Cable One Incorporated (NYSE:CABO)
Q2 2016 Earnings Conference Call
August 4, 2016 11:00 ET
Tom Might - CEO
Kevin Coyle - SVP & CFO
Craig Moffett - MoffettNathanson
Phil Cusick - JP Morgan
Stephan Bisson - Wells Fargo
Good morning and welcome to the Cable ONE CABO Earnings Report for the Second Quarter of 2016. All participants will be in a listen-only mode. [Operator Instructions] Please note this event is being recorded.
I would now like to turn the conference over to Kevin Coyle, Chief Financial Officer. Please go ahead, sir.
Thank you, Gary. Good morning and welcome to Cable ONE's second quarter 2016 earnings call. We're excited to have you with us this morning as we review our results. Before we proceed, I would like to remind you that today's discussion may contain forward-looking statements relating to future events and expectations. You can find factors that could cause Cable ONE's actual results to differ materially from these projections listed in today's press release and in our recent SEC filings.
Cable ONE is under no obligation, and in fact expressly disclaims any obligation to update its forward-looking statements whether as a result of new information, future events, or otherwise. Additionally, today's remarks will include a discussion of certain financial measures that are not presented in conformity with U.S. Generally Accepted Accounting Principles. Reconciliations of non-GAAP financial measures discussed on this call to the most directly comparable GAAP measures can be found in our earnings release or on our website at ir.cableone.net. Joining me today on today's call is our Chairman and CEO, Tom Might.
And with that, let me turn the call over to Tom.
Thank you, Kevin. Welcome to those of you joining us this morning, we have plenty of good news to share on our first anniversary earnings call as an independent company. And our first year adjusted EBITDA was up $36 million or 12%. Last quarter our adjusted EBITDA margin was up over 500 basis points with healthy 43.5%. All this even though video subscribers are down 15% in the last twelve months. If I think about that for a minute, adjusted EBITDA of 12% while video subs are down 15%, well how can that be? And now you know my answer. There is very little cash flow and little or no free cash flow left in the linear video business model for most small operators.
Meanwhile, we have two products of good growth and good margins that deserve to get our focused attention. They are residential internet service or HSD, and business services. After articulating this theory for four years, it is gratifying, finally has strong periodical evidence, so we can move out of the theoretical phase.
Our primary task over the last four years has been to make this transition intelligently and profitably, and sooner rather than later. When we started thinking about this five years ago, it seemed like a tall order because HSD and business service revenues were only 30% of total revenues. The last quarter they were the majority of total revenue at 54%, and they contributed the vast majority of our total cash flow. We expect these trajectories to continue into the future.
Most analysts believe that cable has a huge fixed cost business thought we operate as virtually all costs are variable. While the product mix change away from video and phone and therefore the triple play has caused several hundred thousand PSUs, we have been able to reduce expenses embedded in flow rate to thoughtful and disciplined cost management and operation strategy, all the while maintaining excellent customer service. As examples, bad debt has been reduced from around 1.4% to below 0.34% of total revenues our headcount is down by 154 versus last year, a 7.4% reduction; they are down over 400 from our peak employment several years ago. As a result, we make meaningfully more money with fewer units and equally important, we are shaking our dependence on video.
With our focus of business services, we have grown that revenue steadily at about $11 million to $12 million per year, year-after-year. We now have a hugely successful SMB business and enterprise of fiber business. We have concentrated in 2015 and two 2016 of putting the enterprise products and team in place, so we can you sustain and try to exceed our historical business services revenue growth rate in years to come.
When I focus on HSD, we doubled our standard fee to 100 megawatts for companywide and we announced the 2016 rollout of a one Gig high-end service, almost companywide, and we are 50% deploying that. At this point we're down one Gig service. We also announced a 10% rate increase on HSD last October, our first in five years which equates to less than a 3% annum increase. We will not take an HSD rate increase in 2016. However, we did implement a $5 dollar broadcast TV surcharge on video customers in June to recover a portion of the rapidly escalating growth in retransmission fees.
Our last video rate increase was 17 months earlier. I mentioned these rate increases remind you of their non-annual timing to help you estimate -- help when you are estimating our year-over-year quarterly growth rates that will vary.
We continue to repurchase our shares opportunistically. In our first full year, we repurchased 2.5% of our outstanding shares at an average price of about $431. That matures capital to just an addition to our $6 annual per share dividend which we pull as a payout ratio of about 1.1% than our current stock price. With our strong free cash flow however, we still have a very low inclining debt ratio, even with this capital return.
As I've stated on -- in past earning calls, we will energetically but patiently to explore M&A opportunities and our organic growth opportunities that we believe would benefit our business and our stockholders. Like past earning calls, we will not elaborate or speculate on that topic today.
Now I'm going to turn it back over to Kevin for more details on our numbers. Kevin?
Thanks, Tom. As Tom already mentioned, we are very pleased with the results we have achieved during our first year as a public company, including our strong performance in the second quarter of 2016.
Before I discuss the financial results, I wanted to point out some information regarding our operating statistics. As we mentioned before, we converted to a new billing system last year. This caused some distortions in both, our homes past and some business service PSUs. More detail regarding the reasons for these fluctuations are included in both, our press release and in our 10-Q.
Now turning to our financial results. First, let me share a few highlights from the quarter. Adjusted EBITDA grew by 14.6% with a margin of 43.5%. Free cash flow increased over 28%, residential data revenues increased 18.7%, business service revenues increased 12%, and now residential data and business service revenues now comprise 54.1% of our total revenues.
Now getting into the detailed results, starting with revenues. Total revenues increased $1.9 million or almost 1% due primarily to increases in residential data and business service revenues of $13.6 million and $2.6 million respectively. This was partially offset by decreases in residential video and voice revenues of $12.2 million $1.4 million respectively. The declines in residential video and voice revenues were primarily attributable to residential video customer losses of 15.6% and residential voice customer losses of 13.9%.
Residential HSD and business services now comprise, as I mentioned, 54% of our revenues and gains in these growth products are more than offsetting the revenue losses of our video on phone products. Residential data service revenues increased $13.6 million or 18.7%, due primarily to rate increase taken in the fourth quarter of 2015, an increase in residential data customers of 1.8%, a reduction in package discounting, and increased subscriptions to premium tiers by residential customers. Residential data services now comprise over 42% of our total revenues compared to just under 36% in 2015.
Residential video service revenues declined $12.2 million or 14.2% due primarily to residential video customer losses, partially offset by the impact of a broadcast T.V. surcharge that Tom mentioned earlier. Residential voice service revenues declined $1.4 million or 11.5% due primarily to a decline in residential voice customers of 13.9%. Business service revenues increased $2.6 million or 12% due to primarily to the growth in our business data and voice services to both small and medium size businesses and enterprise customers.
Total business customer relationships increased 10.9% for the twelve months ended June 30, 2016. Overall, business services now comprise 12% of our total revenues for the second quarter of 2016 compared to 10.8% of our total revenues for the second quarter of 2015. Advertising sales revenues declined $0.7 million or 9.6%.
Turning now to our operating costs and expenses. Our continued focus on efficiently managing our business is evidenced by our reduced operating cost. Total operating costs and expenses declined $12.9 million or 7.7% due primarily to decreases in programming costs and certain selling general and administrative expenses. In total our programming costs declined $3 million. Non programming operating expenses decreases $0.3 million.
Selling, general and administrative expenses declined $8.9 million or 17%. This was primarily due to a poor $0.3 million dollar decrease in processing costs for customer billing following the completion of our billing system conversion last year. A reduction of salary, wages and benefit costs of two and a half million as we reduced our headcount by 7.4%, lower equity based compensation of $0.6 million and a reduction of property taxes and pull rental expense of $0.5 million.
For other expense, other expenses increased $6.4 million due primarily to interest expense of $7.5 million for the second quarter of 2016. Adjusted EBITDA of $88.9 million increased by 14.6% due primarily to decreased operating costs and expenses and higher revenues from the gains in residential HSD and business services customers along with the HSD rate increase taken in the fourth quarter of 2015.
On free cash flow. Free cash flow which we define as adjusted EBITDA less capital expenditures increased $11.3 million or 28.1%. For the quarter our conversion rate defined as adjusted EBITDA less CapEx as a percentage of adjusted EBITDA was approximately 58%. This was due to the 14.6% increase in adjusted EBITDA during the quarter.
Capital expenditures totaled $37.6 million in the second quarters of both 2016 and 2015. This represents an 18.4% of revenue for the second quarter of 2016. However, year-to-date capital expenditures were approximately 15.9% of revenues. We continue to believe that capital expenditures as a percentage of revenue will be in the mid-teens through the full year 2016.
Turning to liquidity, during the first half of 2016 our cash and cash equivalents decreased by $16.5 million versus the year ended December 31, and at June 30, 2016, we had approximately $102.7 million of cash on hand compared to $119 million point at December 31, 2015. The decrease in cash during the first half of 2016 was attributable primarily to cash payments for capital equipment, share repurchases, dividends and interest.
As Tom mentioned, we repurchased 25,933 shares during the quarter and an aggregate cost of $11.9 million and have repurchased a total of 145,903 shares through June 30. So since then through the end of the second quarter, that is the total repurchase which represents 2.5% of our shares.
In conclusion, our solid financial performance has continued through our second quarter propelled by the continued growth of both residential data and business services.
And with that, operator, we are now ready for questions.
We will now begin the question and answer session. [Operator Instructions] The first question comes from Craig Moffett with MoffettNathanson. Please go ahead.
Thank you. First of all, congratulations to you, Tom, and to all of you for your one-year anniversary of a public company. It's been a very good first year so all to that. I wanted to just ask about the upcoming anniversary of the five-year rate increase when you hit October. Can you help us think through what that looks like? You have a very graphic growth rate in ARPU that will obviously slow down without the price increase going forward, but it looks like some of the subscriber losses at least on a sequential basis have started to moderate somewhat. Can you just look at -- I'm not asking for long-term guidance, but could you just look out a couple of months and talk about what you think October or November start to look like as you anniversary the price increase?
10% price increase on HSD last October -- if I remember correctly, and Kevin might be able to confirm I think that it was effective for half of October. And then put the full month after that for estimating purposes. And you can see our R2 is growing meaningfully higher than that because we're having a number of people take premium tiers. So on a simplistic basis, we should probably deduct that ten percent price increase when we hit the annualization date of that in the ARPU growth, it would be less -- would be presumably something like the remainder trend line. I think we were 16.4%; that is what we reported in total for the past three months, so you might make that mathematical deduction for the HSD.
And then how does that flow through, I guess Kevin for the financials of the business. As you kind of project out to, to the intersection of volumes and prices that you see in the back part of the year?
Well go ahead Tom. As Tom mentioned we're not planning on taking any rate increase through the end of this year. Obviously we're very bullish on where customer growth will be for HSD. We just launched 100MEG product in the fourth quarter of last year. We are launching a GIG product in the large majority of our systems this year. So we're bullish on where customer growth will go over the remainder of this year. We obviously don't know yet, but we're not planning on taking a rate increase this year.
Yes. That's helpful, thank you.
The next question comes from Phil Cusick with JP Morgan. Please go ahead.
Hey guys, thanks. I wondered first if you could talk about what July sub trends look like given the June price increase.
No we'd rather not, too much of this information. We have not done it in past and we're not prepared to start doing that. I mean not to send a negative message but this is something we've not done in the past and we're going to start at this point. Thanks.
Understood and in terms of the HSD rate increase uptake, are we down sort of fully baked with the revenue per user that we saw in the second quarter? Aside from you know people upgrading?
Yes. I think that's true.
Okay. And then as you said a year in now any change in how the board is thinking about leverage and capital return if not more buyback why not take up the dividends?
We are looking at all options. We have played out during the spend process that involves the various things we can do with the debt capacity or being patient methodical or from M&A organic building dividends and buybacks and such so far other than a M&A it's been a blended approach and we'll continue to be.
Maybe pushing my luck a little bit here but also in terms of love using capital, do you feel like there's a pipeline of potential acquisitions out there? Are you evaluating a number of things or is there sort of a dearth of options that you think are attractive?
We've been through today after the spin Kevin & I turned a significant part of our time to M&A marketplace and we have been spending a lot of time in that space for a year now but would be very patient in this article if we're spending that much time there must be something to look at but I am not going to go beyond that.
Understood. Thanks Tom.
[Operator Instructions] The next question comes from Stephan Bisson with Wells Fargo. Please go ahead.
Good morning. Congrats on the one year anniversary and great quarter guys. I had a simple question kind of just longer term. Clearly we're out of the experimental phase in terms of keeping the margins expanding and based on the revenue shaft, where you think they could ultimately go because you're kind of already in new territory as far as cable operators go?
Great question Stephan. I don't want to give a specific number but it's a concept for those of us not followed our -- picking for the last year or more is obviously when the product mix changes towards products that have higher margins, the overall company margins will move towards the margins of those who are profitable products and with 54% of our revenue now in HSD and business services, the margins are now starting to reflect those margins more than the video and phone margins. But everybody has different models about what the real possibility is each of the products and therefore each person want to do their own math based on their assumptions about fixed costs and variable costs.
Got it. Have you noticed like any, has there been an asymptote at some point, any type of slowing in the rate of expense decline?
The letter make any predictions, you've got several years of quarterly data of our expenses and you know the video subscriber change and obviously there is a lot of expenses loaded in the video. So you can do that math on your own to see what the trend line has been. The only caution I would give us last year we had a lot of higher expenses and CapEx to a lot of projects like own digital going on and moving to 100 GIG and now the launching of one GIG. But there was temporarily an extra expense in CapEx which we talked about in press quarters. A lot of that is behind us for right now so but other than that you can look at the long term trends and draw your own conclusions.
Great, thank you.
This concludes the question and answer session. I would like to turn the conference back over to Tom Might for any closing remarks.
Thank you operator. I think that during our first year as an independent public company it is the result of the efforts of our tireless and dedicated associates that I had the pleasure to work with for almost 24 years now so I'd like to thank each of you, every one of you for helping make Cable ONE what it is today. We appreciate all of you on the phone for joining today's call and we look forwards to speaking with you again next quarter. Thank you very much.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.
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