Charter Communications, Inc. — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016. All dollar amounts are U.S. dollars. The TWC and Bright House acquisitions closed May 18, 2016; reported 2016 results include their operations only from closing, so comparisons with 2015 are not like-for-like. Charter also provides unaudited pro forma comparisons assuming both transactions closed January 1, 2015.
Business context and reporting period
Charter provides video, Internet, voice, advertising and business communications services. Following the May 18 transactions, it became the parent of the combined Legacy Charter, Time Warner Cable and Bright House operations. The company reported approximately 25.6 million customer relationships at June 30, 2016 and one reportable segment: cable services.
Key financial metrics
| Metric | Q2 2016 | Six months 2016 | Comparable information |
|---|---|---|---|
| Revenue | $6.161 billion | $8.691 billion | Q2 and six-month reported revenue increased 154% and 81%, respectively, versus 2015; largely acquisition-driven. Pro forma growth was 7% for both periods. |
| Income from operations | $690 million | $992 million | Versus $269 million and $518 million in 2015; acquired operations and higher depreciation and amortization affect comparability. |
| Net income attributable to Charter shareholders | $3.067 billion | $2.879 billion | Versus losses of $122 million and $203 million in 2015; 2016 results were substantially affected by a nonrecurring tax benefit. |
| Adjusted EBITDA | $2.220 billion | $3.103 billion | Reported growth of 162% and 88%. Pro forma growth was 9% for each period. |
| Free cash flow | $524 million | $463 million | Non-GAAP measure; six-month amount compares with $259 million in 2015. Q2 compares with $158 million. |
| Operating cash flow | $1.590 billion | $2.014 billion | Six-month 2015 amount was $1.059 billion. |
| Capital expenditures | $1.260 billion | $1.689 billion | Six-month 2015 amount was $783 million. |
Pro forma Adjusted EBITDA margin was approximately 35.5% in Q2 2016 versus 34.7% in Q2 2015, and 35.3% for the first half of 2016 versus 34.6% a year earlier; these percentages are calculated from the filing’s pro forma figures. Reported GAAP margins are difficult to compare because acquired results are included only after closing.
Q2 interest expense, net was $593 million; the six-month amount was $1.047 billion. Debt-extinguishment losses were $110 million for both periods. Cash paid for interest was $1.014 billion in the first half.
At June 30, 2016, cash and cash equivalents were $555 million, current assets $2.325 billion and current liabilities $8.807 billion. Total debt principal was approximately $60.3 billion, including $9.0 billion of credit-facility debt; the balance sheet showed $2.071 billion of current debt and $60.132 billion of long-term debt at accreted value. Charter had approximately $2.8 billion of revolver availability. Shareholders’ equity was $51.032 billion, including $10.792 billion of noncontrolling interests.
Material changes versus the prior period
- The acquisitions added substantial scale: pro forma revenue rose 7% year over year, while Internet revenue grew 12%, commercial revenue 13%, and residential revenue 6% in Q2.
- Pro forma residential Internet customers increased by 1.62 million year over year; video customers declined by 30,000. Reported customer statistics combine legacy companies’ differing methodologies and may not be directly comparable.
- Debt principal increased from $35.9 billion at December 31, 2015 to $60.3 billion at June 30, primarily due to acquisition financing and assumed TWC debt. Approximately $47.0 billion of principal matures thereafter, beyond 2020.
- Programming costs and capital spending increased with the larger business. On a pro forma basis, programming costs rose in Q2, reflecting contractual rate increases and additional programming, while the company reported continued growth in Internet and commercial businesses.
Outlook, commentary, risks and unusual items
- Management expects quarterly revenue to increase by over $7 billion year over year as a result of the transactions, and expects Adjusted EBITDA margins to improve over time as synergies are realized. It expects to complete Spectrum pricing and packaging launches and the all-digital transition in the acquired footprints by the end of 2018; corporate, marketing, sales and product development functions were expected to be centralized by year-end 2016.
- Management cited a 4.0–4.5 times target leverage range, and 3.5 times at Charter Operating. The board authorized opportunistic share repurchases of up to $750 million in any six-month period, subject to leverage remaining within its target range; no specific purchase amount or timing was promised.
- Q2 and first-half net income benefited from a roughly $3.3 billion reversal of a deferred-tax valuation allowance, producing an income tax benefit of approximately $3.2 billion. This is not a recurring operating result. Management cautioned that, absent unusual items such as this benefit, the company may continue to incur net losses.
- First-half merger and restructuring costs were $570 million, including transaction, retention and termination costs; $145 million of accelerated equity-award expense was also recorded. A $675 million pension curtailment gain and $157 million remeasurement loss were recorded after the acquired TWC pension plans were amended to freeze future benefit accruals effective September 1, 2016.
- Integration, execution and synergy realization are key risks. The company expects further integration costs and faces risks from customer disruption, employee retention, elevated capital needs, competition, and rising programming and retransmission-consent costs that it may not be able to pass fully to customers.
- Regulatory conditions include building out access to high-speed broadband for an additional two million locations, including one million in competitive areas; restrictions on usage-based pricing and data caps; and limits on interconnection fees and programmer restrictions relating to online video distributors. Several conditions run for five to seven years.
- Other risks include substantial debt and refinancing needs, variable-rate exposure, restrictive debt covenants, limits on subsidiary distributions, potential goodwill or intangible impairment, and litigation. The filing says it cannot reasonably estimate possible losses for certain patent matters. A potential future tax-receivable agreement payment to A/N is estimated at zero to $3 billion if qualifying exchanges or sales occur; no liability was recorded.
Important facts for investors to verify
- Track pro forma revenue and Adjusted EBITDA growth separately from reported growth, and assess whether integration synergies translate into improved margins and free cash flow.
- Monitor debt maturities, refinancing terms, interest expense, leverage and revolver availability against the company’s stated targets and capital-allocation plans.
- Evaluate capital expenditure requirements, programming-cost inflation, subscriber trends and the ability to pass higher costs through without increasing churn.
- Confirm progress on the all-digital transition, Spectrum product rollout, acquisition integration and required regulatory broadband build-out.
- Assess the sustainability of earnings excluding the valuation-allowance reversal and pension-related gains, and follow purchase-accounting adjustments, tax exposures, contingent obligations and litigation developments.