And our service metrics, customer satisfaction and churn rates are all improving. And we will launch new products that leverage the superiority of our network and that will translate into more revenue and even up our home passed. Charter remains in an excellent position to grow its business organically, by additional market share gains, with or without M&A. During the first quarter, we added 86,000 new residential customer relationships, and over the last 12 months, we've grown our residential customer base by 4.5%. Residential PSUs grew by 160,000 during the quarter. Over the last 12 months, we've grown expanded basic video relationships and we still expect to add video relationships for the full-year. In the first quarter, we lost 7,000 video customers, and we added 125,000 broadband customers. Our broadband penetration is now at over 40% of homes passed, and today at about 85% of our residential internet customers subscribe to tiers that provide 60 megabits or more. During the first quarter, revenue grew by 7.3%. Excluding advertising revenue, total revenue grew by 7.6%, faster than last year's first quarter. Residential revenue growth also improved year-over-year, growing 6.7%. And we’re going faster, with less reliance on annual price reasons. And adjusted EBITDA grew by 7% when excluding Comcast transaction transition expenses. Our first quarter results continue to demonstrate the sustainable growth profile of our operating strategy. It also demonstrates Charter’s cash flow potential with all-digital behind us, excluding transaction-related expenses. EBITDA less capital expenditures increased by more than $250 million versus last year's first quarter. Looking specifically at video, during the first quarter we made a few operational changes, including a tightened credit policy. And we didn't have the prior year benefit of all-digital, which drove bulk upgrades and a reduction in unauthorized customers last year. In the coming months, we'll be launching our new cloud-based user interface, Spectrum Guide, in markets like Reno and St. Louis. Spectrum Guide works on nearly all of our boxes and makes content search and discovery easier and fully enables our on-demand offering. Results in the test market have been positive. Over the coming months, we'll increase the number of on-demand titles we have on our set-top boxes and on the Charter TV app by a fact of three. The coming months will also see the wider rollout of our Worldbox, our new more advanced and less expensive downloadable security infrastructure in several markets. So our video product, which is fully competitive today, continues to improve. And with Spectrum Guide and other features, it will get even better throughout the year, offering a rich, fully-featured video package that is superior to the competition at a highly attractive price. We believe that most consumers want fully-featured video products. Those fully-featured video products are at the heart of our video business today, and we believe they’ll be at the core of our video business well into the future. And we expect growth in video in 2015, despite the continued pressure on pay-TV customer growth. That pressure is coming from weak household formation, higher content costs and other entertainment diversions. Given all the reporting on a possible à la carte services and smaller package offering, we've been considering ways to provide compelling services and packages at lower retail price points, with a lower content cost structure, and with the inclusion of direct-to-consumer services, all then offering to satisfy the un-served marketplace. If we can create a new video product that offers real value to this segment we target and the customers will stick with, that also gives us an opportunity to upgrade customers to our fully-featured video product, this consumer needs change. And obviously we'll do it if we can. We haven't found that product mix yet and we don't think anyone else has either. Therefore we remain focused on the opportunity to provide high-quality television service with a modern user interface to all our passings and grow our video business further. Turning to commercial. In early March, we reorganized and the re-branded our commercial services under the Spectrum brand and launched a new pricing and packaging structure for the small and medium business segments. That structure is intended to provide better products and greater value to small and medium business customers and to drive deeper product penetration at the point of connect with manageable price step-ups over time, very similar to what we've done in the residential marketplace. We’re already selling more and we expect this new pricing and packaging to reaccelerate the financial growth of our commercial services unit as it has our residential business. The entire business telecom market footprint remains a very significant growth opportunity for Charter. I'd like to make a few comments on our recently terminated transaction with Comcast. As a company, we put a significant amount of time and effort and money into completing our transaction with Comcast. Obviously, we’re disappointed that our transactions did not close, but I'm pleased that we continue to grow our core business and we've put ourselves in a better position to acquire the $6.5 million un-served passings in our footprint and to acquire other passings in a disciplined manner, consistent with our goal of delivering competitive products and high-quality service at attractive price points to drive market share, cash flow and shareholder value. Our agreement with Advance/Newhouse requires that we negotiate in good faith on the termination with Comcast transactions and we're doing that. There isn't more that I'll say beyond that, except I want to compliment the quality of the Bright House assets and the management team, as we already have. And with that, I'll turn the call over to Chris.

[Chris Winfrey:]

Thanks, Tom. Turning to Slide 3 of today's presentation, as Tom mentioned, we grew residential PSUs by 160,000 during the quarter. In the video, we lost 7,000 residential customers compared to 2,000 non-bulk video customer net-adds in the prior period. This slight decline was related to the factors Tom described and has not dampened our full-year outlook for video. In residential internet, we added 125,000 customers and we grew residential voice customers by 42,000. Over the last year, our residential customer base grew by 254,000 or 4.5% for the last year. And at the same time, first quarter residential ARPU rose by 1.8% year-over-year driven by sell-in, step-ups and a lower level of annual rate increases for the reasons I mentioned on the last quarterly call. Despite good triple-play selling, we continued to have a fair amount of single-play internet which pulls on the average ARPU. Despite five shows, our customer growth, combined with our ARPU growth, resulted in year-over-year residential revenue growth of 6.7% compared to 6.5% one year ago, again with lower rate increases this year. Looking at commercial, we added 21,000 PSUs. Commercial revenue grew by approximately 15%, driven primarily by small and medium businesses. Excluding the lower growth hospitality video business, telecom revenue grew by 17%. As Tom mentioned, we recently re-branded our commercial services unit to Spectrum some associated cost in the quarter and we launched new pricing and packaging to the small and medium business segment. We’re already seeing a significant sales uplift at the new price points. Our advertising revenue declined by about 2% year-over-year, and in total, revenue was up by 7.3% in the first quarter. And excluding advertising revenue, total revenue grew by 7.6%. Turning to operating expenses and adjusted EBITDA on Slide 6. Total operating expenses grew by $127 million or 8.9% year-over-year. And transition costs related to our transactions with Comcast accounted for about $21 million of that $127 million. Excluding transition cost, total expenses grew 7.4% year-on-year, with total programming expense growing by $60 million and that accounted for about half of the year-over-year increase in total operating expense. The 10% increase in programming is driven by contractual rate increases, about 1% growth in our expanded video customer base over the last year and higher penetration of our tiers, broader carriage in the launch of new channels. Cost to service customers, which includes field operations, customer care and network operations cost, grew by 5% year-over-year, driven by similar and larger cost of customer base. Other costs grew by $23 million or 12.6% year-over-year, driven by higher labor cost to support commercial, some additional administrative labor expense and an increased bad debt. Excluding transition costs, adjusted EBITDA grew by $54 million in the quarter or 7% year-over-year with a lower level of rate increases. So our first quarter operating results were solid, generally as we expected. Moving to Slide 8. First quarter capital expenditures totaled $351 million or 15% of revenue, including $14 million, which was related to Comcast transactions. Much of the transition capital we’ve spent won't in fact be lost, as we needed to accelerate the platform investments that would have incurred over the next couple of years anyway. Either way, the significant year-over-year decline in CapEx was driven by the completion of all-digital during the fourth quarter of last year and we continue to expect approximately $1.7 billion in capital expenditures in 2015, excluding spending related to acquisitions. If you just look at EBITDA in CapEx, excluding transition expenses, the increased contribution to cash flow was $256 million in the quarter. That said, we generated $101 million of free cash flow in the first quarter, compared to $74 million last year. Our free cash flow, as I mentioned, was offset by $35 million of transition expenses in CapEx I mentioned a moment ago, M&A expenses which are included below adjusted EBITDA and other expenses, and $36 million of cash interest paid during the quarter for the $7 billion of escorted Comcast transaction debt. But the biggest driver was first quarter trade working capital, as we saw a significant decline in accruals and payables for CapEx year-over-year, which was a one-time reversal for the all-digital build. So absent that roughly $80 million impact in the quarter, which was $150 million year-over-year working capital swing, our business trend should provide us with a slight working capital benefit on a 12-month rolling basis going forward, as they normally do, with a lot of seasonality in the quarters between. Turning to our balance sheet. Our current leverage ratio was 4.4x on an LTM basis, within our target leverage range. And including the impact of our recent debt refinancings, our current weighted average volume cost is now 5.2%. I won't go through all of our tax assets again, but we believe we've constructed an very attractive capital structure profile that supports our operating strategy. And with that, operator we’re now ready for questions.

[Operator:]

[Operator Instructions] We’ll pause for just a moment to compile the Q&A roster. The first question will come from Jason Bazinet with Citi.

[Jason Bazinet:]

Thanks. I just had two quick questions. In your prepared remarks, Mr. Rutledge, you talked about direct-to-consumer offerings that you were explaining. I just never heard that phrase. I was wondering if you could just elaborate on what that is? And then second on the CapEx front. I'm just - can you just provide may be a little bit of color in terms of why the $1.7 billion is still the correct number for the full-year, given the sharp drop-off in the first quarter? Thanks.

[Tom Rutledge:]

All right, Jason. Well, the direct-to-consumer notion in my script was really about a provider of over-the-top services like Netflix, or now in the case of HBO or Hulu or others like that, where the payer of the content has a direct relationship with the customer. And so what I was saying was that our view is that we can mix those products into products that we sell to satisfy the entire customers’ video needs.

[Jason Bazinet:]

And does that - when you say direct-to-consumer, does that imply outside your footprint as well, or you're envisioning DTC within your footprint?

[Tom Rutledge:]

I can't hear him.

[Jason Bazinet:]

Are you talking about - yes, go ahead.

[Chris Winfrey:]

The question was whether direct-to-consumer implies inside of our print or outside of our footprint?

[Tom Rutledge:]

No, I'm assuming that products can be built which would be sold by us inside our footprint, but would also contain products that are sold outside our footprint, delivered by the internet.

[Jason Bazinet:]

Understood, okay.

[Tom Rutledge:]

Generally, but not necessarily.

[Jason Bazinet:]

Understood.

[Chris Winfrey:]

And Jason on CapEx, the $1.7 billion Q1 in cable tends to be a little bit light and seasonal. That's no different here. We also benefited inside of Q1 coming off of all-digital with higher inventory levels. But we think the $1.7 billion is still a fair estimate for the full-year. And when you take a look around, Q1 always tends to be a little bit light than usual.

[Jason Bazinet:]

Okay. Thank you.

[Operator:]

The next question will come from John Hodulik with UBS.

[John Hodulik:]

Thanks. Maybe, we could just explore the video subscriber trends a little bit here in the first quarter. It sounds like churn is coming down, so if you guys were little lighted [ph] on the new connects. And you mentioned a couple of things, but if you could maybe sort of give us an indication of, sort of, the weightings of each, but you said tighter credit standards may be incremental competition from non-traditional guys because with the all-digital transition, and I would say less competition with AT&T, are we expected somewhat higher numbers? Thanks.

[Tom Rutledge:]

So John, it's Tom. I think there are several factors when you got to understand where we were and what our planning was. We were getting ready for a big integration. We also had come off the all-digital project, which has - while it has benefits to consumers and even benefits to us in prior quarters, like for instance, unauthorized customers get cut-off when you digitize and they become your customers in many case, although their churn rates grades are higher than the average customer base. At the same time, the all-digital project is very disruptive. We had to put out six million boxes in a year versus 10 million televisions in a single one-year period. And that's actually - well, it ultimately benefits the consumer to have that, all-digital product, because it frees up our network to increase the data speeds and it frees up our network to put on more HD channels. The whole process is quite disruptive from a consumer perspective and it creates a lot of service transaction. So we’re slowing down the business in the first quarter to manage our service cost. And they you have dropped off, as we expected they would. So we actually had a fairly modest video budget because of all of that activity anyway. And finally, I guess when you think about our incentives as a company, our biggest opportunity was the transaction that was in front of us. We were about to divest 40% of our business. And so, our focus was somewhat distracted. But all in all, the operational issues of changing - credit policies changing year-over-year, outcomes as a result of the termination of the all-digital project and the management of the service issues around the all-digital project, we’re comfortable with where we are, and we are comfortable with our growth prospects for the year, which is why we’re saying we plan to go video throughout the year.

[John Hodulik:]

Okay. Thanks, Tom. It makes sense.

[Operator:]

The next question will come from Ben Swinburne with Morgan Stanley.

[Ben Swinburne:]

Thank you. Good morning. Chris, can you - will you give us the - quantify the level of rate increase now that the first quarter is behind you, so we can speak about it versus prior year? I know it was lower. But if you could put any numbers around it, that would be very helpful. And then just, Tom, could you talk about the set-top platform today and where it’s going? So Worldbox, I imagine it's less expensive than what you've been deploying. Can you give us a sense for maybe how much and what else it might do for you? And then on that Netflix OTT integration idea you brought up, how many of your set-tops today could you deploy a product like that in terms of integrating those services into your core video platform?

[Chris Winfrey:]

So on rates, it's a little more complicated because you don't have - it's just not a Q1. In both years, you had different timing season inside the month. What we did this year was extremely - it’s very minimal. But we also benefit from the retrans pass-through that came through inside of Q4. And so you have to look to those two effects cumulatively. One is what was in place in Q4, and therefore the run rate already in January of this year plus the very minimal increases around the edges that we took this year, as compared to the timing of when larger rate increases, not only just for Q1 but cumulative margin rate increases took place last year. The net effect of all of which is the cumulative Q4 and Q1 increases that we took this year were substantially lower on a percentage and dollar revenue basis than what we had done last year. And without getting in total, the complexities - I think the easier way to take a look at it is, if you look at the quarterly - quarter-over-quarter residential customer ARPU growth, this quarter we are at 1.8% more of a stepping out that we have lot less annual rate increases and if look at Q4 of last year, it was up at 3.1%. We really did go out of our way last quarter to explain that to people as what the Q4 impact was and how we were intentionally not going to take the same level of rate increases this year for the reasons we mentioned last quarter, some of which Tom just touched on, frankly. So it's a roundabout way of saying it's a large difference when you take the cumulative Q4 and Q1, and largely lower than what we did last year.

[Tom Rutledge:]

So then your question on the set-top type on Worldbox and price and integration of other products into our product offering. There are really two platforms that we are currently rolling out that increase and change the nature of our video product dramatically. One is our new cloud-based user interface, our Spectrum Guide. And that's are backward compatible user interface that state-of-the-art and looks like any kind of guy that can be rendered on any kind of device today, it is completely modern and useful and can be changed with very little development time because all of the activity is done centrally in a server-based architecture. The breakthrough that we've achieved in our strategy is that this cloud-based user interface also speaks multiple languages of digital. So it can talk to DOCSIS boxes. It can talk to any device, both in the home or outside the home. And it can talk to historically placed digital boxes in the language of MPEG as opposed to IP, which can be either cable or internet language. And so we can render this user interface on every set-top box that's been historically deployed. So as I said earlier, we now have 10 million deployed set-top boxes, many of them which can’t receive DOCSIS signals, many of which can. And we’re going to deliver this new user interface in both DOCSIS and in MPEG. We’re using the active video platform and other software platforms that we have. And we’re also going to leave a small resident guide on the set-top boxes, so that if the boxes ever lose connectivity to the server, that customer still has user interface. Our view is that, that won't be needed, but we’ve built belt-and-suspenders around it. On that platform, because it's streamed, we can put any other services as well onto very television or outlet we have. Those can be services that we sell directly. They can be services that other companies sell directly. And we can include those in the UI if we want to or not. So it's a open architecture that gives us a tremendous capability depending on which way the television marketplace evolves. Worldbox is a better set-top box and it uses a downloadable security that is under our control as opposed to the box vendor’s control. And it allows us therefore to buy boxes from any vendor anywhere and the reason we call it a Worldbox, it just means we can buy from any world vendor. And we don't have a particular vendor in mind when we think about Worldbox, although we've done deals with Cisco and ARRIS and others to build these boxes and deploy these boxes. It's primarily - it's a very sophisticated box, but it’s inexpensive because, one, the conditional access isn't part of the box price. And two, we’re sort of writing Moore’s Law. And three, we’re getting the effect of having a competitive world marketplace in front of us and people offering their product at competitive prices to us. Interestingly, the all-digital project that we just did was positively impacted by the fact that we built Worldbox. Our traditional box vendors became very accommodating to us and developed Worldbox with us, so all the writing on the wall and proceeded to go where technology takes them. And we actually got very good pricing on the traditional boxes that we deployed and we also worked with the FCC and got waiver, so that we could put out boxes that didn't have cable cords, that waiver since been negated by a change in law. But we took advantage of our rollout strategy and our architectural strategy throughout the period. But going forward, we expect CPE to continue to come down, and that ultimately takes capital intensity out of the business.

[Ben Swinburne:]

Thank you, Tom.

[Operator:]

The next question will come from Jonathan Chaplin with NSR.

[Jonathan Chaplin:]

Great. Thanks for taking the question. So I just wanted to go back to your comments on how you're looking at the video market, and get a sense the opportunity we - one of the opportunities we are excited about at Charter is your ability to take video penetration up fairly significantly from where it is at the moment. Is it your view that the market has changed and you need to come in - you need to put a lower price to offer into the market with the direct-to-consumer products in order to get to penetration levels that we might have thought you could get to before, or is that entirely additive to the original business plan?

[Tom Rutledge:]

Well, I'd say this way, the multi-channel video universe is very highly penetrated. And there is a slight loss of video penetration in aggregate. That said, there is a tremendous opportunity for us to shift share to us to our better platform. So we see lots of video growth in front of us in a market that is mature but not shrinking dramatically. So the whole over-the-top issue or cord-cutting I guess is a better way of describing it, issue, is the fact - it is occurring and its occurring for a variety of reasons that I stated earlier, household formation, income levels, particularly the price of the full package is expensive. And we do have the internet now and people are using the internet for both, video entertainment but other kinds of diversionary entertainment, all of which have - which you see affecting the ratings of video product in a negative way, but which puts more pressure on the price side of the video product from a licensing perspective. All of those factors are real, but it's also reality that people do like the full service and people want the full service. It's just that it’s not that inexpensive. And so we see growth. We’d love to be able to serve people with products that are less than a full package, if their income or light viewer limited in terms of their desire for that product. I mean the elasticity of demand for the product changes by what the alternatives are. And frankly, if you sell people products that they think are cable or the full product and they are not that product, the churn rates go very high. And Philippe Dauman yesterday said something about family packages in the video space, which I think is right. People have played around with packaging in the past. And the reality is that most people want the whole thing, even though that it's true that they don't watch that many channels, they have access to a lot of servers, and the quality is quite good. So when you think about packaging and targeting people, it's not that easy to find niches, and it's not that easy to make the model work without a full service package of product. That said, we are looking at all the alternatives. We see what's going on in the marketplace. We see the maturity of the marketplace. But fundamentally, our growth strategy is driven by high-quality full-service products.

[Jonathan Chaplin:]

Got it. Thank you.

[Operator:]

The next question will come from Vijay Jayant with Evercore ISI.

[Vijay Jayant:]

Thanks. Tom just continuing on your prior comments, obviously FiOS is trying to take creative view on how they can do this. Do you believe that that kind of structure of a consumer proposition is what the market needs and one can you do that? And then for Chris, just of quickly, just the pulse of the higher market today. Is there obviously been borrowing money over the last few months as part of the Comcast transaction, but to get tens of billions of dollars of financing. Is the market fully available, the big banks, will it provide bridge loans broadly speaking. So just want to see if you can give us some sense of how the spread market is? Thanks.

[Tom Rutledge:]

With regard to FiOS package. I think those kinds of products have been tried in the past. And I don't know what’s in FiOS’s contracts with ESPN, but generally there are tiering requirements and there are penetration requirements for service levels that are quite - they have been historic in the industry. Because people have tried these tiers previously, family packages. In fact at one point, the FCC was promoting that idea with the family tier in their last administration. So it is it's not a new concept. Products have been launched even decades ago. HBO light festival and other services like that, they were designed to appeal to niches. But all of them have ended up migrating back into a full package kind of world. And so it's hard to actually given the way that business is structured when you are buying programming to build products that actually satisfy people and - but would I be rather be able to sell lots of smaller tiers? Yes, I would. But I still think the majority of households would buy most of them.

[Chris Winfrey:]

And Vijay on the capital markets question, there is some of that that’s in embedded M&A question that I'd like to steer away little bit. But generally I'd say, it feels to us that the capital markets remains healthy and receptive for good credits and for good operating strategies. And that's what is on our hands is to have a good operating strategy. And beyond that, it’s difficult to say.

[Vijay Jayant:]

Great. Thank you.

[Operator:]

The next question will come from Craig Moffett with MoffettNathanson.

[Craig Moffett:]

Hi, thank you. So I want to return to the trajectory of ARPU for a second, separate and apart from the mix of single-plays and triple-plays which sort of clouds it. Can you just give us a little bit of insight into how you're tracking with respect to the step-ups in pricing, and is that flowing through at the rate that you had come to expect it? And if you could just an update us on how much of that is still to come as we look forward?

[Chris Winfrey:]

Craig, yes, it is as we expected and our model is working. I think the mix is slightly different than I might have talked a couple of years ago in terms of triple-play to single data play and that kind of thing. But it is essentially - those people that price into packages are stepping up as we expected and the retention rates are what we’ve forecasted and planned all along. And so the trajectory of the ARPU is consistent with our model.

[Tom Rutledge:]

And Craig, I'd add onto that. It’s a healthy development. So it's an ARPU development that’s supported by delivering the customer of what they want with the fastest internet speed, the lowest cost voice, the most fully-featured video product at an attractive price, which is what gives you the step-up power to began with, but even more that steps up that’s still at a better price point for all the services with better service than the customer could receive elsewhere, which is really what makes it sustainable, at the same time you're delivering 4.5%, 5% customer growth at the same time.

[Craig Moffett:]

And so how should we think about the growth of ARPU going forward? I know you can't give precise guidance, but can you give us general guidance for how you would expect the ARPU to track over the next year or so?

[Chris Winfrey:]

Sure. I'm not going to give forward guidance, but I think I can direct you to - in our investor presentation that we produce every quarter, you can see the year-over-year growth rates and you can see where point in time where we’ve had some annual rate flowing through and you can see when there is essentially not been that effect flowing through, which is why I was making the healthy ARPU increase is based on the business development. And you have a lot more transactions that are taking place in VCI [ph]. You don’t only have gross connects. You have migrations. You have upgrades. You have downgrades. And you have bundling of those customers and the pricing of the bundle of those customers that are disconnecting. It's a really complex model.

[Tom Rutledge:]

It is.

[Chris Winfrey:]

And I think it’d be wrong to try to oversimplify it, but when you have an operating strategy that has the product pricing and packaging that we have, you can be in an environment where you have steady price increases that are based on the value that you're providing and you can do it in a way that despite the higher input costs that your overall gross margin and EBITDA margin per customer and your EBITDA margin per passing can increase substantially in some cases, despite the fact that some of your input costs are growing up at a higher rate. And that's what puts cable generally and Charter I think in a unique position relative to others, as long as you provide the right pricing packaging.

[Craig Moffett:]

Okay. Thank you.

[Operator:]

The next question will come from Brett Feldman with Goldman Sachs.

[Brett Feldman:]

Thanks for taking the question. You noted in your comments and in your release that there was an increase in bad debt expense year-over-[year and one of your peers had a similar disclosure. I'm just curious, is that coming from the commercial side or the residential side? And then just as a follow-on, could you talk a little more broadly about what you're seeing in the economy and how it’s affecting your business?

[Chris Winfrey:]

Yes, I don't think it's much from an economic development. I think it ties into what Tom was describing before. It's coming out on the back-end of all-digital. We had some uplift from unauthorized customers becoming paying customers, and sometimes you see some of that coming up at back-end as well. We also did make some changes to both our collection and credit policies that weigh into that that has a one-time effect. So it's a combination of those two factors. I would call it more self-inflicted intentionally for good reasons as opposed to broader macroeconomic or cable industry challenges.

[Tom Rutledge:]

Yes, the broader economic situation is actually slightly improving. There’s more housing construction than there has been. Not much, but more.

[Brett Feldman:]

Great. And just as a follow-up, I mean, should we expect the bad debt expense will improve going forward from this point?

[Chris Winfrey:]

That's our goal.

[Brett Feldman:]

Great. Thank you.

[Operator:]

The next question will come from James Ratcliffe with Buckingham research.

[James Ratcliffe:]

Good morning. Thanks for taking my question. Two, if I could. First of all, on the business services side, you talked about free packaging and on that front. How much of an issue you're finding the lack of availability of a bundled wireless product to be, and how much interest are you seeing customers for that? And secondly, just from a staffing perspective. Do you have any replacements or rebuilds needed, particularly the systems you're planning on divesting of folks who decided to depart for that happened? Thanks.

[Tom Rutledge:]

So with business packaging, your question was, do we need a wireless component to that product?

[James Ratcliffe:]

Are you seeing any meaningful number of customers who are looking for to roll wireless into it, or are people mainly making those decisions separately?

[Tom Rutledge:]

Well, we currently - our wireless product in the small business space is a Wi-Fi router, where the business and for the public spaces in the business as part of the product mix. And we see that as highly attractive from a product point of view, and we see increased market share shift to us in that area. With regard to mobile wireless phones, we are not in that business, don't have a product today for small business to do that. And so all of the business that we’re creating is wireline and Wi-Fi. But our fundamental strategy there is to - like it is in the residential space, to stand up a better product than our competitors and to sell it at reasonably attractive promotional pricing and to drive a market share strategy and to - we've reorganized our operations, so that we can actually handle the speed of a higher activity level, which has an effect in our cost structure by the way also, initially. But we're very pleased with the results we’re getting already and our expectations there are proving out. So we expect to have an accelerating small business growth prospect. With regard to staffing, Charter maybe got a little ahead of itself in some staffing areas in hiring people as a result of the proposed transaction, probably aren't reflected in all the transaction cost. But in general, because of the way our operations are structured, the divested areas are not - they’re fully staffed and the people who were planning on going to Comcast and working for Comcast, we really haven't lost people in those areas. And they are all - obviously they were confused and their lives were disrupted and all of that, but they’re with us and their prospects with us are bright and he don't have any deficits in terms of our ability to execute in those areas.

[James Ratcliffe:]

Great. Thank you.

[Operator:]

Then next question will be from Frank Louthan with Raymond James.

[Frank Louthan:]

Great, thank you. Can you give us an update on your prospects for fiber-to-the-tower and small-cell builds in your territories? Are you seeing any meaningful business there, and what do you think your outlook is for getting those kind of contracts?

[Tom Rutledge:]

Fiber-to-the-tower and small cell.

[Chris Winfrey:]

Yes. Well, cell backhaul prospects.

[Tom Rutledge:]

I'm sorry we’re having hard time hearing you. I am anyway. Our fiber-to-the-tower business is still a good business and it’s still growing. It's not as growing as fast because we've covered a lot of the towers in our footprint. With regard to small-cells, we don't have any small-cell arrangements with anybody and haven't done any. We've looked at that, and we’ve looked at the opportunities with combine licensed and unlicensed spectrum in small-cells, but we don't have any business plans to announce.

[Chris Winfrey:]

Frank, what I would tell you is a lot of the capital has been spent on that. And so we're seeing the benefit of the existing contracts through revenue, which is always by design is capital intensive. We are seeing tenants connect to the existing capital that we’ve deployed which was always our hope and not part of the ROI of business case when we built it. So it's an attractive business.

[Frank Louthan:]

Can you give us an update on maybe how many towers you have wired up or the value of the revenue stream?

[Chris Winfrey:]

I don't have that in front of me. And so I could give you a number, but I want to make sure that if I did run the risk of mixing fiber sites and cell backhaul together, I'd rather not do that and have to correct it afterwards. But it's still growing and it’s growing well but it's not growing at the pace of newbuild that it did probably a year ago.

[Tom Rutledge:]

But upgrades are going faster than the pace they were.

[Chris Winfrey:]

Yes, that's exactly right.

[Frank Louthan:]

All right, great. Thank you.

[Operator:]

The next question will come from Mike McCormack with Jefferies.

[Mike McCormack:]

Hi guys, thanks. Tom maybe if you can make a quick comment on just the regulatory environment title two and obviously your consolidation was top of mind, but we don't have to get delve too deeply into it. But just your thoughts on what the environment is from regulatory standpoint, whether or not it's sort of friendly to cable or not. It seems sort of not. And then commenting maybe on the voice side with respect to the pricing strategy there and maybe cost per month per sub and how that's trending? Thanks.

[Tom Rutledge:]

Okay. Well, look on the regulatory side, I mean I think every situation is different. Title two was a - it's actually a long standing issue. The issue of net neutrality has been around for a long time and companies have been agitating. It’s been part of the President’s agenda all along, and he campaigned on it initially. So it's not surprising that the forces that prevailed there did. Although I wish it were structured differently and I thought that the outcome was less than ideal. I don't think that is particularly related to being friendly or not friendly to cable in general. And I think every company is different. Every transaction is different. And they’re really independent structural questions from a regulatory perspective.

[Chris Winfrey:]

And on voice pricing, it's going down.

[Tom Rutledge:]

Yes, our view in the long run is that it has to go down. We price - our permanent pricing at $19.95 all taxes and fees included. And the cost of providing voice is going down and we're still growing voice fairly nicely, because it's worth at that price today. Will it be five years from now? Probably not. But I think having a fully-featured wireline voice product with high quality service is worth something. And so in the package, I think we'll continue to sell it well.

[Mike McCormack:]

I guess I was just trying to get a sense for how that margin trends over time and does it approach sub-overall business type margin?

[Chris Winfrey:]

Yes, the issue that you have seen in our P&L that voice revenues have been coming down, a lot of that’s just allocation in the bundles that we knew from new pricing and packaging despite the fact that we've been growing up. So instead of selling it at $40, it's been priced in on the rack rate of $20. So that's just an allocation issue. But we are in a position now that despite that allocation, you can start to say gross margin despite moving dollars out of that piece of the bundle, gross margin can be increasing. And I believe that started to do so already.

[Tom Rutledge:]

Yes, that's right. Because of the way we transition the pricing, we finally hit the place where we started to grow total revenue.

[Chris Winfrey:]

Yes, I want to be clear that's not how we look at it. And we look at it on per home basis in terms of EBITDA and cash flow that we can get out of their home, because I could price and I'm not saying we’d do this, but you could price and I wouldn't do it anyway big time [ph]. But we could price at zero and you could talk about margin on the product, so you can price it $35. The reality is most people aren’t buying phone on a standalone basis. They are buying it together with their other services. And so what you have to focus is the value that you're providing inside the home, what you should price it at and what's the margin that you have for the whole bundle of service.

[Mike McCormack:]

Sure, understood. Thanks guys.

[Operator:]

And the final question will come from Marci Ryvicker with Wells Fargo.

[Marci Ryvicker:]

Thanks. Chris you mentioned, I think, previously that when your new programming contracts came up, you're going to negotiate as a larger company. And I guess with the transactions now being called off, does anything change with upcoming programming negotiations?

[Tom Rutledge:]

I’ll answer that, probably. But I don't think that the arc of our programming expense will change significantly as a result of this. I think there are synergies that occur in transactions that come from scale or existing contracts attributing to another company. But in terms of Charter as a standalone business, I don't think it materially affects what our costs will be, relative to what they were historically.

[Chris Winfrey:]

The only thing I’d add to that just purely from a financial perspective what we knew was there, and we knew we would get it. We never put it inside of any of our plans because you didn’t forecast exactly where and when it would come from. So we took the conservative approach and when we put things together for acquisitions that ended up publicly disclosed places but didn’t reflect those type of synergies.

[Marci Ryvicker:]

Got it. Thank you.

[Operator:]

Ladies and gentlemen, that concludes today’s conference call. You may now disconnect.

[Tom Rutledge:]

Thank you.