Charter Communications, Inc. — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016. Charter completed its acquisitions of Time Warner Cable (TWC) and Bright House on May 18, 2016. Reported 2016 results include those businesses only from the closing date, so comparisons with 2015 are not directly comparable; pro forma comparisons assume the transactions closed on January 1, 2015.
Business context and financial highlights
Charter is a cable and broadband provider serving residential and business customers, with video, Internet, voice, advertising and other services. At quarter-end it reported approximately 25.9 million customer relationships. The company operates as one reportable segment: cable services.
| Metric | Q3 2016 | Comparable change / context |
|---|---|---|
| Revenue | $10.037 billion | Up 7.4% pro forma year over year; reported growth of 310% was primarily acquisition-driven. |
| Adjusted EBITDA | $3.636 billion | Up 14.5% pro forma; approximately 36.2% of revenue, versus approximately 34.0% pro forma in Q3 2015. |
| Operating income | $924 million | Up 21.1% pro forma year over year. |
| Net income attributable to Charter shareholders | $189 million | $0.69 diluted EPS; versus $54 million and $0.53 in Q3 2015, respectively. |
| Operating cash flow | $2.801 billion | Versus $689 million in Q3 2015; scale and acquisitions affect comparability. |
| Capital expenditures | $1.748 billion | Versus $509 million in Q3 2015. |
| Free cash flow | $1.001 billion | Versus $208 million in Q3 2015. Company-defined non-GAAP measure. |
| Net interest expense | $724 million | Higher mainly due to transaction financing and TWC debt assumed. |
For the nine months, reported revenue was $18.728 billion, Adjusted EBITDA $6.739 billion, operating cash flow $4.815 billion and free cash flow $1.464 billion. Pro forma revenue was $29.748 billion versus $27.813 billion (+7.0%); pro forma Adjusted EBITDA was $10.611 billion versus $9.586 billion (+10.7%). Nine-month reported net income attributable to Charter shareholders was $3.068 billion, including a material tax benefit described below; pro forma net income attributable to shareholders was $616 million versus $29 million.
Balance sheet, debt and liquidity
- Cash and cash equivalents were $1.165 billion at September 30, 2016. Charter also reported approximately $2.8 billion available under its revolving credit facilities.
- Debt principal was $60.168 billion, including $2.050 billion due within one year. The balance sheet reports $59.946 billion of long-term debt and $2.050 billion current debt; carrying values differ from principal, including because of acquisition-accounting premiums and financing costs.
- Principal maturities include $2.197 billion in 2017, $2.197 billion in 2018, $3.546 billion in 2019, $5.216 billion in 2020 and $46.963 billion thereafter. Management said it expects to use free cash flow, cash and refinancing to extend or reduce maturities, subject to market conditions.
- Management’s target leverage was 4.0–4.5 times at Charter and 3.5 times at Charter Operating. The filing states that no debt covenant default existed at quarter-end and applicable subsidiary leverage tests were met.
Material changes, outlook and unusual items
- Acquisitions and integration: TWC and Bright House added scale, revenue, debt and substantial acquired intangible assets. Management was centralizing corporate, marketing, sales and product-development functions; it expected Spectrum pricing and packaging to reach all acquired markets by mid-2017 and conversion of remaining TWC and Bright House analog markets to all-digital service to begin in 2017 and finish by the end of 2018. Management cautioned that it could not assure revenue growth or maintenance of historical margins during integration.
- Taxes and earnings quality: Nine-month 2016 income tax benefit was $3.135 billion, primarily reflecting reversal of approximately $3.3 billion of Legacy Charter valuation allowance after acquisition-related deferred tax liabilities increased. This nonrecurring benefit materially boosted reported nine-month earnings. Q3 income tax expense was $16 million.
- Other unusual costs and benefits: Nine-month merger and restructuring costs were $775 million; the company expected additional costs. Debt repurchases generated a $110 million extinguishment loss. A pension-plan amendment freezing future accruals generated a $675 million curtailment gain and a $157 million remeasurement loss in the nine-month period.
- Operating trends and pressures: Pro forma revenue growth was attributed mainly to Internet and commercial businesses. Residential Internet customers increased by 1.601 million pro forma year over year, while residential video customers decreased by 57,000. Pro forma programming costs rose, driven by contractual rate increases, retransmission-consent costs and new programming; management said it had not fully passed these increases to customers and did not expect to do so without potential customer losses.
- Regulatory conditions: FCC conditions require buildout to two million additional locations with high-speed access within five years, including one million in competition with another provider. Charter is restricted from data caps and usage-based pricing and from interconnection fees for seven years, subject to specified review. DOJ conditions restrict agreements that limit programmers’ licensing to online video distributors and prohibit retaliation, generally for seven years.
- Risks and contingencies: Key risks include integrating acquired operations, realizing expected synergies, competition and customer retention, rising programming costs, significant debt and refinancing needs, interest-rate exposure, capital spending and compliance with debt covenants. Disclosed matters include a revived patent-infringement case brought by Sprint, other intellectual-property claims, and merger-related shareholder litigation. The filing says outcomes and potential losses for certain cases cannot be predicted or reasonably estimated.
No specific revenue or earnings guidance was provided. Management said future capital expenditures would depend on integration pace and residential and commercial growth. It stated that liquidity from cash, free cash flow, credit availability and capital-market access was expected to fund projected needs, while noting refinancing depends on market conditions.
Most important facts for investors to verify
- Use pro forma results, rather than reported year-over-year growth alone, to assess underlying performance; confirm assumptions and reconciliations for these illustrative figures.
- Separate recurring earnings and cash generation from the $3.3 billion valuation-allowance reversal and the pension, merger, restructuring and debt-extinguishment items.
- Track integration execution, customer trends, programming-cost growth, and whether operating efficiencies support margins and free cash flow.
- Assess debt maturities, interest costs, leverage targets, refinancing access and the effect of capital expenditures on cash available for debt reduction.
- Monitor compliance with FCC and DOJ transaction conditions and developments in material litigation, particularly the Sprint patent case.