Cable One Inc (CABO) 2015 Q4 法說會逐字稿

Good morning, and welcome to the Cable ONE fourth-quarter and full-year 2015 earnings conference call.

(Operator Instructions)

With us today are Tom Might, Chief Executive Officer, and Kevin Coyle, Chief Financial Officer. 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, to Cable ONE's fourth-quarter and full-year 2015 investor 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 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 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 or on our website.

Joining me today on the call is our Chairman and CEO, Tom Might. And with that, let me turn the call over to Tom.

Thank you, Kevin. Good morning, and welcome to Cable ONE's earnings call as we report on our fourth-quarter and full-year financial performance following completion of our spin off on July 1. Our 2012 strategic pivot away from video and triple play centric focus to a residential, HSD, and business services focus is starting to yield regular rewards three years later.

Q4 was a strong quarter that showed continued momentum with our strategy and made all of 2015 a very satisfying spin year. I reviewed our strategy in some detail on our last earnings call, so I'm not going to repeat that story today.

Instead I will emphasize the fundamental underpinnings of the strategy briefly and then comment on some high level observations about our results before Kevin reviews the specifics. So here are five fundamental planks in our strategy.

Plank number one, fully allocated cost models. We strongly believe it is more important to look at long-term operating cash flow trends by product, which we also refer to as adjusted EBITDA, and free cash flow trends by product rather than contribution or gross margins by product. In other words, we like to fully allocate all costs when we look at business trends and results.

Every cable company has very significant indirect operating costs and capital costs per PSU. Contrary to conventional thinking, they are both highly variable, not highly fixed. Thus are fully allocated cost models.

Plank number two in the strategy, what we don't like, residential linear video and phone for many reasons produce very modest operating cash flow today and no free cash flow to speak of. That is they have no real margin left, and volumes are challenged, as consumers want to migrate to alternatives like smartphones and OTT video. That is cutting, trimming, shaving, avoiding, or whatever the cord.

And plank number three, what we do like, residential HSD and business services on the other hand, have healthy operating revenue growth and free cash flow margins, and have produced double-digit growth rates. So that is where we are investing; in the future rather than in the past.

Plank number four, lifetime value matters to us. The lifetime values of customers and potential new starts vary dramatically as well, not only by package, but also by demographics. Historically many of our new starts were unprofitable and subtracted from our bottom line a lot. Other starts are highly profitable, letting go of large quantities of unprofitable starts that used to prop up PSU counts as reduced PSUs significantly, but has also increased our cash flow.

And last, plank number five, business mix and margins. As our mix of revenue shifts away from video and phone and towards residential HSD and business services, our operating cash flow margins are already expanding predictably, up almost 300 basis points since 2013, and so should total revenue within the next few years. Residential HSD and business services have grown from about one-third of total revenues to nearly one-half in just three years on relatively flat revenues, which is why we see this as a margin expansion strategy at least at this time.

So now I'm going to move on to four brief high level comments about our results to help you interpret them before I turn it over to Kevin.

The first is rate increases. To make sense of our quarterly performance throughout 2015 and 2016, you should be aware of our non-annual schedule of price changes.

We plan rate increases to optimize long-term results and not to smooth earnings. As a result, some quarters will be rate rich, meaning our results were partially driven by rate increases, and some quarters will not be rate rich. Q4 was rate rich.

And I will explain. We made a $10 residential video price adjustment that was effective last February 2015. We have not announced any video price increase so far for 2016.

And second, we also made a $5 residential HSD price adjustment, 10%, when we doubled our speeds this past October after no HSD price increase for nearly five years. The annualized increase was less than 3%. These uneven price adjustments have and will definitely impact quarterly comparisons throughout the year.

Item number two to point out, head count reductions. Proving that most costs are variable and not fixed, we are down over 400 FTEs, a 17% reduction in just four years, even though we were down only 50 last year. However, 2015 was heavily loaded with labor-intensive projects and conversions.

We have already resumed a more rapid pace again -- a pace of improvement again in 2016. This is important because after programming expense, which has also decreased at Cable ONE, labor is the second largest operating expense at any cable company. These reductions have been accomplished through attrition, and we are proud that since 2008 our associates have helped us find and eliminate or automate hundreds of thousands of unnecessary customer contacts to make these savings possible.

Number three, capital spending. Our CapEx as a percentage of total revenues has been running high over the last few years due to various plant investments. As we have previously said, we expect that CapEx spending should return to a more historical range of mid to high teens in 2016, which should have a large positive impact on free cash flow.

And last, allocation of capital. With leverage at just 1.4 times operating cash flow and with significant free cash flow, we have a lot of capacity to make strategic investments, including M&A opportunities and/or continuing to repurchase our shares. We have been methodically investigating organic and inorganic ways to expand our business with superior long-term free cash flow growth opportunities.

There is nothing to report yet, but we are assessing various opportunities. In the meantime, we repurchased stock in our first six months at prices we consider very attractive, given the trajectory of our strategy.

Now I'm going to turn it over to Kevin for a more detailed review of the numbers.

Thanks, Tom. As Tom already mentioned, we are very pleased with our financial results for both the fourth quarter and the full year. But before I discuss our financial results, I wanted to point out some information regarding our operating statistics.

As we mentioned in previous investor calls, we converted to a new billing system over the past year. This conversion is complete, but it has caused several fluctuations in our operating statistics that I would like to briefly highlight.

First, we had an increase in homes passed primarily attributable to converting data into our new billing system. The new system counts every unit in a multifamily dwelling that is served by a bulk account as one home passed, whereas our prior billing system counted each bulk multifamily dwelling unit as a single home passed.

For example, if an MDU has 200 units, it is now counted as 200 homes passed versus one in our previous billing system. We believe this is the primary reason that our homes passed increased this past year.

Second, you will also see that we had a significant growth in both business service customers and revenues, but our business PSUs decreased in the fourth quarter of 2015 versus the fourth quarter of 2014. This decrease in business PSUs was also attributed to our new billing system as it counts each business/customer relationship at a unique business address as a single customer, whereas our prior billing system calculated multiple relationships based on revenue generated at an address. For example, if you had five phone lines in your office, the old billing system would have counted that as five PSUs versus the new system counting that as one.

So in summary, the change in billing system accounts with the unusual fluctuations in both homes past and business PSU counts. And this will continue for the next several quarters as we continue to compare quarterly operating statistics derived from our old billing system versus our new one.

Now, turning to our financial results, reviewing revenues for the quarter, total revenues increased by $2 million, or 1%, due primarily to increases in residential data and business service revenues, where we had both increased customers and also some rate increases. And this was partially offset by decreases in residential video and residential voice revenues. For the full year, total revenues declined $7.5 million, or 0.9%, due primarily to declines in residential video and residential voice revenues, and partially offset by increase in residential data and business service revenues.

For the fourth quarter and full year, residential video service revenues declined $7 million, or 8.2%, and $29 million, or 8% respectively, due primarily to residential video customer losses, partially offset by the impact of video rate increases. Quarterly residential data service revenues increased $9.7 million, or 14.2%, while full-year residential data service revenues rose $28.8 million, or 10.8%. These increases were due primarily to increase in residential data customers of 2.5%, a reduction in price discounting, a rate increase in the fourth quarter of 2015, and increased subscriptions to enhance data packages by residential customers.

Residential voice service revenues for the quarter and full year declined $2.5 million, or 16.2%, and $12.2 million, or 19.6%, due primarily to a 15.2% decline in residential voice customers. Business service revenues increased $2.8 million, or 13.5% for the quarter, and $11.9 million, or 15.5% for the full year, due primarily to a 10.9% increase in business customers. Overall, business services comprised 11% of our total revenues now compared to only 9.4% of total revenues in 2014. Advertising sales revenues for the quarter declined $0.8 million, or 8.7%, and $4.3 million, or 12.2% for the year respectively, due to the negative impact of decreased video customers.

Turning to operating costs and expenses, for the quarter total operating costs and expenses decreased $4.6 million, or 3%. This was due primarily to the positive net impact of a $2.3 million benefit for certain insurance-related benefits and other costs realized during the quarter, and decreases in selling, general, and administrative expenses, and it was partially offset by increased depreciation expense.

The increased depreciation expense was primarily attributable to capital additions in both 2015 and 2014. For the full year, total operating costs and expenses declined 5.5 million, or 0.8%, due primarily to a $17 million increase in operating expenses and partially offset by increases in selling G&A of $5.1 million, and depreciation expense of $6.5 million.

Turning to other income and expense, other expense for the fourth quarter increased $6.7 million, primarily due to interest expense of $7.3 million in the fourth quarter of 2015. This was attributed to our long-term debt the Company incurred in conjunction with the spin off. No interest expense was incurred in the fourth quarter of 2014.

Meanwhile, other income and expense for the full year had a negative variance of $90.5 million. This was primarily driven by two items.

One, in 2014, we had a $75.2 million nonoperating gain from the sale of wireless spectrum licenses. And in 2015, we had $16.1 million of interest expense.

Turning to adjusted EBITDA, as Tom already mentioned we had a very positive result for both the quarter and for the year. For the quarter, adjusted EBITDA of $88 million increased by 12.7% due primarily to the impact of increases in HSD customers, business service customers, and an HSD rate increase. There was also, as I mentioned previously, a $2.3 million positive net impact of certain insurance-related benefits and other costs realized during the quarter.

So to get apples to apples and excluding the net impact of these benefits and costs, fourth quarter adjusted EBITDA grew by 9.7% year over year, with an adjusted EBITDA margin of 42.1%. For the full year, adjusted EBITDA was $317.7 million, which increased by 4% from the previous year due primarily to the impact again of increases in HSD customers, business service customers, and rate increases. Our adjusted EBITDA margin in 2015 was 39.4%, which is roughly a 200-basis point improvement from the previous year.

Turning to free cash flow, free cash flow, which we defined as adjusted EBITDA less capital expenditures, increased $3.5 million, or 11%, and $33.5 million, or 26.2% respectively for the quarter and full year. The Company believes that free cash flow is one of several benchmarks used by investors, analysts and peers for comparison of performance in the Company's industry. For the year ended, our conversion rate defined as adjusted EBITDA, less CapEx as a percentage of adjusted EBITDA was approximately 51%.

Turning to capital expenditures, capital expenditures totaled $52.7 million in the fourth quarter of 2015, compared to $46.3 million during the fourth quarter of 2014. This increase was primarily due to increased spending for customer premise equipment, our all-digital initiative, plan upgrades, channel bonding, and fiber deployment.

Capital expenditures for the full year ended 2015 totaled $156.1 million, as compared to $177.4 million in 2014, a decrease of 12%. As Tom mentioned previously, we're still comfortable with our guidance of CapEx as a percentage of revenue in the mid to high teens for this coming year.

Liquidity, now turning to liquidity, our fourth quarter of 2015, our cash and cash equivalents decreased by $25.3 million versus the prior quarter ended September 30. And at December 31, 2015, we had approximately $119.2 million of cash on hand. This compares to $6.4 million at the end of 2014.

The decrease in cash during the fourth quarter of 2000 is primarily attributable to cash payments for interest, capital equipment, a federal tax payment that we made in December, and in addition, we repurchased 23,933 shares under our stock repurchase program, aggregate cost of $10.4 million during the fourth quarter of 2015. For the year, our cash and cash equivalents increased by $112.8 million, and we repurchased 38,136 shares under our stock repurchase program at an aggregate cost of $16.4 million.

So in conclusion, we had a very positive year, and the final two quarters of 2015 following the completion of the spin, have demonstrated the successful execution of our strategy, with both solid cash flow and margin expansion.

And with that, operator, we're now ready for questions.

(Operator Instructions)

And our first question will come from Craig Moffett of MoffettNathanson. Please go ahead.

Thank you. Good morning. Tom and Kevin, two quick questions, if I could. One is, you've obviously been in what I would describe as a rebalancing phase as you try to put your video business on a more profitable footing.

How do we think about the balance of price increases and volumes going forward as you get through this rebalancing phase? And then to touch on something you said during your prepared remarks, Tom, where you talked about customer lifetime value. Have you gotten to the point now where the customer lifetime value of the video customers that you have is something you're comfortable with at this point.

So that you're mostly through the rebalancing? Or is there more rebalancing left to be done?

Well, I've stated in past calls and on our road show that we've actually grown our video free cash flow from the time we started the strategy. Even though we're down substantially in units, we started making some operating cash flow and a modest amount of video -- free cash flow per unit.

That doesn't go on forever. We're -- on our lifetime value strategy tool, it's not video specific. I've tried to articulate in my fundamental points that there are a couple different axis through we look at cost.

One is by product, but the other is also the customer. So there are video customers that are profitable. It's just that video in total is not very profitable.

And so we're years into the process of parsing through the profitable customers of any kind, including video, from the unprofitable ones. Our bad debt has gone down to like one-fourth, I believe, I'm looking at Kevin. About one-fourth of what it was before.

So we're doing it on -- we're looking at the profitability of products, the profitability of customers, both of which are -- we're well into that process. We've been doing it for three years. I'll give you an historical example, which we did during our spin off in November two years ago.

We stopped doing direct sales on November 1, and we gave up 9% of our starts on one day by discontinuing direct sales. We did not give up any profit.

So that was one huge step. So many of those big steps -- the dropping of some programming increased the profitability of video substantially.

We made one enormous step there you're aware of with Viacom two years ago. We haven't made another one of those since. So we've taken a lot of big steps historically like direct sales, like Viacom.

There are only so many of those of that scale available. We took the large opportunities early. So without being more specific, that's how we've gotten to where we are without saying exactly what's going to happen in the year ahead.

And if you could just comment on the more general -- as you think about the balance of pricing changes and volumes going forward, are we close to something where you'll have an equilibrium that looks a bit more like other operators? Or are we still -- are we in the eighth inning of this, or are we still in the fourth or fifth inning of this?

Well, I'm not going to predict what our subscriber numbers are going to be going forward. But you can look at the quarterly trends and deduce from that what the trend line is.

Those trends do not suggest we're at an equilibrium yet, but I'm not saying what I expect the next few quarters to be. But there's definitely some trending in the quarterly year-over-year changes.

Okay. That's helpful. Thank you, Tom.

Our next question will come from Stephan Bisson of Wells Fargo. Please go ahead.

Good morning. I've got one question on video and then one on data. First, I think in the past you have talked about increasing price -- passing through all price increases to the subscribers. You didn't raise rates this year, so is there a change in that strategy at all?

No. We did take a $10 rate increase last year, which was significantly more than last year's price increase. We do not, have not for a long time, and maybe this is part of not being a public company for a long time, had a pattern of let's do everything to smooth quarterly results.

We used to take video rate increases every two years for about a decade. So we took more than enough programming cost increase -- or more than enough video increase last year to cover our programming cost growth last year and so far this year.

Got it. And then on data, penetration levels are a bit lower than the rest of the public peers, and that's clearly because of some geographic footprint differences. Could you remind us about the overall data penetration in your particular markets? And what might change to drive those markets to be more in line with the national average?

It's a very, very interesting and very important story and question. Thank you for asking it.

We talked about it a lot again during our spin off process, that all the non-urban operators hover on the lower end and all the pure urban operators, say Cablevision or Cox, hover on the upper end. And those that are a blend hover in the middle.

Clearly, there's a lot of demographic impact -- penetration is heavily impacted by demographics: urban, rural, income, et cetera. We are in 19 states, about 40 markets. So we have an enormously rich blend, even within our more or less non-urban operation.

We have dramatically different penetrations in growth rates in different Cable ONE markets with the same packaging and pricing. So we're quite comfortable with where we are given our demographics and given our competition. The other large variable that we're convinced is important other than demographics is competition.

That's certainly understood in the industry. And we are -- 25% of our homes passed are overbuilt. So we're also able to isolate the impact of -- when I say overbuilt, I mean there is a wire triple play alternative. So we have quite a range of markets with more or less competition and better or less good demographics.

And when you factor all that in, we are right where we would expect our markets to be, given the demographics and given their level of competition. The good news is that leaves us a lot of upward momentum, whereas other markets or other MSOs may be reaching near saturation. We believe we will continue to trickle up for many, many, many years, both in adoption rates and in market -- taking market share from DSL.

So we're aware of where we are, we know why we are there. We have the best broadband product available in the industry as a standard product, and we think it just will continue to perform well year after year after year. I've said also in this respect, anticipating an unasked question, I think I said it on either the first quarter, we had a call in the second, we are not out to get 5%, 6% HSD growth or internet growth per year.

We're out to get 2% to 3%, 4% per year for a long number of years. Added to that, 2% to 3% CPI-like rate increase. Add to that a 2% to 3% tier move up or premium ARPU improvement.

That gets you to a nice high single digit long-term rate of growth for HSD, with a product that has a terrific margin. That is our long-term strategy for how to manage HSD in our Company.

And again, Stephan, this is Kevin. To add onto that, we believe we have a superior HSD product to anyone out there, and we believe it's at a fair price.

This is not a PSU game where we're motivated to do heavy discounting in order to drive penetration levels up. We're focused on cash flow and free cash flow. So I think that's our strategy across the board.

Just to footnote that, even with the $10 rate increase at the beginning of the quarter, our rate of HSD growth went up -- unit growth went up.

Great. And then if I could sneak one more in there on capital returns, how do you think about share repurchases versus dividends?

Well, that's an interesting question. Probably would see them both as good ways to return money to shareholders when we don't have an appropriate better use for it. If you're asking do we prefer one -- I think they serve different purposes.

Once you set a dividend policy, you better stick with it. Whereas share repurchases, if we do find the perfect strategic investment opportunity with a superior return, we can turn off the share repurchases.

Or if the share price goes too high, we can turn off share repurchases on a dime and devote that money to the M&A side of the business. So I see them as both equally good ways of returning money.

There is obviously a little bit of a tax difference one to the other. But one is, one, we really should not mess with once we set it in place. And the other, we can turn on and off as our other opportunities dictate.

Great. Thank you so much.

Thank you, Stephan.

(Operator Instructions)

Our next question will come from Phil Cusick with JPMorgan. Please go ahead.

Hi, guys. First, a follow up on what you just said. I think you said 3% to 4% penetration growth is the goal, which would be a lot faster than it has been. Did you mean 3% to 4% growth, or--

I said 2% to 3%, maybe 4% if we get lucky. We're not going for the industry 6% range.

Okay. That would still be a pretty significant acceleration over what we've been doing. Is there anything going on that would accelerate that growth of HSD?

There are things going on. The customers will decide whether it accelerates or not -- they and the competitors. We did double our speeds.

We took our first price increase in four years; a 10% price increase for doubling of speeds. One helps one hurts, although net-net, like I said, we did better -- rate of growth improved slightly in the fourth quarter. The other is we announced in the fourth quarter our GigaONE product, which will launch to almost every customer by the end of this year.

Our first six test markets are launched as of now, and that won't necessarily grow customer counts. I think that's more important for a branding statement that we have the capacity, we have the know how, and we have a product that is so superior to DSL that you really ought to -- this is to attract people away from DSL for branding purposes.

So it's too early. We're only -- we've announced it in all of those markets that we'll get it this year, but we've not started advertising it, except in the six markets that launched in the past week or so. It will be a rolling launch throughout the year.

So we invested a lot of money in the capacity to be able to do that, but it's capacity we would have to have purchased in the next 12 to 24 months anyway just to keep up with the doubling of demand of consumers every 18 months. So it's just a slight early-ing up of some spending.

So those would be the things that I can think of that might -- where we're not predicting, but might influence a rate of growth of HSD. But again, our approach is not to jump from 2.5% to 6%.

If you looked at the HSD revenue growth for the year of those that report revenues by products, ours might be the very best in total revenue growth. That's far more important to us -- and it's balanced between units, rate increase, and ARPU growth due to premium tier purchases.

Understood. And a couple of clarifications. Voice ARPU and revenue have bounced the last couple of quarters.

Is there anything changing in your cost allocation model? Or is that fundamental growth?

That was on voice and --

Voice -- it was ARPU and revenue have been growing.

Oh, both -- two aspects of VoIP. We have had over the past year, and we've mentioned it, some slight reallocations of things like modem revenues and whatnot from quarter to quarter. I don't think from third quarter to fourth quarter we changed.

I'm looking at someone who have these answers here. Third to fourth quarter, we changed any allocation? We did, okay.

He's saying there was a tiny allocation change of some kind in the fourth quarter. The bigger ones were in prior quarters.

Okay. So we need to think about this is the run rate going forward?

I think so. That's fair.

We've been sorting it out. The billing system got the numbers a little confused, and the spin-off perhaps a little bit too. So we've been trying to get our units and our ARPUs on a stable run rate, and I think we are finally where they should be in the past quarter.

Okay. That helps.

As far as how we calculate them.

And the insurance benefit in the fourth quarter, was that one time, or is this the new run rate?

No, that's a one time, Phil.

Okay.

That's why we excluded it when we talked about it. We technically call it adjusted [adjusted] EBITDA. These are unusual items that hit in the quarter and not expected to be recurring.

These are not ongoing health insurances. This was -- we received a payment for being insured, and I think it was a patent lawsuit where we got compensated for the cost of it.

So they are unusual and nonrecurring.

Understood. You talked about mid to high teens for CapEx. Are there still projects like billing systems that are finishing up here, or is this a good run rate number?

And you and I have talked about capital intensity before. Given the shift toward broadband, does capital intensity go up, down, flat over time? How do you think about it?

Well, we're sticking with the guidance we gave last summer. We think it was correct and we're looking at it now. We still think it's correct and we're just leaving it at mid to high teens.

But I'm trying to remember the first part of your question. The unusual projects. The only significant one that is not finished, there were four we itemized in our Form 10 and on the road shows, in past calls.

And the only one not substantively finished is all digital. But we are in the last year of four years. That's been going on for four years.

And we're well into the last year at this point. But it will go on all the way, some will even be in the fourth quarter. It doesn't end until early fourth quarter.

Okay. Last one, if I can, you talked -- you just mentioned a minute ago the potential to find assets that you might buy as a reason to not put more money into your dividend. What's it look like in terms of assets in or out of footprint?

How are you thinking about it? How is the Board thinking about it, things that could be accretive to value over time?

Well, there's not a lot of traditional cable assets available like there were 10 years ago, 15 years ago. There are some. And we're looking at anything that is available to see if it would be highly accretive and could be purchased at a price that's very attractive to our shareholders.

We're not going to buy it just to get bigger, but if there's an opportunity to do it very attractively or there are some honest synergies that are real that we believe in, it would be to the benefit of the shareholders, we would look at traditional cable purchases. But we're looking at things.

There are some nontraditional business services related opportunities that -- obviously our business services is growing very well. Some other cable operators are doing -- most cable operators are doing very well in the business services, and there could be organic or inorganic opportunities in that enterprise business services space, so we're interested in that as well.

I'll leave it at that. The cable bolt-ons are just very limited in volume at this point, limit ourselves to just traditional cable.

But Phil, just to add on to that, as we look we want to stress that we're being disciplined about this. And Tom mentioned we're not going to make acquisitions just for the sake of doing it.

We want to make sure it's accretive to shareholder value; so that's very important to us and that's why it's taking us sometime to look at these. Until we can find the right M&A opportunities, we're not going to do it just for the sake of getting larger.

Understood. Can you tell us, though, if you're thinking more in-footprint, out of footprint, adjacent, totally new businesses?

Rather not.

Understood. Thanks.

Thanks, Phil.

Ladies and gentlemen, this will conclude our question-and-answer session. I would like to turn the conference back over to Tom Might for any closing remarks.

Thank you. Many of our shareholders on this call may be new to Cable ONE, since there's been a major transition in shareholders since the spin off last July. Of the top 25 institutional shareholders at the end of this past year, approximately half are new to us since the spin off date.

A big thank you to all of you, to all of our investors for your investments in Cable ONE. We would also like to thank our associates as well for their hard work and their dedication in this past very demanding year. Well done, team.

We would appreciate, or we do appreciate your time today for the opportunity to update all of you on our strategy and our financial results. We are very pleased with our trajectory so far, and we look forward to speaking with you about it next quarter. Thank you.

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