Charter Communications Inc (CHTR) — Q4 2019 Earnings Call Transcript

Good morning and welcome to Charter's fourth quarter 2019 investor call. The presentation that accompanies this call can be found on our website, ir.charter.com, under the Financial Information section. Before we proceed, I would like to remind you that there are a number of risk factors and other cautionary statements contained in our SEC filings, including our most recent 10-K filed this morning. We will not review those risk factors and other cautionary statements on this call. However, we encourage you to read them carefully. Various remarks that we make on this call concerning expectations, predictions, plans, and prospects constitute forward-looking statements. These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ from historical or anticipated results. Any forward-looking statements reflect management's current view only and Charter undertakes no obligation to revise or update such statements or to make additional forward-looking statements in the future. During the course of today's call, we will be referring to non-GAAP measures as defined and reconciled in our earnings materials. These non-GAAP measures, as defined by Charter, may not be comparable to measures with similar titles used by other companies. Please also note that all growth rates noted on this call and in the presentation are calculated on a year-over-year basis unless otherwise specified. Joining me on today's call are Tom Rutledge, our Chairman and CEO; and Chris Winfrey, our CFO. With that, let's turn the call over to Tom.

Thank you, Stefan. Our operating strategy continues to deliver strong results, and we remain focused on driving customer growth by delivering superior services and value to our customers, improving the quality of our operations by reducing unnecessary service transactions and truck rolls per customer, delivering sustainable free cash flow growth by driving EBITDA growth while reducing capital intensity; and finally, positioning our company for long-term customer relationship growth with current and new products by continuing to evolve a fully converged network that delivers high speed, low latency, seamless connectivity services inside or outside customers’ homes. In 2019, we created over 1.1 million new customer relationships, substantially more than 2018. We added over 1.4 million new Internet customers, also more than 2018. We grew our full year cable-adjusted EBITDA by 6.6% in a non-political advertising year. Combined with our lower cable capital expenditures, our 2019 cable free cash flow grew by over 100% year-over-year. We expect that our cable EBITDA growth combined with our declining capital intensity and disciplined capital deployment strategy will drive continued strong free cash flow growth. Our mobile business is a strategic extension of our core connectivity capabilities today and in the future, and it continues to grow. We now have well over 1 million mobile lines in service with over 900,000 of those added in 2019 at an accelerating pace. In 2019, we saw a substantial reduction in service transactions per customer relationship, reflected in lower calls, trouble calls, truck rolls, and billing calls. We also performed fewer physical installation truck rolls, giving way to growing levels of self-installation activity. Looking forward to 2020, we're well positioned to continue to reduce service activity per customer, given the higher level of customers in Spectrum pricing and packaging, the completion of our in-sourcing program, and increasingly experienced in-house call center and field operation workforces. Overall, we expect improvements in customer satisfaction, lower churn, and a reduction in the cost to service customer relationships. Our in-home connectivity product set also continues to improve with 85% of our residential Internet customers now receiving minimum Internet speed of 100 megabits or more, and nearly half receiving minimum speed of 200 megabits or more. We continue to outperform in megabits, our ultra product, and our gigabit speed tier across our entire footprint. We made our network capable of providing gigabit service everywhere we operate using DOCSIS 3.1 technology over the course of 13 months for $450 million in planned capital. Through our 10G plan, we also have a cost efficient pathway to offer multi-gigabit speeds and lower latency to consumers and businesses that continue to attach more devices to our network, using more data on a daily basis, demanding greater network responsiveness and reliability. During the quarter, we also continued to deploy our advanced home Wi-Fi capabilities to new markets beyond Austin, Texas, including Dallas, San Antonio, and close to Southern California. Our advanced Wi-Fi capability provides enhanced security, privacy, and app-based control of all IP devices in our consumers’ homes while simultaneously delivering a superior customer experience with better in-home Wi-Fi coverage. So far, our deployment has gone well, and we plan to roll out this capability throughout our entire footprint. Our Spectrum Mobile business continues to grow quickly, and we added over 280,000 lines in the fourth quarter, more than we added in the third quarter. While it's still early, we believe that our results so far indicate our mobile product drives core connectivity, customer satisfaction, and will generate standalone profitability at scale. Additionally, we continue to test tools and technology using CBRS spectrum by small cells mounted on our own high capacity two-way network, with our tests continuing to go very well. We continue to add features and functionality to our Spectrum Mobile product, and in the first quarter, we plan to offer 5G mobile service. Now, I'll turn the call over to Chris.

Thanks, Tom. Before covering our results, a quick reminder that we closed the sale of Navisite managed cloud services business within the Spectrum Enterprise in September. We have not prepared pro forma financials reflecting the results of Navisite in the fourth quarter of 2018 but not in the fourth quarter of 2019. For the next few quarters, I will discuss Enterprise revenue growth including and excluding Navisite for comparability. On an annual basis, Navisite generated roughly $150 million in revenue, and its impact on our EBITDA and CapEx was not material. Turning to our results on Slide 5. Over the last 12 months, we grew total residential and SMB customer relationships by over 1.1 million, or 4%, and by 268,000 in the fourth quarter. Including residential and SMB, we grew our Internet customers by 339,000 in the quarter and by 1.4 million, or 5.6%, over the last 12 months. Video declined by 101,000 in the quarter, wireline voice declined by 128,000, and we added 288,000 higher ARPU mobile lines. At the end of the fourth quarter, 85% of our residential customers were in Spectrum pricing and packaging. Residential customer relationship growth accelerated to 3.8% year-over-year. As we look at 2020, our goal is to accelerate our full year customer growth rate as we deliver highly competitive products with better service driving connects and reducing churn. In residential Internet, we added a total of 313,000 customers in the quarter, resulting in residential Internet customer growth of 5.4% year-over-year, driven by continuing churn improvements. In residential video, we lost 105,000 customers in the quarter, primarily driven by lower video gross additions year-over-year. In wireline voice, we lost 152,000 residential customers in the quarter, driven by lower sell-in following our transition to selling mobile in the bundle and continued fixed and mobile substitution in the market generally. Turning to mobile, we added 288,000 total mobile lines in the quarter, driven by the value of our mobile product offers, growing brand and product awareness and increased sales effectiveness. As of December 31st, we had nearly 1.1 million lines with a healthy mix of both Unlimited and By the Gig lines. Spectrum Mobile continues to scale with less EBITDA loss per line even at an accelerating net addition rate, and that does not include any benefits to our traditional cable connectivity business. Over the last year, we grew total residential customers by just over 1 million, or 3.8%. Residential revenue per residential customer relationship grew by 1.8% year-over-year given a lower rate of SPP migration and promotional campaign roll-off and rate adjustments. Those ARPU benefits were partly offset by a higher mix of non-video customers, a higher mix of streaming and lighter video packages within our video base, and $29 million of lower pay-per-view revenue year-over-year in the quarter. Our cable ARPU does not reflect any mobile revenue, but Q4 especially benefited from the timing of the rate adjustments this year. The Slide 6 shows our cable customer growth combined with that elevated Q4 ARPU growth resulted in year-over-year residential revenue growth of 5.7%. Turning to commercial, SMB revenue grew by 6.3%, faster than last quarter as the revenue effects from the repricing of our SMB products continue. SMB customer relationships grew by 6.8% year-over-year. Enterprise revenue declined by 4.5% year-over-year driven by the sale of Navisite and the one-time cell tower backhaul fees that we mentioned as a benefit in the fourth quarter of 2018. Excluding Navisite from the fourth quarter of 2018, Enterprise revenue grew by 1.3% in the fourth quarter of 2019. Excluding both cell tower backhaul and Navisite, Enterprise grew by 8.5%. I expect that retail portion of Enterprise to continue to grow nicely, as the wholesale piece including cell tower backhaul will continue to be challenging. Fourth quarter advertising revenue declined by 23% due to less political revenue in 2019. Our non-political advertising revenue grew by 4.6% year-over-year primarily due to our advanced advertising capabilities and recently deployed products that efficiently sell highly viewed long-tailed inventory using our own anonymized and more detailed viewing data. As we look to the full year 2020, we expect to continue that growth driven by our advanced advertising business and a healthy year of political revenue. Other revenues declined by 6.6% year-over-year driven by lower processing fees and lower home shopping revenues related to video subscriber declines, partly offset by higher levels of video CPE sold to customers. Mobile revenue totaled $236 million, with $138 million of that being device revenue. In total, consolidated fourth quarter revenue was up 4.7% year-over-year. Cable revenue growth excluding mobile was 3.4%, or 5.2% when excluding advertising in both years and Navisite in 2018. Moving to operating expenses on Slide 7. In the fourth quarter, total operating expenses grew by $165 million, or 2.3% year-over-year. Cable operating expenses excluding mobile were essentially flat, or up 0.6% when excluding Navisite, despite strong relationship and revenue growth. Programming increased by 0.6% year-over-year due to higher rates that were offset by video customer decline of 2.8% year-over-year, a higher mix of streaming and lighter video packages such as Choice and Stream, and lower pay-per-view expenses year-over-year tied to the $29 million of lower pay-per-view revenue I mentioned. Looking at full year 2020, we expect programming costs per video customer to grow in the mid-single-digit percentage range. Regulatory, connectivity, and produced content grew by 4.3% and that was driven by higher costs of video CPE sold to customers and original programming costs. The cost to service customers declined by 2.3% year-over-year, compared to 4% customer relationship growth. We're meaningfully lowering our per relationship service costs through several operating, quality, and efficiency improvements, which is core to our strategy. Key metrics like calls per customer, truck rolls per customer, churn, self-install rates all continue to move in the right direction as Tom mentioned. Looking ahead, we expect further declines in the cost to service customers on a per customer relationship basis; however, this quarter’s level of operational productivity was exceptional, and it will be replicated every single quarter. Cable marketing expenses increased by 2.1% year-over-year, and other cable expenses were down 1.4% driven by lower ad sales costs, which will reverse in a political year. Mobile expenses totaled $372 million and were comprised of mobile device costs tied to device revenue, customer acquisition and usage costs, and operating costs to stand up and operate the business. Our 2020 mobile EBITDA probably looks similar to 2019 due to growth and the scale of costs. However, looking further ahead, our current expectation is that in 2021, our mobile service revenue will exceed all regular operating costs, excluding acquisitions and growth-related mobile costs. Turning to EBITDA, we grew total adjusted EBITDA by 8.8% in the quarter when including the mobile EBITDA startup loss of $136 million. Cable adjusted EBITDA grew by 8.9% in the fourth quarter, including a roughly 3% negative growth rate impact from advertising revenue net of its associated expense in both periods. Turning to net income on Slide 8, we generated $714 million in net income attributable to Charter shareholders in the fourth quarter versus $296 million last year. The year-over-year increase was primarily driven by higher adjusted EBITDA and the loss on financial instruments in the prior year period, partly offset by higher income tax expense. Turning to Slide 9. Capital expenditures totaled $2.3 billion in the fourth quarter, with the cable CapEx declining about $200 million year-over-year, driven by the same CPE trends, DOCSIS 3.1 benefits, and lower in-sourcing and integration costs I’ve mentioned throughout the year. We spent $151 million in mobile-related CapEx this quarter, mostly accounted for in-support capital; it was driven by software and development costs and retail footprint upgrades for mobile. In 2020, we expect our mobile capital expenditures to be similar to 2019 and then decline significantly in 2021 as that work will be behind us. And mobile CapEx outlook excludes any potential mid-band Spectrum acquisition buildout, which would be based on a separate ROI evaluation. In 2020, we expect our cable CapEx intensity to continue to decline from the 15% in 2019. And on an absolute dollar basis, we don't expect our cable capital expenditures to be meaningfully different from 2019 levels. Similar to what I just said about our mobile capital expenditures, if we find new high ROI projects during the course of the year, we’d still do so. The Slide 10 shows we generated $1.6 billion in consolidated free cash flow in this quarter. Excluding our investment in mobile, we generated $1.9 billion of cable free cash flow, up $700 million versus last year's fourth quarter. For the full year 2019, we generated $5.8 billion of cable free cash flow, up $3 billion versus 2018, despite a cable working capital headwind of $800 million this past year. For the full year 2020, we would expect cable working capital to improve significantly with a neutral to slightly negative impact on our cash flow. We still have typical seasonal swings including the first quarter in which our working capital is almost always a use of cash. With respect to mobile working capital, we continue to add mobile customers at an elevated pace, which will continue to drive handset-related working capital needs in 2020. In any event, our free cash flow profile improved significantly last year. We are positioned to continue to couple our free cash flow growth with our return-focused investment and capital strategy. We finished the year with $78.4 billion in debt principal and $74.9 billion in net debt. Our current run rate annualized cash interest is $4 billion. As of the end of the fourth quarter, our net debt to last 12 months adjusted EBITDA was 4.45 times at the high end of our 4 and 4.5 times leverage range. While calculating our leverage, we include the upfront investment in mobile to be more conservative than looking at cable-only leverage, which was now 4.31 times at the end of the fourth quarter. During the quarter, we repurchased 5.6 million Charter shares and Charter Holdings common units totaling about $2.6 billion at an average price of $459 per share. For the full year 2019, we repurchased over $7.6 billion of our equity. Since September 2016, we've repurchased over $27 billion, or a bit more than 25% of Charter's equity at an average price of $346 per share. Turning to taxes, our tax assets are primarily composed of our NOL and our tax receivables arrangement with Advance/Newhouse. We do not anticipate becoming a meaningful federal cash taxpayer until 2022 with some modest federal cash tax payments beginning in late 2021, as we expect the bulk of our existing NOL to be utilized by the end of that year. For the years 2022 through 2024, we expect our federal and state cash taxes to approximate our consolidated EBITDA, less our capital expenditures, and less our cash interest expense multiplied by 21% to 23%. That estimate would include part of our tax distributions to Advance/Newhouse captured separately in cash flows from financing in the financial statements. There are multiple factors that impact what I just described, and we're always looking for ways to improve our cash tax profile, but it's a good baseline for today. We’re pleased with our results and we believe in our operating strategy, our network capabilities, and the balance sheet strategy which all work in concert to create value over a long period of time. Charter has infrastructure assets with strong growth characteristics and cash flow yield. We have a lot of ancillary products to utilize on top of core connectivity services, and combined with good value and service will drive cash flow growth with tax-advantaged levered equity returns.

Chris, you gave a lot of good detail on some of the cost metrics, as we look out into 2020. And the 200 basis points you guys saw in cable margin improvement this quarter, especially with the advertising headwind, I think was really the highlight. But putting it all together in terms of the programming and cost to serve continuing to come down, how should we think of cable margin trends heading into 2020?

Sure. On one hand, you had a headwind, as you mentioned, political advertising not being in the fourth quarter of 2019. On the other hand, we had some fairly exceptional pieces that were taking place as well as the timing of our rate increases earlier inside of Q4 2019 than it has been in prior years. I think that results in a higher ARPU for customer relationship growth in what would be a sustainable either prior to that quarter or inside of 2020. So you need to take that into account. I think that growth rate given the subscriber mix could look a lot more like what we saw for the full year of 2019 and that with what we saw in Q4. The second thing I'd mention is that programming has done very well on a gross and per customer relationship basis. I think it'll still do well relative to other years. But at least like a mid-single-digit per customer relationship growth in programming cost in 2020. And then finally, as I mentioned, the cost to serve was exceptional in the fourth quarter. Our cost to serve for customer relationship has been declining, and it's going to continue to decline, which is our expectation. But to have an actual gross decline, significant one inside the quarter was a big step down. I encourage people not to replicate that every single quarter. So then working against that, again, I am not giving guidance but ways to help you to build a model, particularly later in the year, we expect to see a pretty good year for political advertising. All-in, I think it's going to move around, and it's not something that we actively manage inside the business. What we’re managing is can we grow our customer relationships faster? And that's our goal, which will then drive better revenue growth.

Following up there, Chris, you talked about lower video gross ads year-over-year. Is that a result of fewer promotions and changed incentives? And you said the goal is to accelerate customer growth rate. How do you expect that to go in terms of gross ads and churn going forward? And then, a follow-up if I can on the in-sourcing program, you talked about it in your commentary. Where are we on the completion of that, and how much in terms of costs are still being duplicated as you in-source labor and everything else?

Sorry, Phil, what was your second question? So first one is lower video gross ads, third one is status of in-sourcing program. But I think it's more a function of the marketplace more than anything else. We still believe in video as an attractive piece of the user connectivity package that we offer. It’s an important attribute and it’s investment in the growth of the traditional set-top box as well as all of our IP platforms.

The lower gross ads I think are a function of the marketplace. It's not material to what drives our economic model, but it is a nice small addition to our broadband connectivity business.

On the in-sourcing program, the in-sourcing is essentially complete. We have well over 90% of our service calls handled in-house and onshore. In the field service side, you need to have some contract labor available for service, but we're well over 75% with our labor in-source there. This has been the case for both of those for some time now. There's very little in the way to talk about costs anymore that's in the system. I think that it's going to continue to get better for all the reasons Tom mentioned. The tenure of our employees gets longer, which means they get more experienced and do higher quality transactions. The amount of self-installation is going up. The number of calls and truck rolls are going down. The churn is going down. The amount of digital transactions is also going up which means less labor intensive service infrastructure. I believe this trend will continue for a long period.

Tom, you just mentioned how video can be very complementary to your core broadband product. There are a number of new direct-to-consumer video products coming soon, whether it's HBO Max or Peacock, and those providers have all said they're looking for distribution, including through MVPDs. I was hoping you could give us your updated thoughts around being a partner for some or all of them. And maybe some of the factors that you have to think through as you decide whether it makes sense, whether it's the economics, technical issues, or just some strategic considerations that are weighing on whether or not you're intending to do this?

There's an opportunity enough marketing direct-to-consumer products in our relationship with programmers. Those relationships are operating under the old model, too, which is the bundled cable model. We can have a bundled product that will be selling for years to come; however, we are also selling direct-to-consumer products. Because of our customer relationships, we can package these products into our overall product mix, with user interfaces designed to help enhance. We have an opportunity to create and help programmers sell their content in a mutually beneficial way. So we have ongoing discussions with all of the entities out there. While there's a lot of dislocation going on in the video business, there's an opportunity within.

Two questions for either of you or both of you. Tom, any change in how you're thinking about pricing the video business in particular? It seems to us like a more aggressive increase in your video pricing than you've done in the past. I was wondering if that reflects a change in your mind about how you manage the business? And then Chris mentioned in his prepared remarks the mid-band spectrum and any acquisition buildout there. I was just curious where your collective head was at on that opportunity, if that’s something that's becoming more likely, less likely or just how we should be thinking about that as we go through this year.

I think fundamentally, we didn’t change anything with regard to our pricing strategy, which is price isn’t the major component of how we drive our revenue growth, it’s subscriber growth, and we have accelerating subscriber growth. We expect to continue to have accelerating subscriber growth because of the product strategy. The bulk of our revenue growth comes from that. The adjustments with retransmission consent fees are part of the video pricing. However, our fundamental strategy is not different. We are interested in mid-band spectrum; there's an auction coming up for CBRS. We are likely to participate in that auction. I think there's an opportunity for us. The SEC has been helpful in positioning that spectrum in a way that's an opportunity for us. We will be disciplined in terms of the ROI for the spectrum, considering costs, what are the costs to build and the financial return for doing so.

Two questions if I could. First on the wireless business, how much traffic do you think you'll eventually be able to offload, and is there any scenario where you'd want to go to a full facilities-based strategy where you would own your entire network? And then back to the videos question, how do you think differently about programming renewals given the change in tone around your video strategy?

The wireless situation really stems from the economics of what you pay for your MVNO rate and what's the cost to build, what's the economic traffic zone inside of a particular area, and how all that works. As we think about it, there's no immediate plan to change our fundamental relationship with our carriers. Over time as the market evolves and as capacity goes up, the economics may change, and we will take advantage of those changes as the marketplace unfolds. Regarding programming, the biggest issue in the bundled package is price, and many people have been priced out of the market. We continue to negotiate contracts and the relative value of the content is changing. I don't expect the distribution dynamics to change considerably in the next couple of years.

Your thinking is correct about needing to evaluate the need for physical network pieces, taking into account various costs and how those interact. We haven’t seen anything demonstrating the need to move to a fully facilities-based strategy with our current relation with Verizon.

Just clarifying regarding the cost of service. Should we assume we're not going to see the same level of improvement in cost of service year-over-year? And when it comes to Legacy Time Warner churn, where does that sit relative to Legacy Charter churn, and whether Legacy Charter churn has finally bottomed out?

The cost to serve trend has continued to go down on a per customer basis. There are reasons for this trend. However, the pace and how it manifests quarterly isn't something you should extrapolate straight-line. The overall customer activity is due to digitization and software-defined operations, which have lower overall operating costs. Legacy TWC churn continues to be elevated relative to Legacy Charter, but continues to decline at a faster rate than Legacy Charter.

I have a follow-up. You mentioned that you expect to accelerate customer growth rate. Are we talking high speed data only, or are you including video in this? Additionally, can you discuss your plans to offer a service similar to Comcast Flex, or how you're thinking about evolving your broadband product to enhance its differentiation?

When I spoke about accelerating growth, I was discussing high speed data and customer relationship growth. Regarding Flex or similar products, yes, we are pursuing various IP relationships. We have IP-based relationships with companies like Apple, selling devices through them. We are investing in our broadband platform to enhance it further. We're taking our minimum speeds up while enhancing our advanced Wi-Fi products, allowing customers to manage devices effectively via our network.

Tom, you mentioned 10G as the next phase now that the 3.1 rollout is complete. Can you share the timing or magnitude of that deployment? Also, you noted that your strategy isn’t dependent on M&A. What are your thoughts on the M&A landscape, particularly in terms of horizontal or incremental vertical acquisitions?

With 10G, we just upgraded our network to 1 gigabit everywhere. 10G includes specifications that allow us to get to 10 gig symmetrical services with very low latency. There's no immediate need for a major deployment; it's more of an evolution that we can invest in as we move forward. With M&A, we don’t have anything to discuss right now. Much of the cable business is owned by controlled shareholders in the United States, and we think we have a great business with growth opportunities.

Can you discuss the factors contributing to the decline in scalable infrastructure capital in 2019, and how you foresee spending in the coming years? Also, as you finish up your SEC commitment for new homes passed, what should we expect for homes passed growth rate moving forward?

We're experiencing advantages from the 3.1 deployment, which decreases the required scalable infrastructure capital for now. Internet utilization is continuously on the rise, which impacts capital requirements. Homes passed will increase as household formation progresses, and we've already built more passings than originally required by consent decrees.

We're temporarily lower in the scalable area for 2019 and likely for 2020 due to the ongoing benefits of the DOCSIS 3.1 rollout. Various line items will continue to adjust based on integration capital, but while capital intensity may be temporarily lower, we're still investing to drive growth.