Charter Communications, Inc. — Q3 2015 Form 10-Q
Business context and reporting period
Charter provides residential and commercial video, Internet and voice services, advertising and fiber connectivity. This unaudited filing covers the three and nine months ended September 30, 2015; amounts are in millions of dollars unless noted. Charter reported approximately 6.5 million residential and commercial customers.
Financial performance and liquidity
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Revenue | $2,450 | $2,287 | $7,242 | $6,748 |
| Operating income | $273 | $218 | $791 | $694 |
| Net income (loss) | $54 | $(53) | $(149) | $(135) |
| Adjusted EBITDA | $850 | $783 | $2,498 | $2,345 |
| Free cash flow | $208 | $(62) | $467 | $82 |
Revenue rose 7% year over year in both periods. Q3 operating margin was approximately 11.1% versus 9.5%; Adjusted EBITDA margin was approximately 34.7% versus 34.2%. Adjusted EBITDA is a non-GAAP measure. Nine-month operating cash flow was $1,748, up from $1,729; capital expenditures were $1,292, down from $1,678. Q3 capital expenditures were $509 versus $569.
At September 30, 2015, total assets were $36,873 and shareholders’ equity was $60. Long-term debt was $33,281 carrying value ($33,334 principal), compared with $21,023 carrying value at year-end 2014. Cash and cash equivalents were less than $1; restricted cash was $19,626, primarily transaction financing held in escrow. Approximately $1.0 billion was available under credit facilities. Management said it believed liquidity sources, including free cash flow, revolver availability and capital-market access, would fund projected operating needs. Cash paid for interest was $742 for the first nine months, compared with $624.
Material changes versus prior comparable periods
- Internet revenue grew 17% in Q3 and the first nine months; residential Internet customers increased by 430,000 year over year. Commercial revenue rose 13% in Q3 and 14% year to date.
- Video revenue increased 3%, despite a 25,000 decline in residential video customers. Residential voice revenue declined 5% in Q3 and 8% year to date. Advertising revenue fell, partly reflecting lower political advertising.
- Programming costs increased $46 in Q3 and $170 year to date. Operating costs rose $102 in Q3 and $358 year to date, including higher transition, corporate and customer-service costs.
- Interest expense increased $136 in Q3 and $233 year to date, principally due to interest on acquisition-related debt held in escrow. Nine-month results also included a $128 loss on extinguishment of debt.
- Q3 net income included a $169 discrete tax benefit associated with a July tax election and deemed liquidation of Charter Holdco for tax purposes. Despite that benefit, nine-month net loss widened to $149 from $135.
Transactions, outlook, risks and unusual items
- The proposed Time Warner Cable transaction had an estimated enterprise value of approximately $79 billion. The Bright House transaction was also pending. Charter had issued $15.5 billion of senior secured notes and arranged $3.8 billion of bank loans, with proceeds largely held in escrow pending transaction closings. Additional financing commitments remained. These transactions had not closed by September 30.
- Management said it hoped to close by year-end but realistically anticipated closing in the first quarter. Regulatory review was ongoing; the FCC comment period was expected to close in mid-November, and most state approvals had been received.
- Charter expected 2015 capital expenditures of approximately $1.7 billion, excluding acquisition-related transition costs. Management cited customer growth, product development and service improvement as priorities, while cautioning that revenue growth and historical margins could not be assured.
- Management expects programming costs to continue rising and said it may not be able to pass all increases to customers without risking customer losses. Competition, video substitution to Internet services, customer retention, transaction approval and integration, increased debt and access to financing are key risks.
- Charter terminated its Comcast transactions in April 2015. Debt issued and held in escrow for those transactions was repaid; related activity contributed to debt-extinguishment losses. Patent infringement and ordinary-course litigation remained outstanding; the company said potential losses in certain patent matters could not be reasonably estimated.
- Disclosure controls were considered effective, and no material change in internal control over financial reporting was reported for the quarter.
Important facts for investors to verify
- Whether the TWC and Bright House transactions received all required approvals, closed on the anticipated timetable and achieved expected financing terms and synergies.
- How much of the $19.6 billion restricted cash and related escrow debt becomes available or is repaid, and the resulting post-transaction debt, interest burden and leverage.
- Whether Internet and commercial growth can offset video customer losses and rising programming costs without weakening margins.
- Whether the $1.7 billion capital expenditure outlook and free cash flow remain achievable as transition and integration spending develops.
- The sustainability of reported Q3 net income, given the discrete tax benefit, and the outcome of pending litigation and other transaction contingencies.