Cable One, Inc. (CABO) Q4 2017 Earnings Report, Transcript and Summary

Hello, everyone, and welcome to the Cable One, Inc. Fourth Quarter 2017 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Kevin Coyle. Please go ahead.

Thank you, operator. Good morning, everyone, and welcome to Cable ONE's Full Year and Fourth Quarter 2017 Earnings Call. We're excited to have you with us this morning as we review our results. Before we proceed, I would like to remind you that today's discussion may 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 and in our current 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 website at ir.cableone.net. Joining me on today's call is our President and CEO, Julie Laulis. And with that, let me turn the call over to Julie.

Thank you, Kevin. Good morning, and welcome to our fourth quarter and full year 2017 earnings call. I'll start by touching on a few highlights and then turn the call over to Kevin to provide a full recap of our financial performance. We announced in our press release this morning that we revised our historical financial statements mainly related to our capitalized labor change that we've discussed on prior calls. Kevin will address this later in the call. I'd like to first take a moment to reflect on 2017, which was a year of growth, opportunity and teamwork for Cable ONE. We acquired NewWave Communications, which enabled us to expand into new markets and bring faster and more reliable service to customers in these cities and towns. I consider the NewWave acquisition a resounding success at this stage. From a financial perspective, adjusted EBITDA as well as both HSD ARPU and margins have improved faster than our original internal forecast. We are also ahead of our operations plan. And we continue to work to culturally assimilate the 2 companies, sharing best practices from both. Capital improvements and streamlining processes and platforms as well as embracing our strategies for success have been areas of emphasis. In keeping with our long-term focus, our work on NewWave, or what we call our Northeast Division, has us targeting actions that will pay off over time. Despite some short-term impacts that decelerated unit growth there, we're confident that a shortened, more disciplined collection cycle, a cessation of deep and lengthy discounts as well as other lifetime value measures focused on profitability, not pure market share at any cost, will benefit us when we roll out our eventual pricing and packaging migration. For Cable ONE as a whole, there are many moving parts to keep track of: our accounting change associated with capitalized labor; a partial year of Northeast Division financials; the impact of Hurricane Harvey across both legacy Cable ONE and Northeast Division systems; and most recently, the revision of our financial statements. We have attempted to provide and will continue to lend transparency to these items. Meanwhile, Kevin and I will help to offer clarity in the big picture as well. And speaking of the big picture, we believe that our strategy continues to bear fruit as we emphasize growth products of residential HSD and business services, drive operational efficiencies and capitalize on favorable competitive dynamics in our largely non-metropolitan markets. As we focus on the long term, the company has been taking steps to ensure a strong, diverse and talented bench. Our team has been evaluating our strategy and refining our tactics. As part of that effort, we are employing expanded business intelligence tools to help us make informed decisions. We believe that these initiatives are providing a sound path to sustainable adjusted EBITDA growth and situate us well for the future. One example from 2017 was moving away from year-round discounting of our flagship 100 meg HSD product in order to establish and dimensionalize the value of this service. Early indications show that our already low churn is going even lower. And as a side result, ARPU rose in the fourth quarter due to the lack of these promotions. This approach allows us to strategically test marked sales techniques and offers to drive profitable connects and growth. Additionally, we are shifting away from a one-size-fits-all marketing philosophy. Armed with data, we're confident that the adjustments we're making to be more responsive to market demand will prove profitable in the long run. We have multiple levers, which include units, ARPU and total revenue, at our disposal to wisely calibrate growth that make sense for both our customers and the future success of our company. A combination of testing, data mining and implementation of alternative approaches will help set Cable ONE on the path for reliable growth over time. Given all that we have done and what is currently in process, I am comfortable where our HSD product and pricing is headed. On the business side, we had another strong year as revenues climbed nearly 12% for legacy Cable ONE. On the enterprise side, we continue to see robust growth while SMB is providing positive performance despite its maturity and higher penetration of this segment in our market. To continue driving that growth, our plan is to accelerate deployment of Piranha Fiber, given its success. As a reminder, Piranha Fiber offers an extremely reliable fiber-based architecture and shared bandwidth service to mid-market businesses that delivers faster speeds for customers and higher revenue per customer for the company. We are also preparing to release SIP trunks and hosted voice in the second quarter of 2018, which will provide cost-effective, flexible and scalable solutions for our business customers. Overall, we delivered strong financial results in 2017, generating more than $960 million in revenue, increasing adjusted EBITDA by nearly 27% and finishing the year with adjusted EBITDA margins north of 46%. From an operational perspective, we are striving to make the lives of our customers easier by offering value-added services. For example, we began offering self-installation for residential customers. And we launched Wi-Fi ONE, a solution that provides our customers with enhanced Wi-Fi signal strength and extends and improves the Wi-Fi signal throughout their home. As we look forward to 2018, we envision our business continuing to evolve. Our strategy remains the same, to attract long-term profitable customers, to take care of our associates and to deliver solid results for our shareholders. We will continue to execute to achieve our goals. We know that we must not be complacent in the face of competitive pressures, emerging technologies and the changing needs of consumers. That is why we are exploring ways to refine our business to continue to drive sustainable growth in residential data and business services. We enter 2018 energized and enthusiastic and purposeful as we embrace the many opportunities on our horizon. And before we move on to Kevin and the financials, I want to take a step back to the industry versus just our company and reinforce something we've said regarding Title II. As a provider of broadband Internet service in more than 750 communities across the U.S., Cable ONE has always been committed to an open Internet that gives our customers the freedom to be in charge of their online experience, and that will not change. We firmly stand by that commitment because it is good for our customers and good for our business. And now Kevin will provide more details on our fourth quarter and full year 2017 results.

Thanks, Julie. Before getting into the details, I want to remind everyone that our 2017 results include 8 months of NewWave operations and also the negative impact of Hurricane Harvey. Further, as we mentioned in our earnings release, we revised our historical financial information to properly reflect the accounting for certain categories of capitalized labor costs and other immaterial adjustments. During 2017, as previously mentioned, we changed our accounting related to the capitalization of certain internal labor and related costs associated with construction and customer installation activities. This was the result of additional information available from new systems and processes. Initially, we classified the entire change as a change in accounting estimate. After various discussions with the SEC staff, we determined that a portion of what had been previously disclosed as a change in estimate should have been categorized as a change in accounting principle. A portion was determined to be the correction of an error and a portion remained as a change in estimate. There were no changes to our previously reported results from the change in principle or the change in estimate. We revised our historical financial statements to properly reflect the impact of the labor capitalization, including the related impact of depreciation expense and income taxes based on the correction of the error. The impact of the revision was immaterial on our comparative prior periods with 2016 increases in net income of $2.2 million and adjusted EBITDA of $5.8 million. There are no changes to revenues, adjusted EBITDA or capital expenditures in 2017. And the only effect in 2017 is an immaterial change to net income due to increased depreciation and amortization. And you can find more detailed information available on our press release from this morning. And it will also be included in our Form 10-K filing. Now getting into the full year 2017 results compared to '16. Revenues increased $140.4 million or 17.1%, including $127.3 million contribution from NewWave operations. Residential data revenues increased 20.4% and business services revenues increased 30.7% year-over-year. Excluding the contribution from NewWave operations, organic growth for our residential data and business service revenues showed healthy increases of approximately 8% and 12%, respectively, compared to the prior year. Net income increased $132.9 million or 131.5% to $234 million in 2017 compared to $101 million in 2016. This increase in net income included a $113 million income tax benefit resulting from the favorable impact of the federal tax reform legislation enacted in December 2017. The remaining increase was primarily attributable to the reduction in our operating and selling, general and administrative expenses as a percentage of revenues year-over-year. Our operating expenses were $337 million in 2017 and increased $40.5 million or 13.6% compared to 2016. Additional operating expenses attributable to NewWave operations were $63.1 million in 2017. This increase was partially offset by a $12.7 million decrease in labor costs associated with our capitalized labor change, lower programming costs of $3.8 million, lower backbone and Internet connectivity fees of $3.1 million and lower insurance costs of $1.3 million and lower repair and maintenance costs of $1 million. Without the NewWave operations, operating expenses would have decreased $22.7 million or 7.6% in 2017 and operating expenses as a percentage of revenues would have been 32.9% in 2017 compared to 36.2% in 2016, an improvement of 330 basis points. Selling, general and administrative expenses increased $20.8 million or 11.3% to $204.8 million. Additional selling, general and administrative expenses for the NewWave operations were $16.6 million for 2017. Without NewWave, selling, general and administrative expenses would have increased $4.1 million or 2.2%. Higher severance costs of $4.4 million, deferred compensation of $2.4 million and software maintenance of $2.1 million were partially offset by lower labor costs associated with the capitalized labor change of $3.6 million and employee incentives of $1.8 million. Adjusted EBITDA was $443 million and $357 million for 2017 and 2016. Adjusted EBITDA growth of 24% in 2017 includes the contribution from NewWave operations and the positive impact of the capitalized labor change. Without NewWave, adjusted EBITDA growth would have been 10.7%, increasing $38 million to $395.5 million in 2017. Excluding both NewWave and capitalized labor change, adjusted EBITDA growth would have been 6.1%, increasing almost $22 million to $379 million in 2017, and our adjusted EBITDA margin would have increased 190 basis points from 43.6% in 2016 to 45.5% in 2017. Further, adjusted EBITDA growth would have been 6.6% if we had adjusted for the effects of Hurricane Harvey. Adjusted EBITDA margin would have increased 210 basis points to 45.7% for 2017 compared to 43.6% in the prior year. Capital expenditures totaled $179 million and $131 million for 2017 and 2016. The 2017 capital expenditures represents approximately 18.7% of revenue. Adjusted EBITDA less capital expenditures for 2017 was $263.7 million, an increase of $37.2 million or 16.4% from the prior year. Excluding NewWave, capital expenditures would have been $149 million or approximately 17.9% of revenue. Next, turning to the 2017 fourth quarter results compared to the fourth quarter of 2016. Revenues for the fourth quarter of 2017 were $257.7 million, including a $47.6 million contribution from NewWave operations compared to $206.7 million in the prior year quarter. Residential data revenues increased 27.2% and business service revenues increased 37.2% year-over-year. Excluding NewWave operations, our residential data and business service revenues grew at 8.6% and 9.9%, respectively, year-over-year. Net income for the fourth quarter was $143.2 million compared to $24.5 million in the prior year quarter due to once again the $113 million income tax benefit resulting from the 2017 federal tax reform. Further, the NewWave operations and capitalized labor change contributed incremental increases of $2.8 million and $1.8 million, respectively, to the fourth quarter net income. Adjusted EBITDA was $117 million for the fourth quarter of 2017 and increased 26.8% from $92.2 million in the prior year same quarter. Without the $18.8 million contributed from NewWave operations, adjusted EBITDA would have been $98.2 million, a 6.5% growth from the fourth quarter of 2016. Our margin for legacy Cable ONE increased 210 basis points from 44.6% in the prior year quarter to 46.7%. Further, NewWave's margin improved 270 basis points sequentially to 39.5% in the fourth quarter compared to 36.8% in the third quarter. After accounting for capitalized labor change, adjusted EBITDA would have been 95.9 - $95.1 million, a 3.2% year-over-year growth, and adjusted EBITDA margin would have improved 70 basis points to 45.3% in the fourth quarter of 2017. These results were also affected by a positive insurance reserve adjustment of $1.6 million received in the fourth quarter of 2016. Taking that into account, adjusted EBITDA for this credit, adjusted EBITDA would have increased 5% year-over-year for the quarter. Capital expenditures totaled $50.5 million and $35.5 million for the fourth quarter of 2017 and 2016. Adjusted EBITDA less capital expenditures for the fourth quarter of 2017 was $66.4 million, an increase of $9.7 million or 17.2% from the prior year quarter. Excluding NewWave, capital expenditures would have been $39.3 million. From a liquidity standpoint, we remain in excellent position as we have had approximately $162 million of cash on hand as of December 31. We continue to generate significant free cash flow, and we anticipate that this will be further enhanced as a result of the 2017 federal tax reform legislation. The company expects to realize approximately $38 million to $42 million of cash tax savings in 2018. At year-end, our debt balance was approximately $1.2 billion, which included approximately $745 million of term loan borrowings to finance the NewWave acquisition. We also had approximately $197 million available for borrowings under our revolving credit facility. Overall, our debt to adjusted EBITDA was only 2.5x, and after adjusting for our cash on hand, was only 2.2x, providing us with significant liquidity. As Julie mentioned, we continue focusing on the integration of NewWave into our operations, and we look forward to continued growth and continued realization of operating synergies during 2018. We are very pleased with the financial results thus far as you can see in our numbers. Operator, we're now ready for questions.

Thank you [Operator Instructions] And our first question comes from Philip Cusick with JPMorgan. Please go ahead.

Hey, guys. A couple, if we can. First, can you expand on the change in broadband promotions and how it impacted churn?

Phil, this is Julie. The broadband promotions is actually a lack of broadband promotions.

Right. I just didn't understand how it's impacted the numbers. And you said it has impacted churn. I didn't really get it.

So let me take you through that. I'll take you behind the scenes about what we're doing and what we're trying to accomplish because the results that you're seeing are essentially of our own making. So first of all, let's talk about the levers. We've talked about different levers that we have to move that are at our disposal in the past. And we're working to calibrate them for sustainable growth over the long term, so a couple percentage unit growth, a couple percentage ARPU growth from upgrading tiers and UBB, usage-based billing, reasonable CPI increases over time, all in accordance with our LTV strategy, our profitability strategy. What we're doing now is we're taking actions that we believe will set us up for the long term and will create a balance between these levers, a titration, if you will. But those tactics are causing a short-term lull. So let me give you a little bit more color, and I'm going to divide it up between NewWave, Northeast Division and legacy CABO. In Northeast Division, through the transition, we are endeavoring to make them look more like Cable ONE. So what that means for them recently is we've been changing their collection cycle, which was 90 days previously, down to 40 days. It means that we are pulling in pre-periods of service. It means we are stopping deep discounting. It means we are stopping lengthy discounting. There are other LTV strategy shifts at play. After normalizing, we expect that multiple factors of growth, both units and ARPU, will restart and gain momentum. But in the short term, you can imagine those things would cause unit growth to lag and it also pushes ARPU up. But the current metrics show that overall, we're heading towards stabilization with Northeast Division. And I think we're getting exactly what we expected from those actions. Now legacy...

I understand. So churn, churn in the future will be down. I thought you had said that it was down already. That was just my mistake.

No, it is. It is down. So on the legacy CABO side, still talking about the actions that we're taking that are causing the churn to go down. Still being committed to our strategy, we're using enhanced business intelligence tools and quite honestly, new thinking. And we are refining some of our tactics. So again, we're trying to balance those levers. So one of the things that legacy CABO did is we stopped the year-long sales discounting on our flagship 100 meg product. Our goal there was to firmly establish and dimensionalize our value in our consumers' minds. So things like Wi-Fi ONE, free same-day service, the concierge service for our high LTV customers, all those things going into dimensionalizing the value of the product. We're doing that to set the stage so that we can test sales tactics, sales offers and pricing. And that's what's going on right now. So again, in the short term, with no promos, with nothing being on sale, you get the slowdown in units and the rise in ARPUs. But in the long term, we envision growth in balance. We're also moving away from one-size-fits-all marketing philosophy so that we can better meet market demand. And this, too, will serve to increase unit growth and regulate ARPUs in a more competitive market. So I mean, churn has slowed down, it's because of the actions that we're taking, we're going to go through this normalization period. And then you're going to see a shift, I predict, again to the balance between unit growth and ARPU growth. I'm confident where we're headed. Our journey requires a tad of patience, large doses of data and human sweat, but we are on our way.

That's great. And I do want to follow up on the move away from one-size-fits-all. Should we think that applies to the video side? Are you sort of moving away from deemphasizing video?

Well, Phil, I'm smiling because you should not assume anything that we talk about has to do with video. But no, I'm talking about broadband and business services.

Okay. Thank you

Our next question comes from Craig Moffett with MoffettNathanson. Please go ahead.

Hi. Good morning. I guess, can you talk to us about where the big buckets of cost reduction remain? And how much - separate and apart from just the mix shift from video to broadband and the margin impact of that, how much margin upside is there left in the business from just cost reduction and sort of taking unnecessary activities out of the business?

Well, so how much cost reduction remains? What I'm going to talk to is our sort of industrial engineering mentality and say that we believe that there is always room for continuous improvement. As far as how much margin upside is there, that is not something that I am going to specifically comment on.

Craig, this is Kevin. I mean, obviously some of the margin is driven by the product mix. As you know, we've said that we believe the margins on residential HSD and business services are 4 to 5x that of the video model. So obviously, as we become more residential HSD and business services-centric, they represent almost 60% of our total revenue base right now, the margins will start to mimic those businesses. And as Julie already said, you can see from an industrial engineering perspective, we continue to look for ways to do things more efficiently. You can see our headcount continually coming down year-over-year, quarter-over-quarter. So we're looking for ways to do it more efficiently, whether that's from installation activities or other. But it's an ongoing process.

Okay. Thank you.

Our next question comes from Stephan Bisson with Wells Fargo. Please go ahead.

Good morning. It sounds like for NewWave, you expect to kind of harmonize ARPUs there on the data product with what you have at legacy CABO. Is the underlying product identical already? Is there work to do there? And over what time can you get that harmonization?

Yes, exactly, Stephan. It will take time to harmonize the ARPUs. As you see, their ARPU - their HSD ARPU is already going up. There is work to be done though. In the last quarter, folks in the Northeast Division worked on largely throughout the footprint bonding 32 channels. We still need to make channels available through an all-digital process in order to complete them looking like Cable ONE, that is to say multiple tiers. We've increased speeds where we can already. We've put sort of a temporary or an interim pricing and packaging in effect. But we have yet to move over to the Cable ONE pricing. So it is going to take time. One of the very first pieces besides the technology platform ones is moving them to our billing system, which is in process for this year.

Great. And then one more, you guys are clearly generating significant free cash flow. And in the past, you've looked at M&A opportunities, including NewWave. Is that still something you'd be considering if the right deal came along or maybe fiber assets if they were to become available?

Stephan, this is Kevin. As we've said in the past, and nothing has changed, we continue to look at any and all M&A opportunities that are out there that make sense for the company. It's an ongoing process. We also look from time to time to other activities, whether it be dividends on our stock or share repurchases. So it's a three-pronged approach. I don't think that's changed since we became a public company. But obviously, we'd love to have numerous NewWaves if you could find them. And we continue to look at all opportunities that are out there.

Great. Thank you

Our next question comes from Frank Louthan with Raymond James. Please go ahead.

Great, thank you. I'd just apologize if I missed this, but was there any lingering hurricane impact in Q4 that might have impacted some of your subs? And then the number of homes that you passed in the quarter improved a little bit. Talk to us a little bit about the outlook there and your ability to capitalize on that over next 12 months.

Frank, the impact financially from Hurricane Harvey was mostly a third quarter event. The good news, almost all of our customers are back and up and running. And great effort by all of our associates to do that. We're very appreciative of all their efforts. But no, there is not much of an impact and we didn't note that because it was so insignificant in the fourth quarter. It was mostly a third quarter event.

And I think the second half of your question had to do with homes passed growth. Is that correct?

Correct. It was a little bit stronger than what we were looking for. Just curious, your plans to capitalize on that and the subs on the next 12 months. And what should we see in that trend of passing additional homes?

I don't think it's that significant. I think we're seeing here 2016, it was a 1.669 million and now it's 1.694 million, not that significant in terms of the actual 3,000 homes passed. I think that's just normal growth within the communities.

Right. We certainly have sections of the country that are growing quite robustly. That would be the West, by and large. And of course, we make sure that we are into those newbuilds first. It's essentially a fiber-to-the-node platform, so we end up taking some more share than we do in our market at large.

Okay. Thank you very much.

And this concludes our question-and-answer session. I would like to turn the conference back over to Julie Laulis for any closing remarks.

Thank you, operator. Our accomplishments in 2017 would not have been possible without our more than 2,300 dedicated and talented associates. Your willingness to embrace change and your steadfast dedication to taking care of our customers is what makes our company such a success. Kevin and I will be presenting at the Raymond James Institutional Investors Conference in Orlando on March 6. And we look forward to seeing some of you there. Thank you for joining us for today's call.

The conference has now concluded. Ladies and gentlemen, thank you for attending today's presentation. You may now disconnect.