Insight Communications Q3 2007 Earnings Call Transcript

Nov. 6.07 | About: Insight Enterprises, (NSIT)

Insight Communications (NASDAQ:NSIT)

Q3 2007 Earnings Call

November 6, 2007 1:00 pm ET

Executives

John Abbott - CFO

Michael Willner - Vice Chairman, President, CEO

Dinni Jain – EVP, COO

Analysts

Anton Anikst - Morgan Stanley

Adam Spielman - PPM America

Robert Berzins - Post Advisory Group

Operator

Welcome to the third quarter 2007 Insight Communicationsearnings conference call. (Operator Instructions) I would now like to turn yourpresentation over to your host for today's call, Mr. John Abbott, ChiefFinancial Officer.

John Abbott

Good morning and welcome to Insight's 2007 third quarterearnings call. Before we begin, I would like to refer everyone on the call tothe forward-looking statements disclaimer in our press release and Form 8-K,both of which are available on our website.

Today's call may contain forward-looking statements that aresubject to risks and uncertainties as outlined in our Form 10-K and otherfilings with the SEC. Any of the forward-looking statements on this call arequalified by reference to those cautionary statements.

Also, please refer to our press release and 8-K for areconciliation of non-GAAP financial measures which will be discussed on thiscall.

Additionally, there's a short slide presentation on ourresults that's available on our website, InsightCom.com, that you might want tofollow during our remarks. Now I would like to turn our call over to our CEO MichaelWillner.

Michael Willner

Thank you, John andthank you all for joining us today for our third quarter 2007 conference call.The third quarter was a terrific quarter for us. It was the best operationalquarter we've ever had. We had record RGU net additions which drove continuedstrong financial performance. The outstanding number of customer additions forthe last few quarters have further added to stability of our growth platformand continue to support the basis for accelerated future financial growth.

The third quarter was a record quarter for RGU net additionswith 139,100 for the quarter. That was a 15% increase in RGUs over the thirdquarter of 2006, including our best Q3 basic growth and phone growth for anyquarter in our history.

The third quarter revenue growth was 14% over '06. Ouradjusted OIBDA growth was 15%. Our free cash flow was $13.6 million which wasan increase over the third quarter of 2006 which was actually a negativenumber, driven largely by the 15% increase in adjusted OIBDA along with positivechanges in working capital.

As you all know, we are coming towards the conclusion of atransaction that will split the company in half with our 50% partner Comcast.That transition is moving towards what we expect to be a timely close at theend of the year. It had been subject to a number of government approvals,regulatory approvals and all of that is moving along as expected.

The third quarter was a strong quarter for RGU net adds. I'm going to break this down now for the firsttime, frankly, because we're so close to the split date of December 31st, we'regoing to begin to discuss with our bondholders the Insight Systems Groupnumbers on an operating basis, so that you can start to get a feel for thecredit that you'll be holding after the split.

So the third quarter RGU net adds for the Insight SystemsGroup or ISG as we refer to it was 73,900 net adds, resulting in a 15.7% growthrate over the third quarter of '06. The ISG saw basic customer growth of 4.9%over the third quarter of '06 and as has been disclosed previously, we continueto evaluate strategic alternatives for Insight after the split up.

While we encourage questions at the end of this call, pleasenote that we will not be addressing this particular issue in any furtherdetail.

After reporting the second quarter results three months ago,we were extremely excited yet again about our recent performance. Our Q3results continue to support the belief that we are growing the business in acompletely sustainable manner and believe that we are well-positioned forcontinued strong growth and cash flow growth well into the future.

On that note, a high level review, I would like to turn itover to Dinni and then John for more detailed discussions with you.

Dinni Jain

Thanks, Michael. Ashas become the norm in the last several quarters, I get to follow Michael andvirtually repeat exactly what he just said. However, despite my discomfort inpossibly being boring, there is nothing I would rather speak about right nowthan this past quarter.

As Michael mentioned, we added 139,000 RGUs in the thirdquarter of '07, the highest quarterly net add quarter we've ever had and morethan 50% higher than our RGU gains in Q3 of '06. While, as Michael said, this was in large part driven by our phone netadds, particularly in those markets in which we launched VoIP earlier thisyear, it's important to realize that we have seen real growth in each and everyone of our product lines. In addition, we now have 3 million RGUs as of September 30, 2007, bringing us to2.2 RGUs per basic customer.

If you turn now to slide 9, you can see what I believe isperhaps our greatest achievement in this quarter. As we discussed last quarter-- and frankly every year since I've been at Insight -- Q2 is a seasonally lowquarter for us, due to our broad exposure we have to several universities suchas the University of Kentucky, Indiana, Illinois, Ohio State, Purdue,Louisville, Western Kentucky, Western Illinois, Illinois State, et cetera andevery Q2 we lose at least 14,000 students, many of whom also take digital HSIand increasingly phone services from us.

In Q3, we should therefore have a seasonally up quarter,supported by the return of those 14,000 students. But interestingly, for thelongest time from 2002 to 2004, we did not really see the benefit of thestudent return and in fact, in the first of those two years, we were actuallynegative. In the last couple of years, however, we have started to see thatbenefit and this year in particular, not only did we see the return of thosestudents but we added an additional 7,000 on top of that.

With this gain in basic customers, over the last 12 monthswe have grown basic customers by 3.3%. We ended the quarter with a penetrationrate of 54.6%, which has moved up almost 90 basis points from 12 months ago.Basic ARPU was $41.81 in Q3, up $1.20 from the year prior. This is drivenprimarily by rate increases and partially offset by our bundled promotionalpricing.

Turning to slides 11 and 12, you will see that we gained26,100 digital customers this Q3, which represents our second-best Q3 ever. Weadded 140 incremental basis points of penetration and 540 incremental basispoints of penetration over the last 12 months, ending the quarter with apenetration rate of 53%. Digital ARPU is now $21.16, up $1.23 over last yearand down $0.61 from last quarter.

If we turn now to slides 13 and 14, you will see that weadded 47,900 HSI customers, which ties our record-high net adds, not just of a Q3,but as Michael mentioned, for any quarter. We ended the quarter with apenetration rate of 29.2%, or incremental penetration gains of 170 basis pointsfrom last quarter, 410 basis points from the beginning of the year, and 520basis points over the last 12 months.

We're particularly proud of our growth from an industrytrailing position to among the industry leaders over the last several years inthis product category, a story which I think slide 15 tells very well.

Also this quarter, HSI ARPU was $36.72, which was anincrease of $0.57 compared to last year. This was the first quarter of HSI ARPUgrowth since 3Q05. The impact of our promotional pricing has started to bottomout, allowing ARPU to stabilize on a year-over-year basis.

Turning now to slides 16 and 17, you'll see that we added44,000 telephone customers, our best quarter ever for telephone net adds andfor the first time, achieving our ambition of growing phone adds at a similarrate to our HSI product.

Year to date, we've added 97,800 new telephone customers, or79% to our customer base. We've been very pleased with the VoIP platform wecompleted rolling out in Q1 and that product continues to generate moremeaningful customer financial results for us. Our telephone-enabled footprint,which is over 2 million homes passed now, covers 81% of our total homes passedversus only 41% at this time last year.

In Q1, when we completed the roll-out of our VoIP product,our penetration rate was 7.5%. We ended the third quarter of this year with apenetration rate of 10.9%, which is an incremental penetration gain of 190basis points from last quarter, and 340 basis points for the year. TelephoneARPU was $41.22, an increase of $1.09 from last year.

As you heard Michael mention and you'll see both in ourpress release and the slide presentation accompanying this call, we've begun tobreak out our operating numbers for the half of Insight that we will continueto operate after our partnership split with Comcast is complete on 12/31. Thiscall, therefore, represents the last call we will have as a combined company,since our year end call will not be held until early next year.

I therefore wanted to conclude my remarks with anopportunity to say thank you in a very public forum to the great team atInsight which has made these results that we have posted possible over the lastcouple of years. While I have had many professional experiences in my careerand I'm actually even proud of a couple of them, none of them compare to thegratification of seeing this great team achieve its potential. You all shouldbe very proud.

To those of you that will be going to Comcast at the end ofthe year, I want to say a special thanks for everything you guys have done overthe last four years in making our dream to be a great performing cable companya reality. Your performance this last quarter in particular, despite all thedistractions of transitioning to Comcast, was truly an inspiring thing towitness. Thank you all.

I'll turn it over to John to tell us about our excellentfinancial results.

John Abbott

Thanks, Dinni. Myremarks start on slide 19, if you're following in the slide presentation. Ourrevenue in the third quarter was $362.3 million which represents growth of13.9% over the third quarter of 2006. Our strong revenue growth was primarily aresult of increased RGUs, which have grown 15% over the last four quarters.

Specifically, the key drivers of revenue growth were, first,HSI revenue, which accounted for over 4.5 percentage points of the growth andwas driven by growth in HSI customers and a slight move up in HSI ARPU as Dinnimentioned.

Telephone service revenue, whose contribution is reallystarting to increase since we rolled out our phone product to our previouslyunserved markets late last year and early this year, telephone service revenueadded 3.6 percentage points of growth.

Third, basic video revenue which contributed just under 3percentage points of our growth as a result of rate increases and our strong3.3% basic customer growth since last year.

Digital video revenue, which contributed 2.5 percentagepoints of growth and was driven by very strong digital unit growth andincreased digital ARPU versus a year ago. And lastly, Insight BusinessServices, our commercial video and data business which contributed almost a fullpercentage point to our revenue growth this quarter.

Moving on to expenses, our third quarter operating expensesincreased $25.5 million, or 13.2% over expenses in the third quarter of 2006.These increases exclude $3.5 million of expenses recorded in Q3 2007 related tothe announced split-up of our partnership with Comcast and the company'sexploration of strategic alternatives post-split.

As a result of our continued strong revenue growth andimproved expense comparisons, adjusted operating income before depreciation andamortization or OIBDA for the third quarter 2007 grew 15% over Q3 2006 to$143.6 million. The operating leverage reflected in this continued stronggrowth in adjusted OIBDA clearly demonstrates that the investments in the company'sgrowth and customer service platforms over the last couple of years are bearingfruit.

Moving now to capital expenditures on page 20 of the slides,in the third quarter of 2007 our CapEx was $76.5 million, a $5 million increaseover Q3 2006. This increase was driven primarily by the timing of purchases ofdigital set-top boxes as well as the increased cost of those boxes to complywith the new separable security requirements.

Capitalized installation costs also increased this quarteras a result of the increase in new connects over Q3 last year. These increaseswere partially offset by a reduction in capital expenditures for HSI capacity,which was particularly high in the third quarter last year as we prepared toroll out our enhanced HSI service, Insight Broadband 10.0.

Free cash flow on slide 21 which we define as adjustedOIBDA, less CapEx, cash interest, cash taxes and changes in working capital forthe quarter was positive $13.6 million, as compared to negative $4.2 million inthe third quarter of 2006. The primary drivers of the $17.9 million increase infree cash flow were first, an increase in adjusted OIBDA of $18.7 million;second, a positive change in working capital of $9.1 million this year ascompared to a negative change in Q3 2006 of $6.9 million.

These increases in free cash flow were partially offset byan increase in cash interest of $11.9 million. In November of 2006, werefinanced all of the 10.5% notes and $185 million of the 9.75% notes with ournew credit facility. We make interest payments on the credit facility quarterlyversus the bonds on which we made interest payments semiannually in the secondand fourth quarters. Secondly, the $5 million increase in CapEx I discussedearlier.

Slide 22 shows our capital structure as of September 30, 2007. We repaid $20million on our revolver in the third quarter, and other than the change inaccrued interest in the intercompany loan, all other debt instruments remainedunchanged from Q2.

As shown on slide 23, as of September 30, our consolidateddebt totaled $2.771 billion. Leverage at Insight Midwest Holdings, the issuerof our bank debt, was 4X against a covenant of 6.25X and consolidated net debtto LQA adjusted OIBDA was 4.8X. As of September 30, 2007, we had ampleliquidity with $40 million of cash and $214 million available under ourrevolver.

As can you see on slide 24, our leverage ratios continue todecline nicely as a result of growth in adjusted OIBDA as well as debt paydownfrom free cash flow. At this point, we would like to open up the call toquestions.

Operator, we're ready for the first question.

Question-and-AnswerSession

Operator

Your first question comes from Anton Anikst - MorganStanley.

Anton Anikst - Morgan Stanley

Congrats on bucking the trend in the disappointing RGUtrends for the broader cable industry. A couple questions here. First of all,thank you for giving us some detail on the RGU split between the InsightSystems and the Comcast Systems. I know it's preliminary, but could you atleast take a stab at what the pro forma P&L looks like in terms ofoperating cash flow and CapEx? Anything you could offer would be very helpful.

John Abbott

Anton, we've not released anything on that publicly and so Idon't think it's appropriate to do that on this call. I mean, we are gettingroughly half the customers, half the systems, so if you wanted to use veryrough numbers, you just cut everything in half, right?

I thinkour share of the debt, which is roughly half, we disclosed in the press releaseon the split when that was initially announced in the April 1st timeframe.

Anton Anikst - Morgan Stanley

It looks like theactivations on the Insight Systems side were a little bit higher than they wereon the Comcast side, so is it reasonable to assume that perhaps the near termprofitability is slightly more depressed on the Insight side of the house thanthe Comcast side of the house?

John Abbott

I don't really wantto comment any more. What I said is about as broad a stroke as I want to takeit, dividing up the cash flow and revenue. Those numbers will be availablecertainly to bank lenders that we have to provide that information to at somepoint before the close and we'll certainly do that at that point.

Anton Anikst - Morgan Stanley

.3% annualized basic sub growth is obviously veryimpressive. I was hoping you guys could give us some color on where thoseincremental subs are coming from? Your basic penetration improved 90 basispoints year over year. Are you taking subs from satellite? Is there a generalpopulation growth in your markets? Where do you think those incremental subsare coming from?

Dinni Jain

We have housing growth of somewhere in between 1.5% to 2%usually every year. So that certainly wouldn't explain the bulk of it. Ingeneral, I think that we focus on executing better, both in terms of ourcustomer service that we're providing and in our sales and marketing and thereare a lot of people in our markets, just during normal moving periods, that wetry to get at before they can go to a competitor. So that may show up assomebody coming to us but not necessarily going away from a competitor, if youknow what I mean.

So I can't tell you definitively what I think thepenetration rates, the market share is for the satellite companies in ourmarket and whether we are winning versus them but you know, at the end of theday, the customers are coming from some place.

John Abbott

Suffice it to say,the true measure of how successful you are in a competitive environment is tosee your penetration rates go up and that's what we're experiencing.

Anton Anikst - Morgan Stanley

My last question, which I'll phrase as a clarification and hopefullyit doesn't ban me from future calls with you guys, but Dinni's comments seem tosuggest this may be your last public call. I wonder if the implication there isyou're about to refi your bonds with bank debt and therefore no longer hostpublic calls? Or if there's another strategic development that you're at thispoint not in a position to discuss.

Dinni Jain

I didn't mean tosuggest this was our last public call. This is just our last public call withboth sides of the company under our management.

Anton Anikst - Morgan Stanley

Understood.

Dinni Jain

Come 12/31 when the other half of the company goes over toComcast, that's really what I was referring to.

Operator

Your next question comes from Adam Spielman - PPM America.

Adam Spielman - PPM America

Could you just comment a little bit or try to give a littlemore color on the competitive landscape? We heard from so many people in theindustry about it was not the Bell fiber roll-out, it was more just the kind ofbasic DBS alliances, particularly we heard that AT&T and Dish had somethinggoing with a year of free video. What are you seeing out there in terms of thetraditional DBS/RBOC alliances and why do you think you're able to do so well?

John Abbott

Well look, the firstthing I would say is that at Insight, we have seen such tough competition overthe last couple of years. We compete against the [overbuilder], WOW, who's justa tremendously formidable competitor. We compete with Cincinnati Bell innorthern Kentucky. We competewith Windstream in Lexington, Kentucky,and we compete with AT&T almost everywhere else.

So yes, we have seen what everybody else has seen, which isa step up in competitive ferocity and the fact of the matter is that's nevergoing to change. Part of the competitive game is that they're going to keepadjusting to our tactics and vice versa. I think what you do to stay on top of that isthat you stay on top of it. It's a lot about executing well and anticipatingwhat you think they're going to do. Ithink that we have been doing that quite well over the last couple of years.

But every year we see the competitive landscape gettingtougher. Every single year.

Adam Spielman - PPM America

A second question is just without going into great detail,just conceptually on how the EBITDA will look pro forma split? I understandobviously it's 50% of the assets but just so I understand this, you've got todeduct effectively there will be some dissynergies for program and then you'vegot to put some overhead on the company; is that right?

John Abbott

We certainly don'thave to add any more overhead to the company. It's just that the overhead wehave will be spread over a smaller base, right? So it's certainly from a marginstandpoint, that's dilutive. And as you said, we have programming dissynergiesif you will. We'll no longer be an affiliate of Comcast. Currently we buy 60%of our programming through Comcast. We'll lose that benefit after the split.

Operator

Your next question comes from Robert Berzins - Post AdvisoryGroup.

Robert Berzins - Post Advisory Group

Good quarter, guys. With respect to the success that you hadin adding subs, without getting too specific but just giving me a sense as towhat happened, do you essentially attribute that to churn improvement or was itan improvement in gross adds that were added during the quarter?

John Abbott

Yes. And I don't meanto be flippant. This is blocking and tackling. There is nothing sexy about whatwe're doing. It's just execution.

Robert Berzins - Post Advisory Group

Should I interpretthat as both churn improvement and gross adds improvement as well.

Dinni Jain

Yes, absolutely.

Robert Berzins - Post Advisory Group

Second and lastquestion, with respect to 12.25% bonds, have you thought of possiblyrefinancing those before you took any kind of strategic steps or have youdecided to leave those in place for the time being?

John Abbott

I am not going to comment I think on what we would do orwouldn't do with the 12.25% bonds at this point.

Operator

There are no furtherquestions. I would like to turn the call back over to Mr. Michael Willner.

Michael Willner

Thank you, operator and thank you everybody for joining ustoday. We really had a terrific quarter. I echo Dinni's comments as well thatnone of this could be possible without the terrific people that we have workingfor this company out in the field and here in the home office. I also want totell them that I thank them very, very much. We all do.

So on that note, have a good afternoon and we'll see younext time around.

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