Charter Communications, Inc. — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014; comparative figures are for Q1 2013. Charter is a U.S. cable operator offering video, Internet, voice, commercial connectivity and advertising services. It reported approximately 6.1 million residential and commercial customer relationships at quarter-end. The July 2013 Bresnan acquisition affects year-over-year comparisons.
Financial results and liquidity
| Metric | Q1 2014 | Q1 2013 | Change / context |
|---|---|---|---|
| Revenue | $2.202 billion | $1.917 billion | Up 15%; pro forma for Bresnan, up 8% |
| Operating income | $243 million | $223 million | Operating margin 11% vs. 12% |
| Adjusted EBITDA (non-GAAP) | $767 million | $670 million | Up 14%; Bresnan contributed $45 million |
| Net loss | $37 million | $42 million | Loss per share $(0.35) vs. $(0.42) |
| Operating cash flow | $577 million | $541 million | Up $36 million |
| Capital expenditures | $539 million | $412 million | Up $127 million |
| Free cash flow (non-GAAP) | $74 million | $118 million | Down $44 million |
| Cash and cash equivalents | $4 million | $21 million at Dec. 31, 2013 | Cash declined $17 million during the quarter |
| Long-term debt, carrying value | $14.090 billion | $14.181 billion at Dec. 31, 2013 | Principal debt was approximately $14.2 billion |
Revenue growth reflected Bresnan, higher residential Internet and triple-play customers, commercial growth, pricing and service-mix changes. By service, video revenue rose 14% to $1.090 billion, Internet rose 23% to $616 million, commercial rose 29% to $234 million, and voice declined 12% to $150 million. Residential customer counts included 4.195 million video, 4.519 million Internet and 2.325 million voice subscribers; monthly residential revenue per customer relationship was $110.29, compared with $107.25 a year earlier.
Operating costs excluding depreciation and amortization rose 15% to $1.447 billion. Programming expense increased to $606 million from $512 million, driven in part by contractual rate increases. Depreciation and amortization increased to $505 million from $425 million. Income tax expense was $64 million versus $9 million; Q1 2013 included a $57 million tax benefit from a tax-basis step-up, making the comparison unusual.
Free cash flow is defined by Charter as operating cash flow less capital expenditures and changes in accrued capital expenditure costs. Its decline reflected higher capital spending and cash interest paid of $225 million versus $120 million, partly offset by stronger EBITDA and working-capital effects. Charter reported approximately $1.2 billion available under its credit facilities. Current liabilities were $1.523 billion, compared with $304 million of current assets, so liquidity also depends on cash generation and credit availability.
Material changes, outlook and significant developments
- Capital investment: Charter expected 2014 capital expenditures of approximately $2.2 billion, including about $400 million for its all-digital transition. It expected positive free cash flow for 2014. Actual spending and cash generation remain dependent on operating results and the pace of the transition.
- Customer and operating strategy: Management described plans to grow customers and revenue through product and package changes, service improvements, increased digital and HD-DVR penetration, and insourcing of certain field, call-center and sales operations. It expected elevated capital spending to support these efforts.
- Comcast agreement after quarter-end: On April 25, 2014, Charter entered into a binding agreement covering an approximately $7.3 billion debt-financed purchase of systems serving about 1.4 million customers; an exchange of systems serving about 1.6 million customers for systems serving a similar number; and a contribution/spin-off arrangement. Charter expected to hold about 33% of SpinCo, which would serve approximately 2.5 million customers, and to provide management services for actual costs plus 4.25% of SpinCo gross revenue. The transactions were contingent on Comcast’s proposed TWC acquisition and other closing conditions. Charter said transaction valuations were based on a 7.125-times 2014 EBITDA multiple, subject to adjustments.
- Debt and interest-rate exposure: Debt principal maturities included $398 million in 2014, $1.1 billion in 2017 and $11.9 billion thereafter. Approximately 83% of debt was effectively fixed-rate, including swaps. Management cited refinancing and credit-market access as part of its liquidity plans; subsidiary distributions to parent entities are subject to debt covenants and legal restrictions.
- Risks and contingencies: Management cited competition, weak or mixed economic conditions, video customer losses, rising programming and retransmission-consent costs, and the risk that price increases could cause customer losses. The Comcast transactions carried regulatory, financing, integration, ownership-dilution, tax and execution risks, as well as potential added debt, interest and transaction costs. Montana property-tax litigation remained unresolved: approximately $25 million of protest payments were held in escrow, and prior-year assessments were accrued. Patent and other litigation could also result in material costs, though outcomes were not predictable.
- Unusual items: Q1 2013 included a $42 million loss on debt extinguishment, absent in Q1 2014. The Katz patent case settled in March 2014 for an amount described as not material. No impairments were recorded in either comparative quarter.
Most important facts for investors to verify
- Whether revenue, customer growth and Adjusted EBITDA continue to improve after separating Bresnan’s contribution from underlying performance.
- Whether Charter achieves its 2014 capital-spending and positive-free-cash-flow expectations, given Q1 free cash flow of $74 million and cash of only $4 million at quarter-end.
- How programming-cost inflation, video trends and competitive pressure affect margins and customer retention.
- Whether the Comcast transactions receive required approvals and financing, close on the stated terms, and deliver anticipated benefits without materially increasing leverage or costs.
- The outcome and potential cash impact of the Montana tax dispute and other legal contingencies, and Charter’s ability to refinance upcoming debt maturities while complying with covenants.