Business context and reporting period
Charter Communications, Inc. is a U.S. cable operator offering video, Internet, telephone, commercial connectivity and advertising services. This unaudited Form 10-Q covers the three and nine months ended September 30, 2011; financial amounts below are in millions of dollars unless stated otherwise. Charter reported approximately 5.2 million residential and commercial customers.
Financial and operating performance
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Revenue | $1,809 | $1,769 | $5,370 | $5,275 |
| Adjusted EBITDA (non-GAAP) | $653 | $632 | $1,989 | $1,915 |
| Income from operations | $237 | $240 | $776 | $745 |
| Interest expense, net | $244 | $222 | $718 | $645 |
| Loss on extinguishment of debt | $4 | $3 | $124 | $38 |
| Net loss | $85 | $95 | $302 | $152 |
| Loss per share | $0.79 | $0.84 | $2.74 | $1.34 |
| Operating cash flow | $405 | $441 | $1,312 | $1,422 |
| Free cash flow (non-GAAP) | $90 | $135 | $317 | $467 |
Q3 operating margin was approximately 13% of revenue (14% in Q3 2010); nine-month operating margin was approximately 14% in both periods. Adjusted EBITDA is a company-defined non-GAAP measure and should not be treated as a substitute for GAAP earnings or cash flow.
- At September 30, 2011, cash and cash equivalents were $5; restricted cash was $27, for $32 combined. Current assets were $335 and current liabilities were $1,081.
- Long-term debt was $12,581 on the balance sheet, approximately $12.6 billion at accreted value. Available revolving credit capacity was approximately $1.1 billion. Other long-term liabilities were $1,112.
- Nine-month capital expenditures were $984. Management expected 2011 capital expenditures of $1.3–$1.4 billion.
- Revenue by service in Q3: video $899 (down 2%); Internet $433 (up 7%); telephone $216 (up 4%); commercial $148 (up 17%); advertising $73 (down 3%).
Material changes versus the prior comparable period
- Revenue increased 2% in both Q3 and the first nine months. Growth in Internet, telephone and commercial services, along with pricing and product upgrades, was partly offset by declining video revenue.
- Basic video customers declined by about 176,800 over the nine months, after reflecting system acquisitions and divestitures; residential Internet and telephone customers grew. Management reported total customer decline of about 21,100 over the period after those transactions.
- Adjusted EBITDA increased, but operating income was slightly lower in Q3 and higher year to date. Interest expense rose as weighted-average interest rates increased; the company cited 7.5% versus 6.3% for Q3 and 7.3% versus 6.1% for the nine-month periods.
- Nine-month net loss widened by $150, principally reflecting higher interest expense and $124 of debt-extinguishment losses, compared with $38 in 2010. The 2011 losses largely related to credit-facility refinancing and repayment activity.
- Operating cash flow and free cash flow declined year over year. Charter attributed the free-cash-flow decrease to less cash provided by working-capital movements, higher cash interest and increased capital expenditures.
- Debt rose from $12,306 at December 31, 2010 to $12,581 at September 30, 2011. During 2011, Charter issued $1.4 billion of 7.00% notes due 2019 and $1.5 billion of 6.50% notes due 2021, using proceeds to repay credit-facility debt.
Outlook, management commentary, risks and unusual items
- Management expected continued free cash flow generation and considered cash, free cash flow, revolving credit availability and capital-markets access sufficient for projected operating needs. Refinancing plans and terms depend on market conditions; this is not a quantified earnings forecast.
- Management expected advertising revenue for Q4 and full-year 2011 to be below the comparable 2010 periods, primarily because of lower political advertising. Programming costs were expected to continue rising, including from contractual increases and retransmission-consent costs.
- Management cited competition, economic weakness, housing-market conditions and unemployment as pressures on customer demand, particularly basic video. It warned that persistent adverse conditions could further affect results and potentially contribute to franchise or goodwill impairments.
- Debt maturities disclosed included $938 in 2012, $1.0 billion in 2014, $4.6 billion in 2016 and $5.5 billion thereafter. Management said distributions from subsidiaries are subject to debt covenants and other legal restrictions. The company reported no covenant default for the quarter and said subsidiaries met applicable leverage tests at quarter-end.
- Charter repurchased 4.5 million shares from Franklin Advisers for $207 in March and, under a separate $200 share-and-warrant repurchase authorization announced in August, had repurchased approximately 2.4 million shares for $116 by quarter-end.
- On October 11, 2011, CEO Michael Lovett announced his resignation following a transition period, no later than April 30, 2012; Charter was searching for a successor.
- Remaining appeals related to the bankruptcy-plan confirmation were pending for Law Debenture Trust and R2 Investments; the company said it could not predict the outcome or estimate a reasonable loss range. Ordinary-course litigation, including patent claims, could be material in the aggregate. Charter also disclosed EPA communications regarding self-reported backup-battery reporting issues, which it did not view as material.
- The company used $2.0 billion notional of interest-rate swaps; approximately 86% of debt principal was effectively fixed at September 30, 2011. Interest-rate and refinancing exposure remain relevant risks. The filing also highlights competition, programming costs, regulation, franchise renewals, and access to funding.
Most important facts for investors to verify
- Whether Internet and commercial growth can offset continuing basic-video customer losses and pressure on telephone growth.
- Whether free cash flow can recover while capital spending, programming expenses and cash interest remain elevated.
- The company’s ability to refinance or repay substantial upcoming maturities, especially the 2016 balance, and maintain covenant compliance and subsidiary distribution capacity.
- Actual 2011 capital expenditures versus the $1.3–$1.4 billion estimate, and the effects of acquisitions, divestitures and share repurchases on liquidity and leverage.
- CEO succession, the outcomes of remaining bankruptcy-related appeals and other legal or regulatory matters, and any changes in impairment, tax or debt-related estimates.