Cable One Inc (CABO) 2015 Q2 法說會逐字稿

Good morning and welcome to the Cable ONE second-quarter earnings conference call. (Operator Instructions) With us today are Tom Might, CEO, and Kevin Coyle, CFO.

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 and welcome, everyone. We are thrilled to be with you on our first investor call to review our second-quarter 2015 results.

Before we proceed, I would 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 and in our most 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 US 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 and on our website.

Joining me on today's call is our CEO, Tom Might. With that, let me turn the call over to Tom.

Good morning, everybody. Since this is our first quarterly call and Kevin and I did not get to meet all of you who are on the phone during our 14 days of roadshow, please allow me a minute to set the context for you in case you did not read our SEC Form 10 that actually lays out our strategy fairly accurately.

Three years ago this summer we turned our attention away from video and the triple-play as centerpieces of our long-term strategy based on several trends that we started seeing back then, and even though video was over half our revenues and units back then.

We saw then that cable TV started losing video subs in 2007, five years earlier. The total pay-TV industry started losing household penetration in 2010, two years earlier. Cable ONE video gross margins have dropped 13% to just two prior years and Netflix, Hulu, and YouTube had started the OTT evolution a few years earlier that may now be a revolution.

On the phone side of triple-play, total landline were dropping at about 10% per year across the US, despite cable phone's temporary success, and phone ARPUs were falling even faster than that. So we decided that what would eventually be left of the triple-play was HSD only and our cost analysis with virtually all of the triple-play profit had already shifted to HSD thanks to forces like programmers, cell phones, Vonage-like companies, the FCC, and many other forces.

Cable ONE's strategic decision in 2012 was to confront these brutal facts, not pretend we had the wherewithal to repeal them. Since then, we have been optimizing the inevitable transition to an HSD home-dominated residential business.

But contrary to popular myth: one, we have not abandoned video. In fact, we have been growing video operating cash flow since 2012. We call it harvesting. Two, dropping Viacom was not our strategy. It was a small tactic that fit our strategy very well. It cost us about 2% of our video subs, not 20%.

And, three, HSD can survive without the triple-play just fine. Since 2011, before this strategy change, video subs are down about 35%. Phone subs are down about 13%, but HSD subs and cash flow are up about 10%.

HSD is the primary source of today's approximately $300 million of operating cash flow. However, business services or commercial sales is the primary growth engine for new cash flow. Both of these products have much higher margins than residential video or phone and their volumes are growing, not shrinking.

As an astute Seeking Alpha contributor observed, Cable ONE is skating to the puck. However, if I may add; when skating to the puck, timing is everything and only time will tell if we have timed our break just right.

Now moving more specifically to 2015 and the last quarter, in our press release I had said the quarter was good, not great. First, we are suffering through several one-time expenses such as a very expensive billing conversion, some one-time spinoff charges, and a few other one timers as well.

Second, with low-margin video and phone revenue still representing about half our total revenue, their maturity will be a drag on revenue and margins for some time, but less so each successive quarter. The good news is that non-video subs grew from 30% to 40% in just one year. We should start to see nice inflection points in revenues and margins in the years ahead.

Now one other introductory note I should make, a couple of our unit metrics and revenue allocations looked a little odd from quarter to quarter and they are. There are two reasons. First, our auditors suggested we change our bundle revenue allocation when they completed the three-year audit to kick off the Form 10 spin process. Their suggestions had some unintended consequences.

Second, we are nearing the end of a long and difficult change in billing platform; very long and very difficult. It turns out different billing systems don't count units exactly the same. Also, we found out that the new billing system unintendedly allocated all modem revenue to phone, rather than sharing it with HSD, and we have corrected for that in the second quarter. So there are some seemingly inconsistencies in some of our metrics.

Kevin, back to you.

Thanks, Tom. Looking at our second-quarter financial results, total revenues were $202.7 million and declined slightly by $2.4 million, or 1.2%. This was due primarily to residential video and voice customer losses and it was offset to some degree by increases in both residential data and business services revenues and the impact of a video rate increase.

Residential video service revenues declined $6.7 million, or 7.3%, due primarily to basic video customer losses and partially offset by a video rate increase. As Tom already mentioned, we are moving to become an HSD and business services-centric company, and we had very positive results on both high-speed data and business services revenue.

Residential data revenues were $74.5 million, an increase of $8.4 million, or 12.7%, as compared to the prior-year period. Business services, likewise, had tremendous growth as revenues were $29.1 million, an increase of $3.1 million, or 16.3%, as compared to the prior-year period.

In total, residential data and business services revenues grew to 47.5% of our total revenue compared to only 41.4% in the prior year. And also, as Tom already mentioned, non-video customers grew from 30% to 40% of total customers. Residential voice service revenues declined $4.8 million, due primarily to a decline in residential voice customers, and advertising revenues declined $1.6 million as compared to the prior year.

Turning to operating costs and expenses, the second-quarter total operating costs and expenses increased $5.2 million, or 3.2%, due primarily to increases in equity compensation, billing system implementation costs, and increased depreciation expense associated with capital expenditures. The non-recurring costs associated with the billing system conversion that Tom already mentioned were slightly over $2 million for the quarter. These costs will be reflected for one more quarter as our billing conversion is completed in the third quarter of 2015.

The increase in equity compensation is a non-cash item related to the accelerated vesting of options from a Graham Holdings Company stock option plan during the spin and this accounted for $3.7 million of expense in this quarter. If you exclude these two non-recurring costs, operating costs and expenses would actually have decreased by $600,000, or 0.5%, on a year-over-year basis.

Focusing on adjusted EBITDA, during the second quarter, adjusted EBITDA was $77.8 million, a decrease of 2.4% from the prior year, due to video and voice customer losses partially offset by increases in high-speed data and business service customers and the impact again of a video rate increase. If you compare this result, however, to our first quarter of 2015, adjusted EBITDA actually expanded by $3.3 million from $74.5 million during Q1. Also, there was a margin expansion from the first quarter of 2015 and now adjusted EBITDA margin is at 38.4% for the second quarter.

Turning to capital expenditures, property, plant, and equipment totaled $32.8 million in the second quarter, compared to $44.2 million during the second quarter of 2014. The decrease was primarily due to the decline in spending for customer premise equipment and it was offset by spending on four major initiatives: our all-digital conversion; remaining plant upgrades to 450 megahertz; 4- to 24-channel bonding; and increases in fiber deployment. We expect significant expenditures for the remainder of 2015 due to the completion of these capital projects, and we are still forecasting that capital expenditures for 2015 will be approximately 20% of revenues.

As we mentioned in our equity roadshow in June, with the completion of most of these capital initiatives by the end of this year we expect capital expenditures to return to historical levels in the mid to high teens after 2015.

From a liquidity standpoint, we are in a very strong position. During the second quarter of 2015 our cash and cash equivalents increased by $99.1 million and at June 30, 2015, we had approximately $105.5 million of cash on hand compared to only $6.4 million at December 31, 2014.

In connection with our spinoff, we incurred indebtedness in an aggregate principal amount of $550 million, of which $450 million was distributed to Graham Holdings Company prior to the consummation of the spinoff. In order to finance this transaction, we entered into several debt facilities.

First, on June 17, 2015, the Company issued $450 million aggregate principal amount of senior unsecured notes due 2022. These notes bear interest at a rate of 5.75%. Second, on June 30, 2015, we also entered into a credit agreement between the Company and various banks. The credit agreement provides for a five-year revolving credit facility in an aggregate principal amount of $200 million and a five-year term loan facility in an aggregate principal amount of $100 million.

Concurrently, with its entry into the credit agreement, the Company borrowed the full amount of the term loan facility and borrowing from the credit facility is currently at LIBOR plus 1.5%. The senior unsecured facility, or seven-year bonds, were used to make our $450 million distribution to Graham Holdings at the spin. The term loan facility provides us with $100 million of cash on hand, and the $200 million revolver is undrawn and provides us with additional liquidity.

With these financings, our current debt to cash flow is approximately 1.8 times on a last 12-month basis and only 1.5 times on a net of cash on hand basis. So we have a very compelling capital structure with low leverage, no near-term maturities. The average life of our debt is 6.6 years and our weighted average cost of borrowing is only 5%. We, therefore, believe we have a very favorable capital structure.

In summary, our results are in line with our historical results that we presented during our equity roadshow in June. We are moving, as Tom mentioned, to an HSD and business services-centric company, while harvesting our video business EBITDA. Our revenue is steady and consistent and the growth in both HSD and business services customers has improved our margins compared to the first quarter of 2015 and the last 12 months.

Also, our free cash flow is a significant asset. During the quarter our free cash flow was $45 million, a 25 -- a 27% increase from the prior year. Our conversion ratio is historically in the 50% range and we expect to generate a significant amount of free cash flow for the year.

With that, operator, we are now ready for questions.

(Operator Instructions) Phil Cusick, JPMorgan.

Thanks. I guess first can you talk about your potential for a buyback or otherwise return on capital? Thanks.

I'll take that one. This is Tom. On the buyback we have an authorization for up to either $250 million or 600,000 shares in place, and of course, we have come out with $6 annual or $1.50 quarterly dividend as well.

And so how do you (multiple speakers)?

You will see that information disclosed as a subsequent event on the buyback in our 10-Q, which will be released today.

How do you think about returning that capital, Tom? Is it opportunistic if the shares were to weaken? Is it sort of a regular return of capital like some other cable companies do?

I would prefer not to describe it at this point.

What about other ways to use this balance sheet? Do you feel like there's an opportunity to build out organically maybe fiber or edge out in your territory, or do you feel like there are assets that may be close or not to your network that you could buy?

All of the above. We are forming our M&A thoughts at this point. [Were] very distracted by the spin process for the past eight months, but in last month we have started to sort out with various sources of information and people in this field to help us find opportunities beyond the traditional bolt-on acquisition cable opportunities, of which there will be few. So we are exploring exactly the ones you mentioned and hope to find others to explore as well, but we are very early in that process.

Got it. And one more if I may. Kevin, you mentioned the very painful billing system conversion. I feel for you, but where are we in that process? When is it going to be done? And what have you been limited from doing through the conversion? Thanks.

It's been a three-year process and it has been painful, as Tom mentioned. It is due to be finalized, as I mentioned, by the end of the third quarter. So, unfortunately, one of the adjusting items that I mentioned is for the last few quarters we have been expensing the billing system costs and we saw a little over $2 million in this particular quarter that was expensed. There will be probably a like number to that in the third quarter and then the billing system should be complete.

I don't think it has necessarily prevented us from doing anything. Hopefully, when we get a full and new billing system it will allow us to do things more accurately going forward.

Is there a conversion date that we should be worried about in the third quarter or has everything -- all those milestones pretty much past?

This is Tom. Kevin, has been here for like four months, so I don't want to saddle him with all the answers that are three years in the making. We started the conversions about a year ago. We are doing -- every month we convert another slice of the Company. And this is -- August is the last conversion month, so we're down to our last group of systems.

Therefore, the slight inconsistencies in numbers -- some I noticed initially have gradually grown over time until we did notice them, for example, because we got larger and larger portions of the customer base on the new billing system, which was counting and allocating slightly differently.

By the way, to help you wondering what are our ARPUs, since you see some strange balances from first quarter to second quarter, if you use -- when you get the Q, if you use the six-month ARPUs they are pretty accurate. Because we corrected in the second quarter what we found to be an error in the first quarter, so neither quarter is correct, but the six months are pretty accurate ARPUs.

Good. Thanks, guys.

Mike Pace, JPMorgan.

Thanks, guys. Just to continue with the billing conversion, I guess it sounds like you have been already converting folks over, so have you seen any disruptions or complications other that I guess just the ARPU that you mentioned before? Just curious on your confidence level that we not going to see any significant problems or churn that we've seen from other cable companies.

And then maybe specifically for Kevin, once you are done with this conversion can you talk about what the quarterly savings might be post completion?

I will take the first half while Kevin is thinking about the second question. We -- I was thinking about -- what was your first question again? I was thinking about how Kevin was going to answer the second question. I'm sorry; what was the first question on the billing?

[What is] your confidence level? It sounds like you have already started converting people, so disruptions and complications, etc.

Right. We shouldn't -- there are no customer impacting -- we bent over backwards. Part of the spending, a lot of the millions of dollars is to make sure that customers were not discomforted in any way by billing conversion. It took a lot of manpower and a lot of software expense to do that.

The one other significant metric that you will notice is odd is the homes passed number has gone up substantially, and that is something that the two different companies or systems of platforms do count homes passed differently. So that would be one other significant one that I would point you to. The revenue should be fine, total revenues. It's just the allocation revenues. But the one number that -- the quantity that is meaningfully different is homes passed.

I think that's the only ones of substance that I would -- when you are trying to do a metric analysis that I would say be cautious of or be aware of that our homes passed counts are going up. And both units were often counted as one unit and now every -- the new billing system you have to put every single unit in a bulk unit in as a separate address. Therefore, bulks are going up substantially in homes passed.

I guess, Tom, just from a customer perspective, have you seen increased call volumes or the confusion? Any churn as you're transitioning different systems over? We have just seen that in the past from other cable companies, [that is why].

That's why it has been long and difficult. We did a test system actually more than a year ago. We found all these issues. We halted the process for many months after just one system and we got all that stuff wrung out at great expense. We did not want the customer to be impacted.

So before a system converts we spend months cleaning up the old database and the old billing platform so it will graciously move over to the new billing. That's where a lot of the expenses common in labor and software to make sure the customer is not impacted.

Fortunately, for us I guess WOW! had gone through a very difficult process. We were a couple years and were planning of right before we started our conversion, WOW! had a very serious conversion, which made us slow down and pay attention and do a couple of test systems. And that saved us probably from having a similar experience.

On the second part of your question in terms of savings going forward, we anticipate that there may be some, but I don't think we want to try to quantify them right at the moment. There may also be a little bit of future development work on the system, too, as we move forward. The large majority of it will be over by the end of the third quarter, and there may be some savings; I just don't want to try to quantify that right now.

There are two parts to that question and we may be answering a different one. There are the project costs which we will definitely save. And they are large, they are millions of dollars. Then there are -- will the one billing system on an ongoing basis save us money over the old billing system? I think that's the question you were answering.

The project costs will come to an end similar to the $2 million you saw in this quarter. There will be another number in the third quarter of similar size. Those will come to an end, but in terms of cost savings -- and I don't know if that was the gist of your question -- I just don't want to try to quantify those at the moment.

Okay, understood. Then, Tom, correct me if I get any of this wrong, but I thought over the last couple of years your margins have actually improved as the mix shift has changed. But then in prepared remarks I thought you said that you haven't quite gotten there and margins were down about 50 basis points in the second quarter year over year. So just some clarity on that.

And then, if margins are going to continue to be pressured, what revenue mix shift do you need to get to before we start to see that inflection point?

We've seen about a 200 basis point improvement from 2012 to 2014, which we had in our Form 10, and in the roadshow we talked about that. We think that's the beginning.

As we explained in our Form 10 and in our roadshow, the margins -- in fact, our Form 10 says that our HSD margins, operating cash flow margins are about 5 times our video operating cash flow margins. Our business cash flow margins are about 6 times. So as we move $1 from video, or phone for that matter, over to those other two categories, we're going to have margin expansion.

The margins of those -- so our overall margins will start looking more like the margins of HSD and business services over many years. We're sort of flattish, more or less, this quarter, but I do expect, as the mix in revenue shifts, we will see both revenue growth and margin expansion over many years.

Mike, this is Kevin. As I mentioned, you are starting to see some margin expansion. When we were on the roadshow we were saying, as Tom mentioned, margins had increased from 35% to 37%. In the first quarter you saw over 37% and now in this quarter on adjusted EBITDA margins are actually 38.4%.

I don't know if they will hold through the remainder of the year, but you are starting to see us gravitate more towards a 38% margin versus a 37%. So I think you are seeing the margin expansion due to the shift in product.

Great. Thanks, guys.

Craig Moffett, MoffettNathanson.

Thank you and first of all, congratulations to you, Tom, and Kevin and all of you for your first earnings call and for a successful move to the public market. So nicely done.

You talked about, Tom, in your prepared remarks that Viacom may have been 2% or so of the downdraft and presumably the rest of the downdraft in your video subscribership was what I would describe as sort of catch-up price increases to sort of fix the pricing of video.

As you get through that process and you sort of finish repricing the video product, how do you then think about the pricing of the broadband product? You've talked about some uplift in broadband pricing that will come when you moved to 100 megabits per second. But how do you think about driving growth from broadband with respect to the mix of pricing and volume?

Going back to the video part of it first, it really wasn't -- our strategy on video started well before the Viacom move, and I will give you an example. It's not just a pricing adjustment and not just Viacom. Our lifetime value strategy did a couple of other things.

We were -- 30% of our starts were video-only when we started this analysis and we realized that we were making no money, on average, on video-only starts. So we are now down to 10% of our starts are video-only.

Another is in November, the November before the Viacom move, we stopped on a week's decision, one-week decision basis, years' worth of direct sales and repositioned all of our direct salesforce to do other work. In October they were 9% of our total starts, so we took away 9% of total starts in one month, in one decision, because it fit our lifetime value strategy. So there are quite a few large elements to the repositioning of video and its profitability, not just getting the pricing and the ARPUs up.

On the broadband side, we would love to get a little bit from ARPU, a little bit from usage-based billing, and a little bit from rate increases. To not be too specific, but it's a combination of all three of those, a little bit each year, that we think particularly with our low penetration -- we have a lot of upside opportunity -- gives us quite a few years of nice single-digit opportunity if we execute well and get a little bit from each of those three sources.

How high do you see the ceiling of broadband penetration in your market? There's been -- I think you described in your initial filings a somewhat lower demographic than the average for the country. Do you see that as kind of just slowing down the penetration or does it lead to a sort of sustainably lower ceiling in some way?

I think, given enough years, it will reach the rest of the country in penetration. But there's no question; in fact, I have in front of me -- because our penetration is low and it's often a question, I have in front of me a Pew Research piece that came out last week titled 15% of Americans don't use the Internet: Who are they?

Well, a lot of them live in our markets. They have a nice bar graph in that article. I refer -- recommend you to it, because it's largely demographically driven. So if 15% don't use it nationally: over 65, 39% don't; 50 to 64, 19%don't; less than a high school education, 33% don't; rural, 24% don't. What you are seeing with us, Mediacom, and Suddenlink, we are all on the low end of penetration.

The other variable that puts us even lower than those other two is we are far more overbuilt than those two are. As we told everybody in the Form 10 and on the roadshow, our best estimate is we are about 25% or so overbuilt. So you put those two together and it puts us in the low end.

Now the overbuilding -- the way we beat that is by taking market share by having far superior product, and we think we're headed in that direction. And the demographic part fixes itself slowly over time.

What we're not doing, which is another important part of the analysis, we are not chasing volume there either. Even though we are HSD-centric in our residential thinking, we're still going for the more profitable part of the market rather than just trying to build up our volume of HSD. So if we can grow just 2% or 3% in units, but do it persistently for a long period time, we are thrilled. Rather than having 5% to 7% growth in one year, but a lot of that coming in at ARPUs down in the 30s or something of that sort.

Very helpful. Again, congratulations to all of you.

You've got a lot to do lately as far as covering the two sides of the industry. Good luck.

Thank you.

(Operator Instructions) Stephan Bisson, Wells Fargo.

Good morning, guys. I just had a couple. So as part of the conditions regarding their TV, AT&T had agreed to build out U-verse more. Have you seen any type of indication that they might be improving the systems already within your markets or possibly expanding their U-verse offerings there?

Good question and the answer is a small yes. To our knowledge -- to my knowledge, there has been no announcement of a complete fiber-to-the-home replacement in any of our markets. We have -- about 20% of our homes passed do have U-verse, so there is concern.

But we certainly do see them doing some fiber-to-the-home, primarily in greenfield, in our markets and maybe selectively in a neighborhood here or two, but nothing more than that at this point. But we certainly have -- are paying attention to it.

Great. Then in this most recent quarter, while they were both kind of going through that process, did they pull back competitively at all? There were some reports out there that AT&T might be less interested in adding U-verse customers until the deal was done.

I don't know that I -- I would have to ask the division VP. It's almost entirely in one division of our company and I'd have to ask her if she has noticed a let up or not. And I don't have that information.

No problem. Then, lastly, do you guys have any interest in possibly offering a video bundle through your data service, maybe something like Dish's Sling TV?

Consistent with our strategy for the last three or four years, we are a big proponent of OTT of any kind because it enhances the value of a really good Internet connection. So, for example, Netflix is channel number one on all of our cable boxes. All you have to do is hit button number one and you open up your Netflix channel.

Anything else we can do like that or like you are suggesting, we are considering. We haven't -- we are not deep into any suggestion like a Sling TV, any product that we somehow invent or own or control. We don't probably have the scale do that unless someone creates a model that we can be a fast follower within the cable space.

But we are very pro-OTT and have been for a number of years. So given our scale, we will do what we can to make over-the-top viewing easy, enjoyable, and fast on our cable plan versus our competitors' plan.

Great, thanks so much.

There are no other questions at this time. This concludes our question-and-answer session. I would now like to turn the conference back over to Tom Might for any closing remarks.

You know, being the first quarterly call, I forgot to prepare any closing remarks. I'm sorry about that, but I would be glad -- Kevin, do you have any thoughts?

No, we are thrilled to be with you. It was a great roadshow and great response from the market. The stock has been trading well; we are thrilled with that. We are looking forward to being with you in future quarters.

I ditto that. Thank you very much, everybody.

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