Charter Communications, Inc. — Q3 2017 Form 10-Q
Reporting period: Three and nine months ended September 30, 2017. Charter is a cable and broadband provider offering video, Internet, voice, commercial services, advertising, and related products. The filing reports one segment, cable services. The May 2016 Time Warner Cable and Bright House acquisitions make reported nine-month comparisons with 2016 substantially non-comparable; pro forma comparisons are also provided.
Key financial metrics
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Revenue | $10.458 billion | $10.037 billion | $30.979 billion | $18.728 billion |
| Adjusted EBITDA | $3.819 billion | $3.636 billion | $11.320 billion | $6.739 billion |
| Operating income | $909 million | $911 million | $2.902 billion | $1.383 billion |
| Net income attributable to Charter shareholders | $48 million | $189 million | $342 million | $3.068 billion |
| Diluted EPS | $0.19 | $0.69 | $1.29 | $15.23 |
| Operating cash flow | $2.908 billion | $2.801 billion | $8.696 billion | $4.815 billion |
| Capital expenditures | $2.393 billion | $1.748 billion | $6.096 billion | $3.437 billion |
| Free cash flow | $594 million | $1.001 billion | $2.876 billion | $1.464 billion |
Q3 revenue increased 4.2% and Adjusted EBITDA rose 5.0% year over year; operating margin was approximately 8.7% versus 9.1%. Nine-month 2017 versus 2016 reported growth largely reflects the acquisitions. On a pro forma basis, nine-month revenue grew 4.1%, Adjusted EBITDA 6.7%, and operating income 3.2%. The filing defines free cash flow as operating cash flow less capital expenditures and the change in accrued capital-expenditure expenses.
- Revenue mix and customers: Q3 Internet revenue rose 10.9% and commercial revenue 8.0%; video revenue rose 2.9%, while voice fell 16.1% and advertising sales fell 11.1%. Residential Internet customers increased 1.265 million year over year, while video customers declined 345,000. Total customer relationships were 26.993 million.
- Cash and liquidity: Cash was $2.164 billion at September 30, 2017, versus $1.535 billion at year-end 2016. Approximately $2.9 billion was available under credit facilities. Q3 free cash flow declined $407 million year over year, principally reflecting higher capital spending.
- Debt: Debt principal totaled $66.8 billion, including $8.8 billion of credit-facility debt. Long-term debt on the balance sheet was $66.064 billion, plus $2.068 billion current. Charter reported a 5.4% blended weighted-average interest rate; approximately 88% of debt principal was effectively fixed-rate. Management’s target leverage was 4.0–4.5 times overall and up to 3.5 times at Charter Operating.
- Capital returns: Charter repurchased 21.9 million Class A shares for $7.6 billion during the first nine months; $5.2 billion of board authorization remained at quarter-end. It also repurchased $922 million of Charter Holdings units from Advance/Newhouse during the period.
Material changes and unusual items
- Q3 net income attributable to Charter shareholders fell to $48 million from $189 million. Higher interest expense and depreciation and amortization weighed on earnings. The nine-month comparison is particularly distorted by the 2016 acquisition period and a roughly $3.3 billion tax benefit in 2016 from reducing Legacy Charter’s deferred-tax valuation allowance.
- Q3 interest expense was $788 million, up $64 million year over year; nine-month interest expense was $2.250 billion, up $479 million. The filing attributes the increase mainly to higher average debt and, for the nine-month comparison, debt assumed from Legacy TWC.
- Q3 capital expenditures increased to $2.393 billion, primarily due to customer equipment for Spectrum pricing and packaging and the all-digital initiative, as well as infrastructure spending.
- Merger and restructuring costs were $293 million for the first nine months, down from $775 million in 2016. Special charges included an $83 million multiemployer pension-plan withdrawal-liability charge. A $30 million pension remeasurement loss was recorded in 2017.
- During 2017 Charter issued or refinanced substantial debt, including notes used for general corporate purposes and share repurchases. In October, after quarter-end, it issued a further $1.5 billion of notes.
Outlook, management commentary, and risks
The filing gives no specific numerical earnings or revenue guidance. Management said it expects to use free cash flow, cash on hand, credit-facility capacity, and future refinancing to meet cash needs, and believes liquidity is sufficient. It expects continued integration work, including the all-digital conversion of remaining Legacy TWC and Bright House analog markets, with most of that initiative planned for 2018. Charter cautioned that integration and operating changes could prevent revenue growth or maintenance of historical margins.
- Management expects programming costs to continue rising, citing contractual rate increases, retransmission-consent demands, and additional programming. It said Charter has not fully passed these costs to customers and may not do so without risking customer losses.
- Key risks include intense competition, customer retention and service quality, successful integration, programming-cost inflation, network or information-system disruption, regulation, financing access, and compliance with debt covenants. The Comcast cooperation agreement provides for a one-year exploration of wireless operational cooperation; any resulting arrangement or its success is uncertain.
- Legal matters include a $146 million Sprint VoIP patent verdict against Legacy TWC, which Charter appealed, and a New York Attorney General suit alleging misleading Internet-speed advertising. The filing also discusses other patent, shareholder, and regulatory matters; outcomes for some claims cannot be predicted or reliably estimated.
- Management reported disclosure controls were effective. It noted ongoing validation of internal controls as acquired operations are integrated.
Important facts for investors to verify
- Track Internet customer and revenue growth against continued video-customer losses, and assess the effect of advertising weakness and service pricing.
- Review pro forma rather than acquisition-distorted reported comparisons when evaluating underlying growth; account for the 2016 tax benefit when comparing earnings.
- Monitor capital spending, free cash flow, debt maturities, refinancing conditions, leverage, and the extent to which repurchases are funded by borrowing.
- Assess whether programming-cost inflation can be offset through pricing, savings, or customer growth without harming retention.
- Follow integration milestones and the all-digital conversion, as well as the resolution and potential financial exposure of significant litigation and contingencies.