Cable One, Inc. (CABO) Q1 2016 Earnings Report, Transcript and Summary

Good morning and welcome to the Cable ONE First Quarter 2016 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Kevin Coyle. Please go ahead, sir.

Thank you, Operator. Good morning and welcome to Cable ONE's first quarter 2016 investor call. We're excited to have you with us this morning as we review our results. Before we proceed, I'd like to remind you that today's discussion will contain forward-looking statements relating to future events and expectations. You can find factors that could cause Cable ONE's actual results to differ materially from these projections listed in today's press release or in our recent SEC filings. Cable ONE is under no obligation, and in fact expressly disclaims any obligation to update its forward-looking statements whether as a result of new information, future events, or otherwise. Additionally, today's remarks will include a discussion of certain financial measures that are not presented in conformity with U.S. generally accepted accounting principles. Reconciliations of non-GAAP financial measures discussed on this call to the most directly comparable GAAP measures can be found in our earnings release or on our Web site. Joining me today on today's call is our Chairman and CEO Tom Might. And with that, let me turn the call over to Tom.

Thank you, Kevin. Good morning everybody, and welcome to Cable ONE's earnings call as we report our first quarter results. This is our fourth earnings call since our spinoff from Graham Holdings on July 1. And we have been very pleased with our performance over that period. Our 2012 strategic pivot away from video and triple play centrally focused to a residential HSD and business services focus is starting to yield regular rewards four years later. This is our consecutive quarter of strong year-over-year results following our spinoff. By now most of you are familiar with our non standard cable strategy so I will not repeat that story today. Instead, I will just emphasize the fundamental underpinnings of the strategy briefly, and then make some high level comments about our results before Kevin reviews the specifics. Here are five fundamental planks in our financial strategy. Number one, fully allocated cost models, we strongly believe that it is more important to look at long-term operating cash flow and free cash flow trends by product rather than contribution or gross margin by product. Number two, what we don't like for many reasons residential linear video and phone produce very modest operating cash flow today and no free cash flow to speak of. Add cord cutting trends to that and we think we can do better elsewhere. Number three, what we do like. Residential HSD and business services on the other hand have healthy margins and double digit growth rates. So that is where we are investing in the future rather than in the past. And number four, lifetime value matters. The lifetime values of customers and potential new starts, is very dramatically as well not only by package but by demographics. Historically, many of our new starts were unprofitable and subtracted from our bottom line, but not anymore. And number five, and last, business mix and margins. As our rich of revenue shift away from video and phone towards residential HSD and business services our margins should and are expanding predictably. Residential HSD and business services have grown from about one third of our total revenue to over one half in just three years. Now a few high level comments about our performance to help you interpret the results, first, rate increases. To make sense of our quarterly performance throughout 2015 and 2016 you need to take note of our non annual schedule of rate changes. As I have said before, the results of some quarters will be rate rich and some quarters will be rate poor. On the residential side, we are implementing a $4.96 broadcast TV surcharge beginning in June 2016. To recover a portion of our retransmission fees, we have no other 2016 video increases planned. Prior to this, our last residential video rate adjustment was effective in February 2015. We also made a $5.00 residential HSD rate adjustment when we doubled speeds in October of 2015, increasing our standard speed from 50 to 100 megabytes per second, which is the fastest standard speed in the majority of our markets that was nearly five years without an HSD rate increase prior to that. The annualized increase was less than 3%. These uneven rate adjustments have and will definitely impact quarterly comparisons. And number two, headcount reductions with the help of our strategy and our hardworking associates we have reduced our headcount by another 5% in the past year through attrition, which demonstrates that most costs are variable and not fixed. The total headcount reduction is 18% over the last five years. Our associates are committed to keeping Cable ONE on a highly efficient basis, running Cable ONE on a highly efficient basis while maintaining exceptional levels of customer satisfaction. Third, capital spending, so the last three years our CapEx spending is a percentage of revenues ran higher than usual. Meaning in the 20% range due to various plant investments, we have shared before that beginning in 2016 we expect CapEx spending to return to a more normal historical range of the mid to high teens, which should have a large positive impact on free cash flow. We now anticipate that CapEx for this year will trend more towards the mid-teens rather than the mid- to high-teens. And the allocation of capital, last, we are leveraged at 1.3 times operating cash flow and we have significant -- excuse me 1.3 times operating cash flow and we have significant free cash flow. And we have considerable capacity to invest in our business such as M&A activity and/or share repurchases. For example in the first quarter, we opportunistically repurchased more than 34 million of our stock which was considerably more shares than our buy backs in prior quarters. We also continue to thoroughly review organic and inorganic expansion opportunities for our business. Now I will turn it over to Kevin for more details on our Numbers.

Thanks, Tom. As Tom already mentioned we're very pleased with our financial results for the first quarter of 2016. And we're off to a solid start in the New Year. Before I discuss the financial results, I wanted to point out some information regarding our operating statistics. As we mentioned during previous earnings calls, we converted to a new billing system over the past year. This caused some reporting distortions in both our homes past and some business service PSUs. I'm not going to review these again in detail, but I wanted to mention that the explanation for these fluctuations is outlined in both our press release and our 10-Q. Now turning to our financial results, Total revenues declined slightly by 0.1 million or 0.1% due primarily to declines in residential video and residential voice revenues of 13.1 million and 3.3 million respectively. These declines were offset by increases in residential data and business service revenues of 14.4 million and 2.7 million respectively as residential data and business services become a larger portion of our overall revenues at 52.8%. Residential data service revenues increased 14.4 million or 20.8% due to several reasons. First, the fourth quarter HSD rate adjustment that Tom mentioned earlier, second, an increase in residential data customers of 2.2%, third, a reduction in package discounting, and finally, increased subscriptions to premium tiers by residential customers. Overall, residential data now represents 41.1% of total revenues as compared to only 34% in 2015. Residential video service revenues declined 13.1 million or 14.9%, due primarily to residential video customer losses of 17.2% and partially offset by the February 2015 video rate increase Tom noted earlier. Residential voice service revenues decreased 3.3 million or 22.3% due primarily to the decline in residential voice customers of 14.4%, as more residential customers have discontinued landline voice service, and an increase in voice service discounting. Business service revenues increased 2.7 million or 12.6%, due primarily to growth in our business data and voice services to both small and medium sized businesses and also Enterprise customers. Total business customer relationships increased 11.9%. As I mentioned previously the client and business voice customers and total business PSUs was primarily attributable to converting data into our new billing system in 2015. Overall, business services comprised 11.7% of our total revenues for the first quarter of 2016, compared to 10.4% of our total revenues for the first quarter of 2015. Advertising sales revenues declined 0.6 million or 7.5%, due primarily to the negative impact of decreased video customers on the number of viewers available to be reached by advertising spots. Now turning to our operating costs and expenses, total operating cost and expenses decreased 11.6 million or 6.9%. Of this total, operating expenses excluding depreciation declined 4.4 million or 5.5%, due primarily to a reduction in residential video customers. And this reduction significantly reduced programming costs. Selling, general, and administrative expenses declined 5.4 million or 11%, due primarily to decreases in processing costs for customer billing of 3.8 million following the completion of our billing system conversion. We also reduced property taxes of 1.2 million and also had decreases in salary, wages, and pension-related cost. These were partially offset by increases in equity-based compensation expense. Interest expense was 7.6 million for the first quarter of 2016, attributable to our long-term debt incurred in connection with the spinoff. No interest expense was incurred in the first quarter of 2015. Adjusted EBITDA of 85.3 million increased 14.2% due primarily to decreased operating cost and expenses which we already discussed. The impact of increases in residential HSD and business services customers along with the HSD rate increase taken in the fourth quarter of 2015. Free cash flow which we define as adjusted EBITDA less capital expenditures increased 14.9 million or almost 35%. For the quarter, our conversion rate defined as adjusted EBITDA less CapEx as a percentage of adjusted EBITDA was approximately 68%. This was due to the increase in adjusted EBITDA coupled with lower capital expenditures during the quarter. Capital expenditures for the quarter totaled 27.4 million compared to 31.7 million during the first quarter of 2015. This decrease was primarily due to a decrease in spending for customer premise equipment, our all digital initiative, plan upgrades, channel bonding and fiber deployment. As Tom mentioned in his remarks, we now expect 2016 capital spending to be in the mid teens as a percentage of revenue. Turning to liquidity, during the first quarter of 2016, our cash and cash equivalents decreased by 13 million versus the year ended December 31st, 2015. And at March 31st, 2016 we had approximately 106.2 million of cash on hand compared to the 119.2 million at December 31st, 2015. The decrease in cash during the first quarter of 2016 was attributable primarily to cash payments for capital equipment, share repurchases, dividends and interest. During the quarter, as Tom mentioned, we repurchased 81,834 shares at an aggregate cost of 34.6 million. So in conclusion, we're off to a very solid start in 2016 with growth in residential HSD and business services contributing to our strong results. We believe this demonstrates the soundness of our HSD and business services centric strategy. And just to conclude with the highlights that we mentioned in our press release, adjusted EBITDA grew by 14.2% with a margin of 42.1%. Free cash flow increased almost 35%. Residential data revenues increased 20.8%. Business service revenues increased 12.6% and residential data and business services revenues now represent a majority of our revenues at 52.8%. So with that, Operator, we're now ready for questions.

Thank you, sir. We will now begin the question-and-answer-session. [Operator Instructions] And our first question comes from Bill Cusick from JPMorgan. Please go ahead.

So first of all, CapEx in the mid teens what, Tom, do you think you don't have to spend on now?

Well, we've outlined in our Form 10 a year ago and several times since the four major unusual capital investments we were making in things like all digital, CMPS replacements, bandwidth expansion, et cetera. And we've put years on all of those as well in the Form 10, so you could see they were largely expiring last year or a few all digital for example ends at the end of this year. We have three systems left to do. So it's really the expiration of all those onetime unusual plant enhancements that are coming to an end.

Good. And then in broadband, forgive me, because you've talked about this a number of times, but I keep getting the question from investors. Can you remind us why at 28% market share your broadband potential and speed of penetration isn't much higher? It seems like given your low competitive levels that there should be a lot of opportunity here.

Yes, I think we're at 31%, 33% but nonetheless it's low compared to others. And however, there are two things that we're confident predicts, a particular system and a particular MSOs internet penetration generally. And that is demographics, household income, and competitive overbuilds. We have an enormous range of penetrations in our 38 systems. And that's where we're getting that confidence from. We see the correlations and they're very high. So Suddenlink and Mediacom, and Cable ONE all have lower internet penetrations for example, because we're all almost entirely rural operations. Where you have cable vision and the other extreme, the highly metropolitan system, which is another way of sort of confirming that this sense that it has a lot to do with demographics. But we are fairly overbuilt. We've stated from Form 10 a year ago, we're approximately, as best we can estimate it, 25% of our passings are overbuilt. And that has a significant influence as well. But we see a long, long good upside of moving the number up with 2% to 3% growth per year for a long time, particularly with our very superior product.

Phil, this is Kevin. Again what Tom just said on the demographics is the case for most of it. But keep in mind we have a premium product and we do it at a price which we think is extremely fair. We don't do substantial discounting. We could obviously if we were PSU motivated or percentage of homes passed motivated, we could do significant discounting and move that up. But the customers we have on HSD are obviously extremely profitable, and they're getting a very high quality product at 100 migs. So it's a factor of both demographics and pricing.

Okay, and as you think about the penetration of broadband in your markets, national is about 78%. Are you that far below that you think you have less than a 50% share maybe?

No, we have well more than a 50% share. It's just the nature of the markets. And again it varies dramatically in different parts of our company even though it's the same product, the same packaging. It's demographics and competition is the difference from market to market.

And our next question comes from Craig Moffett from Moffett and Nathanson. Please go ahead.

Tom, two questions, first I want to go back to this comment you made about inorganic opportunities. Can you just put some meat on the bones there? Do you see an opportunity to take your sort of video light, broadband heavy strategy to other systems? And if so, what are the characteristics of a system that you'd be looking for that would make it an attractive opportunity besides just valuation? And then I wonder if you could also just talk a little bit about your broadband pricing strategy going forward. You've obviously made some pretty big readjustments. But how do we think about a longer term sort of steady state for what you think is doable with broadband pricing?

Okay, well I don't want to comment about any specific target of opportunity for M&A. But generically talking about video light, almost every cable system smaller than us is using a version of our strategy. It doesn't get reported much because there are few that are public. One is a GCI in Alaska, for example, they're public. You can get their information. They're very much doing a similar strategy. There are one exceptions that are still following the same packaging and pricing of the larger cable companies. So in most cases it's not that there's an opportunity, it's a compatibility if we were to find an acquisition target our size or below from a video point of view. On the broadband pricing, I'm sticking with what we've been saying for over a year even though we're doing much better than that for the last two quarters. But we would like to see a long-term, consistent growth in HSD or broadband revenue made up of three small percentages that could possibly be a double digit compounded or total percentage. And that's 2% to 3% of unit growth residentially, 2% to 3% of CPI or inflationary rate increases annually. Although we may not take them manually, but they would net out over the years to be an inflationary level of increase, and the similar amount of 2% to 3% from higher end customers moving to premium tiers, and that is what's right now running a little hot. We have a lot of favorable mix with customers migrating to the premium tiers at this point.

[Operator Instructions] Our next question comes from Stephan Bisson from Wells Fargo. Please go ahead.

It's Stephan. A quick question on the broadcast fee, is that going to hit 100 percent of subscribers?

Yes, it is.

And is that large enough to cover the increase in programming expenses this year?

Yes, we believe that's the case. That's where we determined that fee to come from.

I think we're maybe about the last one to, Stephan, to implement such a fee.

As far as I know that's 100 percent true. And then lastly you guys had some great expense trends in the quarter, and you outlined them really well. There were no one time in that, so the $3.8 million in customer billing savings, that should be repetitive, the same with property taxes?

Well, on the billing, Stephan, I think you have to be a little bit careful. When you go back to '15 we were in the middle of a conversion to our new billing system, Singleview. We also had double billing system going on because we were still supporting cable data. So you had a little bit of a double up between cable data fees and Singleview conversion fees. We definitely believe that the Singleview billing system will be less expensive than the cable data in the past. But you did have a doubling up in fees in the first quarter of 2015. So I don't think you want to forecast necessarily that kind of savings is going to be there quarter-to-quarter.

And that concludes the question-and-answer session. I'd now like to turn the conference back over to Tom Might for any closing remarks.

Thank you, Operator. As I said earlier, we are pleased with our trajectory since the spinoff. And I'd like you to please note that Kevin and I will be participating at an upcoming JPMorgan global technology media and telecom conference in Boston on May 23rd. And you can access a webcast of our presentation on our investor Web site. Thank you for joining us today. We look forward to speaking with you next quarter.

Thank you all.

Thank you.

The conference has now concluded. Thank you for attending today's presentation. You may disconnect the lines.