Neil Smit – President, Chief Executive Officer
Eloise Schmitz – Interim Chief Financial Officer
Mike Lovett – Chief Operating Officer
Mary Jo Moehle – Vice President of Investor Relations and Communications
Michael Pace – JP Morgan
David Joyce – Miller Tabak & Co.
Jason Bazinet – Citigroup
Jason Kim – Goldman Sachs
Tuna Amobi – Standard & Poors
Richard Greenfield – Pali Capital
Bryan Goldberg – JP Morgan
David Hamburger – Citigroup
Charter Communications Inc. (CHTR) Q3 2008 Earnings Call November 6, 2008 9:00 AM ET
(Operator Instructions). I will now turn the call over to Mary Jo Moehle, Vice President of Investor Relations and Communications.
Mary Jo Moehle
Welcome to Charter Communications third quarter 2008 earnings call. The results we're reporting this morning are included in a news release we issued over business wire at 8:00 Eastern Time and posted to our website charter.com. We also posted a presentation there covering our third quarter results.
This morning's call will contain certain forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ from historical or anticipated results. Certain factors that could affect actual results are set forth as risk factors described in Charters Form 10K and our quarterly report on Form 10Q, which was filed with the SEC earlier this morning.
During the course of this 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.
In today's earnings release we reported in accordance with GAAP as well as pro forma results for the third quarter of 2007. The pro forma results reflect sales and acquisitions of cable systems in 2007 as if they had occurred on January 1, 2007. During this morning's call we'll be referring to pro forma year-over-year growth rates.
With that introduction I'll now turn the call over to Charters President and CEO, Neil Smit.
Thank you for joining us today. We are pleased to report solid third quarter financial and operating results. For the third quarter of 2008 we achieved approximately 8% revenue growth and 11% adjusted EBITDA growth year-over-year. We also added 205,000 RGUs in the quarter and grew ARPU 11% over the year ago period.
In the face of challenging economic conditions this financial performance stems from our ability to quickly make operational adjustments while not straying from our strategic objectives. Our marketing messages reinforce the value of in-home entertainment and savings of the bundle.
We're adding high definition content, promoting the choice and convenience of OnDemand and offering speeds up to 16meg in each of our markets. We've also introduced a bundle of 1meg plus in-state phone to appeal to more cost conscious dialup and DSL users.
We're focused on maximizing the lifetime value of our customers through continued improvements in service and the benefits of bundling. The value message plays well in this economy evidenced by bundle penetration growing to 52% from 45% a year ago. Third quarter customer retention and bad debt were generally in line to favorable with year ago levels.
The initiatives we implemented earlier this year to address bad debt and retention had a positive impact in the quarter. However, early indications in the fourth quarter suggest the economy is having a slight impact on these metrics. We will continue to monitor these trends closely and will continue to focus on delivering value to our customers.
We’ve talked about our marketing structure before. Our database and infrastructure allow us to quickly deploy the most effective offers with the highest expected returns. This allows us to be nimble and react quickly to changing conditions, which is even more important in this economic environment. I believe we're well equipped to expand our core business and we're investing in areas for new revenue growth.
While we've been in the commercial area for several years, we're in the early stages of offering voice which represents sizeable opportunities for Charter business. There is significant demand for choice and value in the commercial market and we're capitalizing on our ability to provide savings through the bundle.
We also continue to deploy technologies to maximize bandwidth allowing us to offer more robust advanced video services including expanding HD content and increased internet speeds. We're launching DOCSIS 3.0 in the next couple of months which will enable us to offer wideband speeds to our customers.
We continue to invest in areas with the highest expected return and remain disciplined in our operating and capital expenditures. Third quarter adjusted EBITDA margin increased 90 basis points compared to a year ago resulting from efficiencies in the operating infrastructure and the increase in bundled penetration.
Approximately three-quarters of our capital expenditures this year have been for success based investments. We expect full year CapEx to total approximately $1.2 billion consistent with our 2007 spend but representing a lower percentage of revenue.
Before I wrap up, let me address the challenging market conditions we're all facing. We continuously monitor our exposure to financial market risk. We've demonstrated our ability in the past to act quickly to execute financing transactions.
We've made investments over the past several years to improve the efficiency of our operating infrastructure and are focused on leveraging those investments and growing the overall business to help maximize balance sheet opportunities.
We continue to deliver value to our customers with bundled savings and quality products and services. Our strategic priorities remain the same, however, we will remain flexible and adapt to the changing environment.
Now I'll turn the call over to Eloise Schmitz for our discussion of our financial results and then Mike Lovett will discuss our operational results.
For the third quarter of 2008, total revenue was $1 billion $636 million, an increase of 8% over the third quarter of 2007. Phone and high speed internet, our highest margin services, accounted for about 65% of our revenue growth in the quarter. Telephone revenues totaled $144 million for the third quarter continuing as our largest revenue growth driver with 55% year-over-year growth.
High speed internet revenues increased by 8% to $342 million as a result of customer growth and the demand for enhanced services, such as increased speed and home networking. Video revenues in the third quarter rose by 3% to $867 million, primarily due to ARPU growth of nearly 7% related to deeper digital penetration, an increase in HD DVR customers and higher VOD usage.
For the third quarter our commercial business revenues climbed 16% to $100 million driven by the expansion of commercial telephone product in the business bundle. Ad sales revenue for the third quarter grew 4% year-over-year with increased political advertising spend in swing states offsetting decreases in the automotive and furniture sectors. Excluding political spend, we would have seen a year-over-year decline in ad.
Adjusted EBITDA grew $55 million or 11% year-over-year to $563 million. Adjusted EBITDA margin increased 90 basis points to 34.4%. While we continue to invest in marketing and improved service capabilities, we captured margin benefit as we drove bundle penetration, scaled investments in our infrastructure and increased the mix of products to higher margins, high speed internet and phone.
We continue to allocate approximately three-quarters of our CapEx dollars to success based initiatives. Total CapEx in the third quarter was $288 million and we continue to expect to spend approximately $1.2 billion in CapEx in 2008.
Turning to the balance sheet, as of September 30 cash on hand and revolver availability totaled approximately $1.3 billion, none of which was limited by covenant restrictions. In response to recent financial markets, we have borrowed amounts under our Charter operating revolving credit facility in excess of our immediate needs.
We may from time to time increase or decrease the borrowings under our revolver as we balance market risk with our liquidity needs and the leverage ratios of our subsidiaries. As Neil said, we're focused on leveraging investments in our infrastructure and promoting the value of the bundle to grow the overall business and maximize balance sheet opportunities.
I'll now turn the call over to Mike Lovett for a discussion of our operations.
During the quarter we added 205,000 RGUs representing more than a 50% increase in net ads versus the year ago quarter and total ARPU per basic customer climbed to $106 an 11% increase year-over-year. With continued focus on the value and savings message, bundle penetration increased to 52% and customers in the triple play increased about 60% year-over-year.
On the video side, we lost 26,000 basic customers during the quarter compared to a loss of 39,000 a year ago. Digital net ads were $62,000 compared to $17,000 in the year ago period. We continue to be successful in moving basic customers up to the digital tier and coupled with the demand for advanced video services such as VOD, HD and DVR we saw a nearly 7% lift year-over-year in video ARPU.
We're leveraging our HD and OnDemand platform to enhance our customer's video experience. Demand for high definition continued in the third quarter with HD customers increasing nearly 50% year-over-year. OnDemand orders increased 57% and the number of users climbed nearly 30% over the year ago period.
During the third quarter we saw continued opportunity to grow high speed market share and we capitalized on seasonal trends. We added 71,000 high speed customers during the quarter more than 30% greater than net ads a year ago with the majority of net gain coming in at our higher speeds.
Our home networking services generated incremental recurring monthly revenue and customers that subscribe to this service have more than tripled year-over-year. In addition, having multiple users in the house tied to our network improves retention of our high speed product, and while speed is still our lead strategy, our 1meg product bundled with in-state phone enables us to target dialup and value conscious customers opening a new segment.
We added about 100,000 telephone customers in the quarter relatively consistent with year ago net ads. Customers increased nearly 60% year-over-year. Phone is now available to about 10.2 million homes or more than 85% of our footprint reaching our yearend goal ahead of schedule. We're at about 12% penetration of telephone homes passed across the company.
While we're the competitive provider in phone service, in some markets we are gaining the dominant share of new connects. As we stated before, we're seeing the benefits of scale as evidenced in our second and third quarter margin expansion driven by approximately a 35% reduction year-over-year in telephone cost of goods sold per customer.
Charter business delivered sold results again this quarter with revenue increasing 16% year-over-year. Commercial phone has been available throughout our residential pone footprint for several quarters now providing the ability to upgrade existing customers into bundle services. We continue to see strong bundled selling to new charter business customers as well as a result commercial phone customers have increased 133% year-to-date.
I am pleased with our team's ability to quickly adapt to today's economic and competitive conditions. We'll continue to stick with our core strategies, balance rate and volume, make adjustments along the way and focus on maximizing our future opportunities.
With that, I'd like to turn the call back over to Neil.
I just have a couple of quick comments before we open the call up to Q&A. I'm pleased with this quarter's solid results. We're all facing challenging economic conditions and we'll watch the competition, the economy and the capital markets closely. I believe we have a solid business model with strong fundamentals.
The investments we've made in the infrastructure have given us the capability to respond quickly to change in market conditions. We're focused on delivering value to our customers through the bundle, quality service and product enhancements.
I'll now turn the call over to the operator and open it up for questions.
(Operator Instructions). Your first question comes from Michael Pace – JP Morgan.
Michael Pace – JP Morgan
A question on the competitive landscape, I guess one of your peers on a conference call recently said that AT&T is I think they used a more formable competitor language and I guess could you comment on in putting that in context between their competitiveness from their service offerings or footprint expansion?
The second, I think for Neil or maybe for Mike, I think you have said in the past that you actually see an acceleration of unit growth or even telephony addition growth as you increase any more highly penetrated markets for telephone penetration. Can you comment on what's going on specifically in those markets?
I will take the first part of the question, Michael, and then I’ll turn it over to Mike for the second. I think there are two ways to look at the competition. One is foot print and the second is in marketing tactics and product related. From a footprint prospective, as we've mentioned before, AT&T has a 64% overlap and Verizon has a 20% overlap with us. In total the video overbuilds represent 9 to 11% of our footprint.
The Q2 market launches for AT&T we saw were in Michigan, Wisconsin and what we call the central states which is primarily Missouri. Competitors continue to increase ad spend but we saw that occur at a lower rate than '07, and we really haven't seen a change in competitive activity or impact from AT&T.
We believe our bundled service offerings provide us the flexibility to respond to various market conditions and offers and I think, as I mentioned in the call, the tools and infrastructure we have in place let us respond quickly to these market conditions and compete effectively. So, I think if anything from AT&T there’s a greater footprint overlap for us, but in terms of product and our ability to compete we haven’t seen a real change.
Michael, regarding the markets we’ve talked about markets where we’re in the 20 to 25% penetration rate and those are the markets where we’re seeing dominant share of new connects. So we feel that has probably the most to do with awareness in the market. There’s good buzz in the market and we’ve been in the market for an extended period of time, and as we drive deeper penetration that seems to be the shift that we see a dominant take of new connects.
Michael Pace – JP Morgan
I hate asking housecleaning questions, but Eloise what was the revolver balance at the end of September, I’m sure I could figure it out from the queue but it’s been a busy morning, sorry.
The revolver balance at the end of September was $565 million. We have drawn down additional funds since the end of the quarter, as we discussed in our comments, but we may continue to review our revolver balances going forward.
Your next question comes from David Joyce – Miller Tabak & Company
David Joyce – Miller Tabak & Company
Can you tell me any kind of regions that had particular standout product net ads?
Really it was widespread across the basis there wasn’t any geographic aspect to it. We’re pleased with the 205,000 net ads which is a significant increase. We think that HSI still has room for growth. So I wouldn’t attribute it to any particular region or area, Mike?
The only thing I’d add, David, is we talked about we have an increase in marketing spend in the quarter. It was tied specifically to the seasonality associated with Q3 driven primarily by the back to school rush. So where we had universities we had an enterprise wide marketing strategy to take the lion’s share of that opportunity and I think you can see that in the results.
David Joyce – Miller Tabak & Company
The marketing spend would that normalize since you’re done with the back to school period, or is there traction you think might still make sense for adding RGUs?
Well as we said before where we see opportunity we’ll put the foot to the accelerator. I think taking advantage of seasonality like the back to school rush is a good example of that. We’re not looking at normalizing at a 4.8% it’s probably going to go back into the 4% range, but if we see additional opportunity we’ll take advantage of it.
David Joyce – Miller Tabak & Company
Have you been seeing, I’m sorry I missed the first couple of minutes of the call. Have you been seeing lower tiers being taken during the economic conditions, even though people have been adding at a pretty good pace on digital video and data?
We haven’t seen that, we’ve actually seen the opposite on the data growth in the quarter it was primarily at our higher speed products.
Your next question is from Jason Bazinet – Citigroup
Jason Bazinet – Citigroup
Just one quick question for Neil, I think in the past you’ve expressed some reluctance to consider asset sales to the extent that the maturities come due and the credit markets remained challenged. Has there been any change in your thinking on that front, or is that still the same?
No, I think our approach to assets has remained the same in that where we see opportunities for clustering which would give us both operating and capital efficiencies we’ll take those. I still don’t believe that fundamentally the asset sales are a solution to any balance sheet issues. So our strategy remains consistent in that regard.
Your next question is from Jason Kim – Goldman Sachs
Jason Kim – Goldman Sachs
Can you give us a little more color in terms of the trends that you’ve been seeing in the fourth quarter to date please?
Yes, I think that while Q3 subscriber trend bad debt in churn were favorable year-over-year. Early indications in Q4 suggest that the economy may be having a modest impact on these metrics. We believe that fundamentally the bundle plays well in this environment, and one interesting trend we’ve seen is that while new connects are down year-over-year, existing customers have been migrating at a greater rate to bundled offers.
We continue to see demand for advanced video services and higher internet speeds, as Mike mentioned, and we’ll continue to leverage the capabilities of our marketing infrastructure to appeal to new customer segments and promote the value of the bundle. We are in the middle of rate adjustments in some of our regions right now, so we’ll see how that evolves.
Jason Kim – Goldman Sachs
A couple of questions on your phone product, now that your penetration levels have gotten to a pretty good level can you talk about the EBITDA margin benefit that we can expect next year? I know that there’s probably a lot of moving parts that goes into margin dynamics, including the negative impact you may see from slower advertising spending, but I was more focused on how you can benefit from the phone penetration continuing to increase?
Another phone related question is have you decided on what you are looking to do with regards to your footprint without the phone service?
It is difficult to talk about the EBITDA benefits so it’s probably best to look at what’s going on from an overall cost of goods sold per customer within the phone product line itself. There’s obviously a benefit of scale as you add more customers. The fixed recurring costs are spread across in obviously a large base.
Then the other thing and I think we talked about this in past calls, we’ve completely automated our back office process, so there’s a fair amount of efficiency whereas in prior quarters we were doing this from a manual standpoint. We’re fully automated now and getting cost benefits there flowing through the product line.
Regarding our footprint, we’re still exploring alternative technologies. We don’t expect to use the current structure that we have in place to go beyond the 85% more or less footprint that we have today, but we are exploring alternative technologies or potential partnerships that may be able to bring voice into those markets.
Your next question comes from Tuna Amobi – Standard and Poors
Tuna Amobi - Standard and Poors
Seems like the margins was up nicely this Q3 so I see part of that might be due to the pricing power operation side that you were able to sustain and it seems also that part of that was due to some cost control. So to put all these together in terms of margins, what levers do you see out there over the next year or so to be able to continue to grow your margins, even at maybe a more normalized level of unit growth?
I think that we’re leveraging the existing infrastructure to drive that growth and the cost savings related to product direct cost and increased network and call center productivity have been offsetting the increases in marketing and service.
So the real drivers of margin growth were A, increased bundled penetration where you improve the product direct cost as product mix shifts to higher margin HSI and phone. B, as Mike referred to phone cost of goods. C, the increased productivity in the network and call centers, and D, bad debt improving. Mike, you want to speak about how we think about that going forward?
Yes, I think that the areas that we have direct control over, Tuna, specifically in the areas of labor and phone call. Phone calls as I just touched with the last question. On the labor side we’ve made investments over the last several years to get a platform in place that allows us to do a couple of things with the primary focus on serving the customer with a higher amount of quality.
There’s also efficiency benefits gained in that structure and we’re seeing that as Neil mentioned not only across our call centers, but also across our technical workforce. So we’re getting greater efficiency across each of our labor pools. It’s also I think you understand this in Q3 there’s a seasonality benefit associated with margin and we certainly see that in this quarter.
Tuna Amobi – Standard and Poors
Yes I understand that and Mike talking about labor, how do you then think about your headcount over the next year? Are you now at a level where you want to be or do you think the trends might make you cut down a bit more on where you’re at now?
We’re in the process of finalizing our ’09 plan, so it’s a little premature to be talking about what the future would look like from a labor standpoint, but we feel like again we’ve got the infrastructure in place. Frankly we’ve got a structure in place that allows us to pull the lever almost in a real time fashion because of the partnerships we have with third party providers. So we have a mix of in-house workforce as well as third party partnerships and that allows labor to be variable, almost in a real time fashion.
Tuna Amobi – Standard and Poors
One last question on wireless, Neil as you look at some of your peers going in different directions, whether it’s WiMAX or Wi-Fi, LTE stuff like that, I know you said that wireless may be more like next year proposition for you. So I mean the recent developments in that area, particularly with the announcement of Cox going on their own. How do you then think that all of this could help to shape your wireless strategy looking at it in next year?
I think with our wireless strategy we’re in a wait-and-see mode, we’ll see how things evolve over time with our various peers and their partners. We don’t mind being in a quick follower mode in that regard and we think there is opportunity in that market. We’re not sure whether the opportunity is revenue based, retention based, or some other benefit from a business perspective.
We have reason to believe that were there traction in any of these various avenues we would be able to participate. So we’ll see how it evolves and look at it as the product and the business model evolves.
Your next question comes from Rich Greenfield – Pali Capital
Rich Greenfield – Pali Capital
Couple of questions, one the last time you reported your press release has focused on a comment about liquidity in 2010 and the GAAP that relates to your maturity in that year. I’m just wondering given the lack of that comment in this quarter especially is whether that has changed given what you’ve done on the balance sheet side, and if you could just update us there broadly that would be great.
Then two, just on video ARPU up 7% that’s the strongest you’ve seen in a while and I’m just wondering given the overall economy how do we think about the rate increases you pushed through in the overall increase in the mix of video subscribers. How should we think about video’s ARPU growth going forward?
I’ll cover the front end of that and then turn it over to Mike for the ARPU section. I think we’re all facing challenging credit market conditions and we continue to focus on the opportunities to gain efficiencies in our operating platform and grow the overall business so that we can help maximize the balance sheet opportunities.
We have as we reported $1.35 billion in liquidity ads of September 30 and the next major maturity is $1.9 billion of CCH2 bonds in September 2010. However we have to maintain the ability to move funds within the structure to pay the interim maturities. I think we’re really focused on operational execution and we'll continue to evaluate the options to improve liquidity and reduce leverage. We’ve shown that as those opportunities arrive we are able to respond in a timely manner and we'll continue to be opportunistic and see how things evolve. Mike, the ARPU question.
Yes, Rich, the ARPU is primarily being driven by our advanced service [inaudible] list. As we’ve mentioned we’re up on HD by 50%, the On Demand category usage is up 57% year-over-year, DVR is up 33% a lot of this is based on self selection from our existing customers.
Earlier in the year we took a strategic approach to upgrade our digital base and as you see we’ve been adding a significant number of digital households. It’s all about getting the platform into the household so we can then up sell downstream without any additional labor costs associated with that so we're avoiding the [inaudible] and what we’re finding is as the consumer gets the product and that platform in the household, they’re starting to take advantage of all the additional services that come with it.
Rich, I’ll have Eloise add a section, please be patient she’s been a little under the weather and losing her voice here.
The liquidity statement is still in the queue and in the queue we do say that we’ve got adequate liquidity through 2009, but not in 2010 primarily as a result of the $9 billion of CCH2 bonds maturing in 2010, as Neil said. As it relates to debt service the use of that liquidity is subject to our ability to make distributions within the corporate structure which is why it continues to be an expanded disclosure in the queue.
The only thing I’d add on the video ARPU looking-forward, I think having been in this business for a number of years and having gone through a couple of recessions. The one thing that remains to be seen, we talk about those things that we can control. We think we have the right strategies in place with the digital platform.
We think we have the right approach that we’ve used over the last several years in how we take on our rate adjustments. Allowing the customer to buy into other products and services and potentially putting money back into their pocket from an overall spend standpoint in the household and that served us well.
What remains to be seen is as we go through the Q4 rate adjustments do we see the same type of take rates into those products and services or are we going to see some type of adjustments within those products.
Rich Greenfield – Pali Capital
You haven't seen any notable change in terms of people signing up without an HBO or signing up without a DVR or evening existing subs dramatically downscaling from HBO to nothing or from HBO and Showtime to one or something to that affect?
No, we haven't seen that to this point but again I'm looking at the Q4 rate adjustments and thinking is that the point where we're going to see some of that type of change because that's what I've seen in the past during recession. During the rate adjustment period there's a triggering point where the customer starts thinking about right sizing their bill.
We still think we have a good value proposition because we provide the opportunity for them to look at their total spend against voice video and data in the household and with the triple play we think we have a pretty good position. Again, I'm cautiously optimistic about the quarter but we're going into a period that we don't necessarily have control over.
Your next question comes from Bryan Goldberg – JP Morgan
Bryan Goldberg – JP Morgan
Could you tell us what marketing was as a percentage of revenues this quarter and on the basic subscriber loss side how would you characterize who these customers are? Are these low end customers? Are these triple play customers that are leaving?
Then, if you could just update us on your plans for DOCSIS 3.0 and how you might implement that across your footprint over the next several quarters or years we'd appreciate it.
Marketing spend was about 4.8% of revenue up from 4% through the first six months of 2008. RGU net ads increased more than 50% compared to a year ago. Concerning the basic loss it was a mix of low end and bundles. Concerning DOCSIS 3.0 we plan to roll it out over the next few months. Mike, anything you'd add?
Yes, Bryan what we saw on the video side on the basic the first two quarters we saw the majority if not all of our losses coming from what we call our broadcast basic service or limited basic. In this quarter we didn't see that same type of play and we think frankly the first couple of quarters were tied to our rate adjustments because we great adjustments on that product line in this year and we haven't had that historically.
So, we think people were looking at that and frankly we lost low end customers. We also had some changes in our credit scoring policy and that affected that customer segment as well. In this quarter we saw video only households the losses are coming from video only, but there was a mix between basic and expanded analog.
Our final question comes from David Hamburger – Citigroup.
David Hamburger – Citigroup
The cash burn has improved over the last couple of quarters in a year-over-year basis and it's improved somewhat meaningfully and you mentioned obviously CapEx has declined in the percentage of revenue. It looks to me like last year it was under 21% and you're down to under 19%.
I'm wondering where you think you can take that as a percentage of revenues and then together with that I'm wondering given that 75% of CapEx is success based, I'm wondering if you could talk a little bit about the interplay even in a slowing economy if [inaudible] to some degree what's the interplay between the potential loss of revenue relative to the lower CapEx for cash burn?
As you noted our CapEx remains at about three-quarters success based and I think as I mentioned we'll be coming in at about $1.2 billion which is the lower percent of revenue as you noted. I think the capital structure requires us to be very disciplined in allocating our capital dollars and the investments we've made in network and service we're confident we have the tools in place to execute on the various growth initiatives and grow the results.
Clearly as the economy softens moves have slowed down, which is one factor primarily in the capitalized labor and line extensions have come down within the overall CapEx spend, so I think that's the way to think of it overall.
As Mike mentioned we’re in the '09 planning so we haven't really finalized our number. I think the other thing that Mike referred to was the variable aspect of our spend, and that would include the capitalized labor as volumes or growth were to soften because we're variablized and we have partnerships that number would adjust accordingly. Mike, anything you'd add?
Well, the variability I think does apply to probably on the CapEx a good example is CPE, so you have the same type of variability in your labor pool as well as your success based capital.
I'd like to thank everyone for joining us today and look forward to speaking with you again in the follow Q4 results.
That does conclude today's Charter Communications third quarter earnings conference call.
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