Cable One Inc

NYSE:CABO

Earnings Call Transcript 2018-Q1

[Operator]

Good day, and welcome to the Cable ONE Q1 2018 Earnings Conference Call. [Operator Instructions] Please note, today’s event is being recorded.

I would now like to turn the conference over to Kevin Coyle, CFO. Please go ahead, sir.

[Kevin Coyle]

Thank you, Rocco. Good morning. Welcome to Cable ONE’s First Quarter 2018 Earnings 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 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 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 website at ir. cableone.net.

Joining me on today’s call is our President and CEO, Julia Laulis. And with that, let me turn the call over to Julia.

[Julia Laulis, President and Chief Executive Officer]

Thank you, Kevin. Good morning, and thank you for joining us for our first quarter 2018 earnings call. These are interesting times for our industry, but I can’t say they are unexpected. Certainly, there are many paths to a solid long-term business. Our path began several years prior to our spinoff in the summer of 2015. It was around 2012 when we had identified what appeared to us to be inevitable trends for linear video service. Rather than fight them, we pivoted our focus to residential HSD and business services, which were continuing to grow and offered significantly higher margins.

We stopped counting video units and instead pursued cash flows. That strategic shift, coupled with the operational excellence of the Cable ONE team, has brought us to a place where we expect to sustainably grow adjusted EBITDA as well as adjusted EBITDA less CapEx in industry-leading ways. You may recall that at the time of the spin, we labeled ourselves contrarian success story based on our differentiated philosophy. Well, after seeing this quarter’s results, I am more confident than ever in Cable ONE’s long-term strategy. With that backdrop, I’d like to take a moment to share with you what our pivot has meant for legacy Cable ONE.

From an operational perspective, let’s look at where we were at the end of the first quarter of 2018 compared to 2012. Our video PSUs have dropped approximately 54%, but our residential HSD units have grown 12%, our business PSUs have grown almost 89% and our headcount is down 23% through process improvement and attrition. So what does that translate to from a financial perspective?

Comparing the 12 months ended March 31, 2018, to full year 2012, our bad debt has dropped 62%, OpEx is down 12% and total revenue has grown 5%. Now keep in mind that the majority of that revenue growth has come after the spin in 2015, which we believe shows that we’re past the tipping point of the strategy. We continue to see modest revenue growth, coupled with strong margins in the first quarter, which are key ingredients in our recipe for success.

Meanwhile, adjusted EBITDA continues to trend in the right direction, with margin up 1,130 basis points and adjusted EBITDA up 36% when comparing full year 2017 to 2012. Over the same period, we have reduced our capital expenditures by nearly 5%. We have made significant progress since 2012 based on a clear and focused strategy, and we positioned ourselves well to continue this solid performance.

With recent adjustments in how we go to market, we’re beginning to see the inflection point sharpen and the balance of rate and volume start to normalize. As we continue to grow and evolve, I’m excited for the future of Cable ONE. Before I get too far ahead of myself, I’d like to talk a bit more about the first quarter of 2018. The continued integration of NewWave Communications, or what we now call our Northeast Division, remained a primary focus during the quarter. Integration is going well and remains ahead of schedule. We are in the process of a billing system conversion, and we anticipate that will be completed by fall.

Migrating Northeast Division customers to the more robust legacy Cable ONE billing system will allow us to gain operational efficiencies, provide a more customer-friendly platform for those subscribers as well as reduce duplicate provisioning systems, all of which will generate savings. Over the next few quarters, we will continue to standardize policies and best practices across the Northeast Division and legacy Cable ONE in order to provide a consistent and seamless experience for our customers.

Despite operational changes as well as modification to business practices, we continue to see sustainable growth in the Northeast Division. We expect that as integration progresses, we will unlock synergies more quickly than originally anticipated. We mentioned some measures on our last call that we were putting in place to make the Northeast Division more closely resemble Cable ONE. These included a shortened, more disciplined collection cycle and a cessation of deep and lengthy discounts to name a few.

We did see a short-term deceleration of unit growth and increased ARPU, but we remain confident that these measures will benefit us in the long term. In legacy Cable ONE, although still in the early stages, our testing of market- based packaging and pricing, alongside increased competitive responsiveness, has produced favorable results. One example is the sell- in and upgrade close rates for residential customers choosing to opt into our higher-tier HSD services, which we targeted in the first quarter.

Of course, the emphasis on the premium end of our product suite contributed to the deceleration of unit growth as well as increased ARPU that I just mentioned. At the same time, we learned a bit about pricing elasticity, customer desires and product positioning. We will continue to monitor this and apply our expanded business intelligence tools to make informed decisions and target offers to drive sustainable long-term growth. Switching gears, I’d like to address the trend that can often follow slowing unit growth rate, which is the inflation of ARPU.

As I mentioned before and as we expected, the same initiatives that recently slowed our growth rate, things such as everyday low pricing, stopping deep discounts and implementing a shorter collection cycle, also happened to drive up ARPU. We will gather more data from our market-based testing, we will continue to hone our offers, and we will find the best levers to pull to meet the needs of our customers. At that time, we anticipate that both unit growth and ARPU will normalize.

As far as HSD ARPU, there were a combination of factors impacting our Q1 numbers. Looking at legacy Cable ONE first, we implemented a rate adjustment for leased modems, which also includes our WiFi ONE whole home wireless service and our HSD Lite Plan that boosted first quarter ARPU to a good extent. We also saw increased premium tier subscriptions with vastly improved sell-ins to such tiers as well as reduced discounts. On the Northeast Division side, we saw some of the same factors impacting sequential quarterly HSD ARPU growth, particularly the modem rate adjustment and reduced discounting.

In addition, over half of the sequential growth was caused by an allocation change associated with discounting that raised HSD ARPUs with corresponding decreases in video and voice ARPU. Ultimately, I’m confident that our strategy is sustainable, going forward, based on the results of a recent testing as well as the expected alignment of our unit growth and ARPU. Turning to business. Our SMB group launched six new Piranha Fiber projects in the first quarter. An extremely reliable fiber-based architecture and shared bandwidth service offered to mid-market businesses, Piranha Fiber has met with much success in previously launched markets.

We anticipate that the accelerated launch in these new markets offer significant opportunity, driving both revenue and market share growth. The first quarter also saw the start of hosted voice trials across several of our markets, which will provide insight as the customer demand for this cost-effective, flexible and scalable solution to our business customers. On the operations front, we are rolling out or expanding self-service solutions that help our customers save time and money while allowing us to effectively manage resources.

For example, customers self-installs for residential HSD reached a 25% across legacy Cable ONE in the first quarter. Self-install is an optional program in which our customers receive an easy-to-use self- installed kit, mailed right to their home or picked up at our office. This allows them flexibility on timing and also costs less than having to schedule a technician visit. Additionally, we saw attrition of just over 4% of our legacy Cable ONE FTEs year-over-year as we continue to improve our efficiency. Increased automation and improved customer experience and the cessation of noncustomer-centric practices help to decrease unnecessary contacts from our business. And now Kevin will provide more financial details on our first quarter results.

[Kevin Coyle]

Thanks, Julia. Before getting into the details, I want to remind everyone that our 2018 first quarter results include NewWave operations, while our 2017 first quarter results do not, as the NewWave acquisition was completed during the second quarter of 2017. Also, as discussed in our fourth quarter earnings call and within our 2017 form 10-K filing, we revised our historical financial information to properly reflect the accounting for certain categories of capitalized labor and other immaterial adjustments.

Our first quarter 2017 results had been revised to reflect such adjustments, and the impact of which is immaterial to our financial statements. Additionally, the new revenue recognition accounting standard went into effect in the first quarter of 2018. We elected to apply the standard on a retrospective basis, resulting in certain adjustments to previously reported amounts. Our first quarter 2017 results have been recast to reflect the impact of applying the standard, and such impact was not material to our financial statements.

You can refer to our Form 10-Q filing, which is expected to be issued later today for further details. There is one other item I wanted to mention. Based on the results of our internal review and validation of residential and business serviceable addresses within our footprint, we reduced the number of homes passed for legacy Cable ONE by approximately 74,000 to 1.6 million from the 1.7 million we reported as of December 31, 2017.

Now getting into our 2018 first quarter results. Revenues for the first quarter of 2018 were $265.8 million, including a $48.6 million contribution from the NewWave operations compared to $207.4 million in the prior year quarter. Residential data revenues increased 31.4% and business service revenues increased 39.8% year-over-year. Excluding NewWave operations, our residential data and business services revenues grew at 10.7% and 12.3% year-over-year.

Net income in the first quarter was $40.7 million compared to $32.1 million in the prior year quarter, an increase of 26.6%. Excluding NewWave, net income would have been $37.8 million, a 17.7% increase. The increase in net income was driven primarily by lower income tax with our first quarter effective tax rate decreasing to 19.6% from 37.3% in the first quarter of 2017 as a result of the 2017 federal tax reform legislation.

Excluding NewWave, operating expenses increased $1.4 million year-over-year, driven by higher repair and maintenance expenses of $0.8 million, group insurance cost of $0.3 million and contract labor expenses of $0.3 million. Meanwhile, legacy Cable ONE selling, general and administrative expenses decreased $1.9 million year-over-year, primarily attributable to $1.5 million of acquisition-related costs and $1.3 million of severance expense incurred in the first quarter of 2017 that did not recur in 2018.

These decreases were partially offset by higher group insurance costs of $0.9 million, resulting from increased claim volume in the first quarter of 2018. Adjusted EBITDA was $123.2 million for the first quarter of 2018, an increase 26.7% from $97.2 million in the prior year same quarter. Without the $18.7 million contribution from NewWave operations, adjusted EBITDA would have been $104.4 million, a 7.4% growth from the first quarter of 2017.

Our adjusted EBITDA margin for legacy Cable ONE increased 120 basis points from 46.9% in the prior year quarter to 48.1%. We’re also very pleased with the performance of NewWave operations, which saw adjusted EBITDA increase from $16 million in the fourth quarter of 2016 to approximately $19 million for this quarter, an increase of 17%.

Capital expenditures totaled $41 million and $35.9 million in the first quarter of 2018 and 2017. The $41 million of capital expenditures represented 15.4% of revenue for the quarter. Adjusted EBITDA less capital expenditures for the first quarter of 2018 was $82.1 million, an increase of $20.8 million or 34% from the prior year quarter. Excluding NewWave, capital expenditures would have been $34.1 million or 15.8% of revenues.

Spending for capital expenditures was lighter than expected during the first quarter. However, we do expect CapEx spending to ramp up in subsequent quarters so that our capital expenditures as a percentage of revenues will be in the high teens for 2018.

Our higher capital spending in 2018 is still due to the integration of NewWave into Cable ONE for initiatives like rebuilding low-capacity markets, launching all digital video services, implementing 32-channel bonding to eventually offer GigaONE’s service and technology and product migrations.

From a liquidity standpoint, we remain in excellent position as we had approximately $185 million of cash on hand as of March 31. We continue to generate significant free cash flow, which was further enhanced by the 2017 federal tax reform legislation, with expected cash tax savings of approximately $38 million to $42 million during 2018.

At quarter end, our debt balance was approximately $1.2 billion, which included approximately $745 million of term loan borrowings to finance the NewWave acquisition. In April 2018, we repriced our Term Loan B, resulting in a 50 basis points reduction in our interest rate, which in turn will save us approximately $2.5 million per year in interest costs.

Overall, our debt to adjusted EBITDA was only 2.4 times, and after netting cash on hand against debt was only 2x, providing us with significant liquidity. We also had approximately $197 million available for borrowing under our revolving credit facility as of quarter end. So in summary, we’re very pleased with our first quarter financial results as reflected in our numbers thus far.

We continue focusing on the integration of NewWave, our Northeast Division, into our operations and look forward to continued growth and the continued realization of operating synergies throughout the remainder of 2018 and beyond.

Operator, we’re now ready for questions.

[Operator]

[Operator Instructions] Today’s first question comes from Philip Cusick of JPMorgan. Please go ahead.

[Philip Cusick, JPMorgan]

I guess, first, can you talk about elasticity? Julia, you mentioned learning a lot. What are you seeing that might help you price more precisely, going forward?

[Julia Laulis, President and Chief Executive Officer]

Thanks, Phil. Yes. So we are in the process of multiple tests in many of our markets. We are working on being able to fuel the unit growth and unlock it. And to do so, we’ve been using our business intelligence tools and working on these tests.

The tests are still in early stages. But what I am most excited about is seeing the number of customers that are opting for higher levels of service. We’ve always concentrated in selling in our flagship service, which is 100 MB and – for $55, and that’s what we’ve marketed. And we marketed it at a discount for actually years on end, as we stopped that discounting and went to everyday low pricing so that we could sort of normalize the market and do these tests.

We’re pushing on all ends of our product suite to see what people like and at what price point. So we’re measuring churn and take rates and all of that. And again, what we’re seeing is people choosing – they must have a need or at least a perceived need for service levels higher than our flagship, so 150 and above.

[Philip Cusick, JPMorgan]

Much interesting. And the strategies you’ve discussed on the last several calls, that should list the pulling back on promotions, testing pricing, has these exceeded your expectations in terms of the potential of the options out there?

[Julia Laulis, President and Chief Executive Officer]

Well, as I said, it’s exciting to me. The testing is still in early phases, Phil. What I see is exciting. I think it’s going to point us to – I sort of think of it as a seesaw or teeter- totter, where maybe one end is up high and the other end is low, and you kind of have to come to the middle before you tilt up to the other way, and that’s our goal. So time will tell as we continue to stay close to the market, stay close to our customers and measure the things that matter. But then, we’ll be ready to go.

[Philip Cusick, JPMorgan]

Okay. And then in terms of the strategic side. As the NewWave deal is integrated and billing conversion is finished up, how do you think about the next strategic opportunity? And what have you learned from doing the NewWave deal that you can leverage into the next transaction?

[Julia Laulis, President and Chief Executive Officer]

You’ve got a bunch in there, Phil. Next strategic opportunity, and Kevin says over and over again that we opportunistically, aggressively, yet patiently, look for what makes sense for us from a value creation standpoint. I think that we absolutely have built upon some of our core competencies, which one of the first that comes to mind is the way we operate and our attention to execution and doing things in a quality manner. And the NewWave integration is going like that. It’s going well and it’s going fast. So my belief is that, for anything that may be on the horizon in the future, we will attack it in the same manner.

[Kevin Coyle]

Phil, just to add to that. We’ve said in the past that we view ourselves as a natural aggregator of cable systems in rural America. We do it more efficiently than anyone else. I think we have our processes down, and that helped very much in the integration of NewWave. We, as Julia already said, continue to look for new opportunities all the time. And hopefully, if we can find those opportunities at the right price, we’ll be able to have a second NewWave. So we’ll continue to look.

[Philip Cusick, JPMorgan]

Since you bring it up, what do you see out there in terms of a pipeline? Is there a decent pipeline of opportunities? Or is it pretty sparse?

[Kevin Coyle]

Phil, I really can’t comment on that. I mean, we’ve been looking continuously now since we became a public company in 2015. We’ve looked at a number of opportunities. Very fortunate to have found NewWave. And hopefully, there’ll be more NewWaves. But there’s still a pipeline out there.

[Philip Cusick, JPMorgan]

Good thank guys will see you next week.

[Operator]

And our next question today comes from Frank Louthan of Raymond James. Please go ahead.

[Frank Louthan, Raymond James]

Great. Thank you. If you look at the customer [indiscernible] does that purge [indiscernible] is there any opportunity to go back and maybe build to some of these homes? Or they no longer exist? And any other opportunities maybe to find some other homes in your market that…

[Kevin Coyle]

Frank, our apologies. Frank, you started to break up. I’m not sure we could hear the question.

[Frank Louthan, Raymond James]

Sorry. When you look at the purge of the customer homes – the homes passed, is there any opportunity to go back, maybe do some low-cost builds there? Are these just homes that don’t exist anymore? Is there any opportunity maybe to look at just some geo mapping or something and find some other customers that have been built over the years, maybe just don’t have an account and be able to – and do some low- cost marketing and get some more share?

[Julia Laulis, President and Chief Executive Officer]

Frank, this is Julia. I think the homes passed change that you saw had to do with updating, bumping up against USPS and other lists to take out addresses that just were wrong. I think this is something that all cable operators do on an ongoing basis and struggle, quite honestly, to get exactly that right homes passed count. Our intention is to use geo-spatial addressing for our homes passed database, and that is something that we are working on, so we can get a count that is very, very, very accurate.

[Frank Louthan, Raymond James]

Okay, great thank you.

[Operator]

And today’s next question comes from Stephan Bisson of Wells Fargo. Please go ahead.

[Stephan Bisson, Wells Fargo]

Good morning. A couple of questions. First, the cessation of discounting, was that to just new subs or just subs that have recently been on-boarded? And how much was the amount of this?

[Julia Laulis, President and Chief Executive Officer]

When we stopped the discounting, Stephan, it was for new. So anyone who came onboard with a discount carried that. Now keep in mind, we’re probably the – we have very short discount periods. So typically, that would have been three months. So they kept their discount for that period of time. But anything new coming on from pretty much last fall through current has been at full price.

We just call it everyday low pricing because we do think that 100 MB for $55, including WiFi ONE if you rent our modem, is a great value. The modem fee increase was $2.50, and that does include our WiFi ONE whole home guaranteed wireless service, so you’re guaranteed to get the wireless experience that you want and need, if that is with extenders, if it’s with us coming out there and helping you with placement of items, that’s all included with that modem fee.

[Stephan Bisson, Wells Fargo]

Great. And then the customer reaction, you mentioned a little bit of choppiness, is that more on the gross ad side or the churn side, that seems to be kind of more near?

[Julia Laulis, President and Chief Executive Officer]

Yes, yes. No, it’s on the connect side, Stephan. Churn is beautiful.

[Stephan Bisson, Wells Fargo]

Great, thanks so much.

[Operator]

And the next question comes from Craig Moffett of MoffettNathanson. Please go ahead.

[Craig Moffett, MoffettNathanson]

Thank you. Julia, I’m going to stay with this theme of price sensitivity and broadband ARPU for a second. If I think about the drivers of broadband ARPU, it’s – you talked about modem rental – the modem rental increase and eliminating promotional discounts. You’ve also got up-tiering of customers due to exceeding usage caps, and then you’ve got voluntary customers opting into higher-speed tiers. Can you disaggregate those things for us? And I’m just wondering if I can sort of try to conceptualize what the underlying growth rates are of the products themselves, or the underlying growth rates of the pricing in the products themselves to try to get a handle on what’s driving the level of ARPU growth that we’re seeing, which is obviously very high.

[Julia Laulis, President and Chief Executive Officer]

Yes. And it is high. And so as you might expect, Craig, we’ve gone through and done that exact exercise. I’m not going to share it today, but I will tell you some of the pieces that you mentioned. So the stop discounting, obviously, that’s going to drive up ARPU. If you – the modem increase, obviously, had some effect. The sell-in to higher tiers, which again we were testing and playing with this, and we’re kind of surprised by the large take rates drove it up as well. There was an allocation change, so that was a part of it. And we do have usage-based data plans as well. I will say that those become less as the voluntary sell-in becomes more. But those are the pieces and parts. I won’t get into the details of how much each one is, though. And it is slightly different for legacy versus NewWave.

[Craig Moffett, MoffettNathanson]

Do you have a sort of a north star in your head of sort of what’s the rate at which you can be raising like-for-like pricing over the long term? Just to get a sense of sort of how price elastic you think the category can sustain.

[Julia Laulis, President and Chief Executive Officer]

I don’t know that I have a north star. I have a direction. And my best analogy is that seesaw again, that teeter-totter, where we’re going to – we’re learning what we need to do to push levers to drive growth. And as we drive growth, it won’t necessarily mean that ARPU will come down.

[Craig Moffett, MoffettNathanson]

Alright, got it. Thank you, Julia.

[Operator]

And ladies and gentlemen, this concludes our question-and-answer session. I’d like to turn the conference back over to the management team for any final remarks.

[Julia Laulis, President and Chief Executive Officer]

Thank you, operator. I want to thank all of our Cable ONE associates for a solid start to 2018. We continue to be stronger together. We will be attending the J.P. Morgan Global Technology Media and Communications Conference in Boston next week, and we look forward to seeing some of you there. We appreciate you for joining us on today’s call. Thank you.

[Operator]

And thank you, ma’am. The conference has now concluded, and we thank you all for attending today’s presentation. You may now disconnect your lines, and have a wonderful day.

[Kevin Coyle]

Thank you.