Charter Communications, Inc. Q1 2008 Earnings Call Transcript

Charter Communications, Inc. (CHTR)

Q1 2008 Earnings Call Transcript

March 12, 2008 9:00 am ET

Executives

Mary Jo Moehle – Investor Relations

Neil Smit – President, Chief Executive Officer

Eloise Schmitz – Interim Chief Financial Officer

Mike Lovett –Chief Operating Officer

Analysts

Michael Pace – JPMorgan

Jason Bazinet – Citigroup

David Joyce – Miller Tabak & Co.

Richard Greenfield – Pali Capital

James Ratcliffe – Lehman Brothers

David Goldberg – Morgan Stanley

Jason Kim – Goldman Sachs

David Hamburger – Citigroup

Peter [Palad] – Imperial Capital

Robert [Berzon] – Post Advisory

Anton [Anakis] – Morgan Stanley

Presentation

Operator

Welcome to the Charter Communications’ first quarter 2008 earnings conference call. (Operator instructions) I will now turn the call over to Mary Jo Moehle.

Mary Jo Moehle

Welcome to Charter Communications’ first quarter 2008 conference call. The results we’re reporting this morning are included in the news release we issued over business wire at 8:00 a.m. Eastern Time and are posted to our website, Charter.com. We also posted a presentation there covering our first 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 Charter’s form 10-K and our quarterly report on form 10-Q which was filed with the SEC earlier today.

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 results in accordance with GAAP as well as pro forma results for the first quarter of 2007.

The pro forma results reflect sales and acquisitions of certain assets 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 Charter’s President and CEO, Neil Smit.

Neil Smit

Throughout 2007, Charter delivered consistent performance as a result of disciplined focus on the right strategies. And today we’re announcing another quarter of strong results. For the first quarter of 2008 we once again achieved double-digit revenue and adjusted EBITDA growth, 7% year-over-year RGU growth and more than a 13% increase in total ARPU which now exceeds $100 per customer.

Nearly 50% of our customers are in a bundle compared to 43% a year ago. And during the first quarter we achieved the highest video RGU net additions and the highest increase in video ARPU since 2003.

We’re focused on increasing bundled penetration. Telephone continues to be the driver, with nearly 80% of our new residential telephone customers taking the triple play. We grew non-video customers 14% year-over-year and see opportunities to gain access to un-served households through telephone and high-speed internet offers.

We continued to improve our customer’s experiences by enhancing the value of our services. Our video product is more robust than ever and we will continue to aggressively expand our HD and on-demand offerings which now include nearly 200 HD viewing choices through bandwidth expansion initiatives such as switch-digital.

We continued to see increased demand for advanced video services. In fact, customers with HD or DVR service increased 50% year-over-year. We also continued to expand the advanced capabilities of our high-speed internet offering. We’re launching service with speeds up to 16 meg in all of our key market areas now and we will begin testing DOCSIS 3.0 later this year.

Speed upgrades and wireless home networking continue to provide value to our customers and revenue growth opportunities. Telephone momentum continues. First quarter telephone revenues nearly doubled year-over-year and we served 1.1 million phone customers, about twice as many as a year ago.

The pull-through effect of phone is evident in video and high-speed performance with markets that have reached double-digit phone penetration demonstrating improved performance in both categories, reinforcing the power of the bundle.

Deeper telephone penetration also benefits operating margin, as evidenced by continued margin expansion in our double-digit phone markets. First quarter margin improved 50 basis points year-over-year in these markets. The introduction of commercial telephone services provides additional growth opportunity for Charter’s commercial business and through interconnect agreements with other operators; we’re able to increase the market for our commercial products.

We’re committed to providing a superior end-to-end experience for our customers. Our focus and investments we’ve made are resulting in improvements in the service levels of our care centers, increased efficiency of our technical operations and improved reliability and versatility in our network.

We have reason to believe these improvements are making a different to our customers. We remain disciplined in our capital spending and we expect to continue to prioritize investments in the products with the highest projected returns to enhance our services and maintain our competitive advantages.

During the first quarter we completed a $1 billion financing transaction and we expect that cash on hand to cash flows from operating activities and the amounts available under our credit facilities will be adequate to meet our projected cash needs through 2009. The business has demonstrated consistent results and we will continue to invest in RGU growth and improvements in the customer experience.

Now I’ll turn the call over to Eloise Schmitz for a discussion of our financial results in greater detail.

Eloise Schmitz

For the first quarter of 2008, total revenue was $1 billion $564 million, an increase of 10.5% over the first quarter f 2007. We added 302,000 RGUs in the first quarter, achieved a 13.4% year-over-year increase in total ARPU as we drove deeper penetration of bundle offerings, and advanced services.

Telephone continues to be our largest revenue growth driver. We nearly doubled revenues year-over-year to $121 million this quarter as we continued to increase telephone and bundled penetration. High-speed internet revenues increased 11.9% to $328 million primarily as a result of an increase in the number of customers and enhanced services such as increased speed and home networking.

Video revenues in the first quarter rose by 3.2% to $858 million. This is due to an increase in digital customers and advanced services growth, up selling to premium tiers and rate adjustments. As a result, video ARPU grew 6.2%. For the first quarter, our commercial business revenues climbed 14.8% to $93 million, driven by the introduction of commercial telephone product and the business bundle.

Ad sales revenues for the first quarter increased by $6 million or about 10% year-over-year as an increase in political advertising offset decreases in the automotive and furniture sectors. Adjusted EBITDA grew $52 million or 10.5% year-over-year to $545 million.

Adjusted EBITDA margins were unchanged year-over-year at 34.8%. We’re seeing the benefits of the bundle through growth in the higher margin internet and telephone services. We also continue to realize cost efficiencies in telephone as we scale this business.

At the same time, however, we increased our year-over-year marketing spend as a percent of revenues to drive RGU and advanced services growth. The resulting increase in activity levels drove higher operating costs and has yielded an essentially flat margin. We continued to allocate approximately three-quarters of our capital expense dollars to success based initiatives, including CPE related to customer and advanced video services growth.

Total CapEx in the first quarter was $334 million. We expect to spend approximately $1.2 billion in CapEx in 2008. As of March 31, 2008, liquidity, including revolver availability, cash and investments totaled approximately $1.9 billion, none of which was limited by covenant restrictions.

I’ll now turn the call over to Mike Lovett for a discussion of our operations.

Mike Lovett

As Neil said our first quarter results reflect continued focus and discipline as well as the hard work and dedication of our employees. RGU net additions were up over 50% sequentially from the fourth quarter, bringing us to 12.1 million RGUs.

The first quarter marked our strongest video RGU and ARPU growth since 2003. During the quarter we gained 103,000 digital customers, and while we lost a net 12,000 basic customers, the loss came from the limited basic category and we grew the expanded basic customer segment.

This growth reflects our focus on targeting the right products to the right customers. Customer awareness and enhanced content on our on-demand platform continue to grow. And in the quarter, two-thirds of our on-demand enabled digital customers used the service, a 20% increase compared to a year ago.

In addition, on-demand orders increased 44% year-over-year, so more customers are using on-demand more often. Our advanced services including on-demand pay-per-view, HD and DVR contributed 65% of total video revenue growth during the first quarter.

We added 86,000 high-speed customers during the first quarter. We now serve 2.8 million high-speed customers, up 10% year-over-year and at 25% penetration, we see continued growth potential in this segment. ARPU was $40 and we aim to continue to drive further revenue growth through faster speed offerings and wireless home networking.

As we’ve mentioned, our plan to widely deploy 16 meg high-speed service should be completed by the end of this year. Home networking is proving to be a valuable enhanced service. We’ve more than quadrupled our home networking customer base and revenues year-over-year.

We reported another solid quarter in telephone business with net adds totaling 126,000. With residential telephone service available to more than 9.5 million homes or about 80% of our footprint, the majority of our efforts are now targeted at driving further penetration.

We expect availability to be approximately 85% of our footprint by yearend. We ended the first quarter with 1.1 million customers or 11% penetration of telephone homes [fast]. We expect further growth reaching 20-25% penetration in the next few years. We already have several markets at or near these levels today.

Telephone continues to be the primary driver of bundled penetration and RGU growth, with triple play penetration doubling year-over-year to 16% of customer relationships. As we’ve said before, we believe there is opportunity to grow customer relationships by targeting or 6.5 million un-served households with a variety of value propositions, some of which may not include video.

This approach delivered a 14% increase in non-video customers year-over-year along with an increase in total customer relationships during the quarter. Charter business delivered solid results with 15% year-over-year revenue growth in the first quarter. Commercial phone is available throughout our residential phone footprint and the percentage of new Charter business customers taking a bundle has increased more than threefold year-over-year.

We’re leveraging our existing residential operating and marketing capabilities and see further growth opportunities in this segment. The bottom line is we believe we are well positioned competitively. The bundle is a powerful tool and we believe we have the people, products and platform to continue to be successful.

With that, I’d like to turn the call over to the operator and open up for questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from Michael Pace – JPMorgan.

Michael Pace – JPMorgan

For Eloise, in our notes we see a onetime benefit in the first of ‘07 on EBITDA, can you just remind us what that was, again I have my notes, it was about 2% of growth in that quarter and further adjusting EBITDA for that, coming up with mid 12% EBITDA growth. Wanted to confirm our math and make sure we’re not double counting.

And then on the digital net adds side, haven’t seen adds growth like that in a while, were there special promotions, was it a rollover from the holiday season for high def TVs and such?

Eloise Schmitz

There was about a $2 million benefit in the first quarter of ‘07, so that is correct. I think your math was right on that.

Neil Smit

Concerning digital RGUs, we did see a good rebound there. I think it was due to targeted marketing strategies where we were looking at increasing advanced services penetrations and up selling really contributed to the success. We think there’s a good opportunity to promote those advanced services once you’ve got a customer into a digital tier.

We’re going to continue to trial and refine the offers that attract different customer segments. We did see overall in video a strong quarter from RGUs at 91,000 and also good ARPU growth in that in the overall product line at 6.4%.

Eloise Schmitz

Sorry Mike, I reversed it, it was about a $5 million benefit, you were right and about a two point benefit, I reversed them, sorry.

Operator

Your next question comes from Jason Bazinet – Citigroup

Jason Bazinet – Citigroup

I think in the commentary you mentioned a 50% increase in HD and DVR net adds on a year-over-year basis, I was just wondering, is that acceleration consistent with your expectations and consistent with the full year CapEx budget that you guys outlined for the year.

Neil Smit

It is consistent with our CapEx budget of $1.2 billion. We did see good HD growth; we’re increasing the on-demand choices. We now have about 200 HD options. We’ve got, on the VOD side, we also saw strong growth at VODR orders were up about 44% compared to the first quarter of last year. So it is consistent with our CapEx budget and we remain optimistic in that overall in the advanced services to video.

Operator

Your next question comes from David Joyce – Miller Tabak & Co.

David Joyce – Miller Tabak & Co.

I just wanted to get your take on whether you’re seeing any over the air customers moving to digital or just to [bate] TV, you did say that you were, most if not all of the losses were at the lifeline basic tier, just wanted to get your color on that and also if you’re seeing anything incremental from the telco competition.

Mike Lovett

From a digital transition standpoint, we don’t believe we’ve begun to see a transition from broadcast households at this stage. I think that’s probably best evidenced in the fact that we saw a decline in broadcast basic, our limited basic service.

We do see an opportunity as Neil mentioned not only on the digital front but it’s really the stepping stone in the video product category of migrating folks up to the expanded analog basic and then hopefully moving them into the digital home product and ultimately into an advanced video service. So we see this as stair stepping, we feel like we’re on the right path with that strategy.

Relative to RBOC competition, we haven’t seen anything unique in Q1 relative to prior year. We feel like the advanced video from a video competitive standpoint, the advanced video products put us in a fairly good position and we feel from a data standpoint as we migrate moving from five, ten, 16 meg services, our speed and our home networking puts us in a very good competitive position there.

David Joyce – Miller Tabak & Co.

Could you please update us on your bandwidth reclamation strategies, at which point do you think you’d be, your switch-digital video or other strategies would be fully rolled out?

Neil Smit

We expect to have switch-digital rolled out across a fairly wide basis by the end of the year. We currently are trialing it in LA, have had good success there and also we continued to migrate analog to digital. We cleared up on the HD side, we currently have about 22.5 channels so as we continued to migrate analog to digital we free up bandwidth and dedicate it to HD. We also expect to be trialing DOCSIS 3.0 later this year.

Operator

Your next question comes from Rich Greenfield – Pali Capital.

Richard Greenfield – Pali Capital

Your CapEx was up substantially in the first quarter, I assume that’s because of the CPE that you spent for the digital growth but yet you’re holding your CapEx guidance similar to what you said going into the year on the fourth quarter call, I’m just wondering therefore, should we therefore expect to see a decline in CapEx in the back nine months of the year and have you built up a significant amount of digital box inventory in Q1 for the back nine months?

And then specifically on St. Louis, could you give us some sense of just how the system is doing. AT&T has recently announced that they are doing two HD streams in the market; they’re trying to make a big deal out of that. I’m curious whether you’re seeing any change in business since they’ve done that and what you’re doing in HD within the actual St. Louis market.

Neil Smit

On the CapEx side, the increase was driven primarily by the growth in scalable infrastructure which was related to HSI network upgrades to support higher data speeds and some investments in the VOD infrastructure. About 80% of our Q1 CapEx was success based with CPE counting for 60% of that success based. I think we feel that we will be in line with 2008 CapEx estimates at $1.2 billion and there is periodically some fluctuation quarter to quarter.

Mike Lovett

From a St. Louis standpoint, we’ve heard that information as well obviously from AT&T specific to this market. We haven’t seen any unique change to date from an HD standpoint. From Charter’s perspective, we don’t specifically disclose market-by-market strategies for any of our product lines until they’re in market, but I can speak to our plans more generically.

We’re looking at having roughly 65,000 on-demand server hours including 500 customer facing HD on-demand hours by the end of 2008. So we’re focused not only on linear launches but also more importantly I think from a customer standpoint, making sure that we have availability in the HD format from an on-demand standpoint. And again on average 500 hours available by year-end, that may vary by market and certainly we view St. Louis as one of our flagship markets.

Richard Greenfield – Pali Capital

Have they changed their marketing at all or have they started to have to actively market this in the territory yet?

Mike Lovett

We haven’t seen that to date.

Operator

Your next question comes from James Ratcliffe – Lehman Brothers.

James Ratcliffe – Lehman Brothers

How much of the basic subscriber loss that is coming from actual disconnects versus higher relative price hikes in non-EBU subscribers. And second of all, if I could get some thoughts on wireless, do you have the option to join the Sprint-Clearwire, Time Warner Cable-Comcast JV down the line? And if so would you be interested in doing so?

Neil Smit

On the wireless side as we’ve said before, we’ll continue to test our way into it and try and determine what offering, whether it’s voice or broadband or any other offering, if the consumer accepts well we are working with some different partnership relationships and we’ll be test running some tests. Concerning the Sprint-Clearwire, we are looking into that but at this point we have not been approached as to a partnership.

Mike Lovett

Roughly, just a little over half of our limited basic loss is tied to a shift in EBUs.

Operator

Your next question comes from David Goldberg – Morgan Stanley.

David Goldberg – Morgan Stanley

On high speed data, we noticed that the ARPU is down a little bit sequentially from the fourth quarter and actually from the past couple of quarters, I’m just wondering what was going on there. And also a lot of the other NSOs have mentioned that an increasing percentage of their cable modem additions are coming from DSL, I’m just wondering if you are seeing the same trends and if there’s any shift in terms of the market there?

Neil Smit

Concerning HSI ARPU it was up year-over-year and we saw good customer growth at 10%. I think that we did shift as we disclosed all of our portal revenue into other and that accounted for some of the ARPU decline. We’ll continue to manage rate and volume as we have in the past and determine what the right mix there is.

Mike Lovett

Relative to the net adds, we do see a shift and we are getting additional adds from the DSL, we think that’s tied directly our increase in speed and then also the growth obviously with 4X growth in home networking, we think that’s driving some competitive advantage as well.

Operator

Your next question comes from Jason Kim – Goldman Sachs.

Jason Kim – Goldman Sachs

I think you had previously mentioned that you expect to have 85% of your footprint that will be available to offer phone services; I was wondering if there was any changes to that target? And beyond 2008, to the extent to which some systems will not be offering telephone because it’s simply not economical, would you consider selling those systems going forward?

Neil Smit

We have not changed the target, we’re still looking at roughly 85% of our footprint to have phone available to and the 15% that remains, we don’t have any specific M&A activity tied directly to phone availability, we’re looking at those properties relative to and in some cases to product availability and in other cases, there’s a video only product there. We are looking at different alternatives, from both an economical as well as a technical viability standpoint on whether we can get product into those markets in future years.

Operator

Your next question comes from David Hamburger – Citigroup.

David Hamburger – Citigroup

When you filed you 8-K concurrent with these financing transactions in March, you mentioned that some third party interest parties had approach Paul Allen and the company with interest in potentially either investing or some transaction associated with the company, I was wondering if you were prepared to provide any additional color on that.

Neil Smit

I think we’ve said at the time in that disclosure that we would not be commenting further and I think we’ll maintain that same position.

David Hamburger – Citigroup

Neil I think you mentioned that there was about 50 basis points of EBITDA margin expansion in double-digit telephone markets. Now I’m just wondering if EBITDA margins were flat year-over-year and that would potentially imply that markets that you don’t have that double digit telephone penetration that maybe you’re seeing EBITDA margin contraction? Would that be the case, is that correct? And if so, what can you do and what are the prospects [inaudible] improving those margins in those markets?

Neil Smit

I think the way to think of it is you saw a good guy on the margin side from both double-digit phone penetration which is really attributed to the mix of products. You have higher margin products like telephone and HSI growing at a faster rate than video. So that’s the good guy.

Some of the things that affected margins the other way were number one increase in marketing expenditures which as I’ve said in the past, if we see good growth opportunity we will spend and we’ll target our marketing to make sure we’re getting the most effective yields. And the second factor there was service. As we’ve seen more growth in advanced services such as DVR and HD, it’s required more service for our customers without the corresponding RGU growth.

I think the way to look at it is, similar to telephone that as we see some of those new products scale, there’s a learning curve, the service level goes up, and then it begins to flatten out. All said, I think as we continued to see the continued phone penetration growth and the growth of those higher margin products, we have no reason to believe that we can’t grow our margins.

Operator

Your next question comes from Rich Greenfield – Pali Capital.

Richard Greenfield – Pali Capital

In the 10-Q that you filed it mentioned some private transactions in terms of debt repurchases. Just wondered if you could give us some color on that and whether that’s something you consider or you’re going to think to consider continuing as we move throughout 2008?

Eloise Schmitz

There were some private transactions. We repurchased about $70 million of bonds which was pretty evenly split between the converts and the CCH bonds through 2009 and 2010. I think over the past several years we have done at various times done some repurchases. This is just another example of the same type of activity.

To the extent that it makes sense for us, we’ll always be balancing thinning maturities and maintaining liquidity, so we’ll continue to weight those as we go forward. But this is an example of a repurchase that allowed us to reduce our outstanding converts that are due in 2009 to about $14 million and address some of the near term maturities.

Operator

Your next question comes from Peter [Palad] – Imperial Capital.

Peter [Palad] – Imperial Capital

In relation to SG&A, obviously that was a bit higher than I expected and that was due to a couple things, improved customer services as well as driving the bundle, I was just wondering if you think this is going to be a run rate for the rest of the year, you would expect it to come down somewhat?

Second for Eloise, looking at our adjusted EBITDA number, is the entire capital structure going to be open to more of those capital market transactions now, or are we closed for a while, particularly given after the very large refinancing operations we saw earlier in this year?

Neil Smit

The SG&A as you pointed out was increased due to customer care and we are pleased that we were able to improve our service levels. We’ll be continuing to improve the customer experience as we feel that’s an important overall element of our success. I think also as you get more RGUs and we felt we had a good quarter from an RGU perspective, there’s going to be more customer care associated with that.

Eloise Schmitz

On the balance sheet side, we are over our leverage ratios under the indentures that CPOH and CCH2, so that would limited the activity but we’ll continue to look at what our options are, again along the same three strategies of enhancing liquidity, extending maturities and to the extent possible, reducing leverage. So we’re always looking at what the options are to work through those strategies and we’ll continue to do so.

Operator

Your next question comes from Robert [Berzon] – Post Advisory.

Robert [Berzon] – Post Advisory

Following up on Michael Pace’s comment, should we be adjusting Q1 2000 EBITDA down by $5 million in order to give us a more representative pro forma and would that suggest 11.7% EBITDA growth year-over-year?

Eloise Schmitz

The 2007 was a onetime, so yes that would be an appropriate way to compare the two, however there are, through all the quarters, various onetime things. But that is the math of the first quarter of 07 versus 08.

Operator

Your last question comes from Anton [Anakis] – Morgan Stanley.

Anton [Anakis] – Morgan Stanley

On ad sales, pretty decent year-over-year growth, curious, A, about your expectations for the balance of the year and secondly I believe you guys, Time Warner Cable took over your local ad sales business in Los Angeles so I believe this should have been roughly 10% growth year-over-year even without Los Angeles, so I just wanted to make sure that that was in fact stripped out of the numbers.

Neil Smit

On the ad sales we are pleased with the overall results. I think the categories as we mentioned, we’re seeing good growth on the political side offset by some weakness in some of the categories such as autos and finance. You’re correct in that we did a transaction to transfer our ad sales activities in the LA market over to Time Warner; we felt that was a good way for us both to serve the customer the most efficiently.

Eloise Schmitz

We are booking that on a net basis, so that 10% growth is the business outside of that relationship.

Anton [Anakis] – Morgan Stanley

So it’s organic or the 08 number excludes LA whereas 07 still includes it?

Eloise Schmitz

‘07 would include it, ‘08 is on a net basis.

Anton [Anakis] – Morgan Stanley

And then a question for you Eloise, just curious mechanically given that you are not in compliance with the leverage ratios at the end of Q1, had you up streamed the cash to either Charter Hold Co. or CCI somewhere beyond the restricted group to be able to redeem the converts, mechanically how were you able to do that? Because it didn’t look like the intercompany loan balances really changed.

Eloise Schmitz

No the intercompany loan balances did not change and without getting too granule on it, we completed those transactions while we were in the first quarter so we were working off the fourth quarter numbers. So those transactions were while we were underleveraged.

Neil Smit

Thank you all for joining us this morning, I look forward to speaking with you again soon.

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Comments

[newbie:]

I know this seems silly to some....in our area the NFL ticket is not offered by Charter. Being avid football fans, we have had to go to pizza places and bars to view the games. If Charter would offer the NFL ticket, I am sure that many people would buy it, and save customers from going to Direct or DISH due to the fact that people who have dropped about $200-$300 a month to watch the games would have the luxury of watching them at home and save money.

2008 May 12 07:59 PM

[jstratt:]

I thought there was a lot to like about the Charter earnings for the 1st quarter. Significant gains of customers in Digital Cable, High Speed Internet and in Telephone was great. The Average Revenue per user increased to over $100 for the first time. Finally a big new area took off with huge gains. The Video on demand revenue grew rapidly which I think holds much long term promise.

I dont expect Charter to make profits as long as it is financed by about 97% debt. However Charter appears to be growing more valuable every day. I think the market will recognize the proper value of the business in the future.

The proper value for a cable company with 5.6 Million customers and growing consistently with over $100 ARPU may be in excess of $4,000 a customer.

Several years ago it was worth around $5000 a customer and it only had one Television product line.

2008 May 13 09:00 PM

[cptnkirk:]

97% dept or not, this company has not reflected a profit in years, or has it? Might I suggest that profits are being transferred to closely held affiliates that are related to company insiders? Revenue growth over the last 5-8 years has been tremendous, yet profit is elusive. We keep hearing that the company is poised to make money, but it never happens. Let me suggest what will happen. The company will eventually declare bankruptcy, the before mentioned affiliates, being the credit holders of the company, will receive the assets of the company and form a new "Charter Communications". Current shareholders will recieve nothing. The company insiders will receive generous severance packages to reward them for their hard work. Many of the insiders will go back to work for the new company.

2008 Sep 27 09:31 AM