Charter Communications, Inc. — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016; unaudited. Amounts are in USD millions unless otherwise noted.
Business context
Charter provides residential and commercial video, Internet, voice, advertising and fiber services in the United States, serving approximately 6.8 million customer relationships. The quarter preceded the proposed Time Warner Cable (TWC) and Bright House transactions, so the reported results do not reflect a combined company.
Financial results and key metrics
| Metric | Q1 2016 | Q1 2015 | Change / note |
|---|---|---|---|
| Revenue | $2,530 | $2,362 | Up 7% |
| Operating costs and expenses | $1,671 | $1,581 | Up $90 |
| Income from operations | $302 | $249 | Operating margin approximately 11.9%, versus 10.5% |
| Adjusted EBITDA | $883 | $800 | Up 10%; margin approximately 34.9%, versus 33.9%. Non-GAAP measure. |
| Net loss | $(188) | $(81) | Loss per share $(1.68), versus $(0.73) |
| Net interest expense | $454 | $289 | Up $165, principally reflecting interest on transaction debt held in escrow |
| Operating cash flow | $424 | $528 | Down $104 |
| Capital expenditures | $429 | $351 | Up $78 |
| Free cash flow | $(61) | $101 | Down $162; company-defined non-GAAP measure |
Internet revenue rose 12% to $804, driven by 458,000 additional residential Internet customers year over year. Video revenue rose 4% to $1,170; residential video customers increased by 21,000. Voice revenue was nearly flat at $135. Commercial revenue increased 12% to $301, and advertising revenue increased 9% to $72, partly due to higher political advertising.
At March 31, cash and cash equivalents were $1,278, compared with $5 at year-end; restricted cash was $22,313 and primarily represented transaction financing held in escrow. Long-term debt was $37,124 at accreted value ($37,313 principal), versus $35,723 at year-end. Approximately $21.8 billion of debt proceeds remained in escrow pending the TWC transaction. Credit-facility availability was approximately $1.2 billion. Shareholders’ deficit was $219.
Material changes and drivers
- Revenue growth reflected residential Internet and triple-play customer growth, commercial customer growth, greater service penetration and price increases.
- Programming costs increased $37 to $703; corporate and other costs increased, while costs to service customers declined slightly. Management cited contractual programming-rate increases, retransmission fees and new networks, partly offset by a favorable programmer settlement.
- Operating income improved, but net loss widened primarily because net interest expense rose substantially. Cash paid for interest increased to $448 from $255.
- Operating cash flow fell and capital spending rose, resulting in negative free cash flow. Management attributed the decline in free cash flow primarily to higher cash interest and capital expenditures, partly offset by higher Adjusted EBITDA.
Outlook, transactions and risks
- Business outlook: Management expects revenue growth from adding products to existing homes, attracting customers, reducing churn and expanding commercial services, but cautioned that growth and margins are not assured. It expects programming costs to continue rising and 2016 capital expenditures to be driven by customer growth, product development and transaction-related transition spending. No quantified company-wide earnings or revenue guidance is provided in the filing.
- TWC and Bright House transactions: The TWC transaction’s estimated enterprise value was approximately $82 billion. The Bright House consideration included approximately $2 billion cash, $2.5 billion of preferred units carrying a 6% coupon, and approximately 34.3 million exchangeable common units. Expected financing includes additional debt, balance-sheet cash and Liberty Broadband investment. Completion remained subject to approvals and other conditions.
- Regulatory status after quarter-end: On April 25, 2016, the FCC chairman said a proposed approval order had been circulated; the DOJ filed a proposed final judgment. California PUC approval remained outstanding, with a decision scheduled for May 12. Proposed FCC conditions included broadband buildout and restrictions on usage-based pricing, data caps and interconnection fees; DOJ terms addressed programmer agreements and online video distributors. Final approvals, timing and conditions were not assured.
- Financing and tax items: In February, CCO Holdings issued $1.7 billion of 5.875% notes due 2024. In April, it issued $1.5 billion of 5.50% notes due 2026, after quarter-end. Management said a preliminary analysis indicated that closing the TWC transaction could support release of substantially all of Charter’s approximately $3 billion preexisting deferred-tax valuation allowance; this was contingent on closing and further assessment, not a realized quarter-end benefit.
- Key risks: High leverage and interest burden; reliance on refinancing and capital markets; transaction completion, integration, synergy and regulatory risks; competition and customer churn; rising programming costs that may not be fully passed to customers; and potential network, operational, legal and covenant risks. Subsidiary distributions for parent debt service are subject to indenture, credit-facility and legal restrictions. The company reported no debt defaults at March 31.
- Contingencies and controls: Transaction-related shareholder litigation and patent and ordinary-course claims remained disclosed; potential outcomes or loss ranges for patent matters could not be estimated. Management reported disclosure controls effective and no material first-quarter change in internal control over financial reporting.
Most important facts for investors to verify
- Whether and when the TWC and Bright House transactions closed, the final regulatory conditions, and the resulting consideration, financing and combined-company debt.
- Whether restricted escrow cash was released or used as intended, and subsequent cash, debt and revolver availability.
- Whether operating cash flow and free cash flow improve as interest costs, capital spending and transition expenditures evolve.
- Whether customer growth and pricing can offset programming-cost inflation without worsening churn or margins.
- Whether the anticipated deferred-tax valuation-allowance release is supported by the final transaction accounting and tax analysis.