Executives
Robin Gutzler
Thomas M. Rutledge - Chief Executive Officer, President and Director
Christopher L. Winfrey - Chief Financial Officer and Executive Vice President
Analysts
Jason B. Bazinet - Citigroup Inc, Research Division
Craig Moffett - Sanford C. Bernstein & Co., LLC., Research Division
Stefan Anninger - Cr?dit Suisse AG, Research Division
Philip Cusick - JP Morgan Chase & Co, Research Division
Benjamin Swinburne - Morgan Stanley, Research Division
Douglas D. Mitchelson - Deutsche Bank AG, Research Division
Frank G. Louthan - Raymond James & Associates, Inc., Research Division
James M. Ratcliffe - Barclays Capital, Research Division
Shagun Singh Chadha - CRT Capital Group LLC, Research Division
Amy Yong - Macquarie Research
Vijay A. Jayant - ISI Group Inc., Research Division
Bryan D. Kraft - Evercore Partners Inc., Research Division
Charter Communications (CHTR) Q3 2012 Earnings Call November 6, 2012 10:00 AM ET
Operator
Good morning. My name is Keisha, and I will be your conference operator today. At this time, I would like to welcome everyone to the Charter Communication Third Quarter Earnings Conference Call. [Operator Instructions] Thank you. I would now like to turn the call over to Ms. Gutzler. Ma'am, you may begin.
Robin Gutzler
Thank you, Keisha. Good morning, everyone. Welcome to Charter's 2012 Third Quarter Earnings Call. This morning, we issued a press release over PR Newswire at 8 a.m. Eastern Time detailing our results.
Before we proceed, I would like to remind you that there are a number of risk factors and other cautionary statements contained in our SEC filings, including our most recent Forms 10-K and 10-Q. We will not review those risk factors and other cautionary statements on this call, however, we encourage you to read them carefully.
Various remarks that we make on this call concerning expectations, predictions, plans and prospects constitute forward-looking statements. These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ from historical or anticipated results. Any forward-looking statements reflect management's current view only, and Charter undertakes no obligation to revise or update such statements or to make additional forward-looking statements in the future.
During the course of today's call, we'll be referring to non-GAAP measures as defined and reconciled in this morning's earnings release. These non-GAAP measures, as defined by Charter, may not be comparable to measures with similar titles used by other companies.
In today's earnings release, we reported results in accordance with GAAP, as well as pro forma results for 2011. Pro forma results reflect the acquisition of certain cable systems in 2011 as if they had occurred on January 1, 2011, unless otherwise noted. The year-over-year growth rates we will be referring to this morning are on a pro forma basis.
Joining me on today's call are Tom Rutledge, President and CEO; and Chris Winfrey, our CFO. The presentation that accompanies their comments can be found on our website, charter.com, under Financial Information. The press release and trending schedules are also posted on our website under Investor & News Center.
With that, I'll turn the call over to Tom.
Thomas M. Rutledge
Thank you, Robin. In the third quarter, we made solid progress in implementing our key strategic changes, and our overall results are in line with our expectations.
We grew residential customer relationships by 19,000 during the quarter compared to a loss the last several years, increased primary subscriber units by 48,000 and we generated 3.75% revenue growth. As expected, EBITDA was impacted by the transition to our new operating strategies. Our adjusted EBITDA was effectively flat year-over-year.
We also accelerated capital investment to $488 million in the quarter, reflecting the significant growth opportunity in front of us and the need to create an initial working inventory of CPE.
Before we go further into details about our financial results for the quarter, I'd like to give you an update on how we're changing the way we do business. My goal is to generate more cash flow per home passed and long-term shareholder returns. I started in February, and I'm confident that Charter has all the necessary pieces in place, but we're making some changes to the operating model.
We've revamped our product, changed our offer structure and changed our selling structure, we're going all digital, and to offer a competitive product with clean bandwidth and secure our plan. And we're reorganizing our operations, including the bulk of operating responsibilities at Charter, all of which is intended to give a clear line of ownership, authority and accountability for every aspect of the customer experience.
For example, by centralizing network operations, we'll be able to centrally manage our infrastructure, allowing us to move more quickly to implement product changes uniformly across the network and maintain consistent service quality. We now have a centralized marketing and sales organization clearly focused on bringing in long-term and profitable new customers.
Our regional teams will focus on operations, including installation, service, maintaining quality outside plant and they'll focus exclusively on doing these critical responsibilities well. These are just some of the examples of recent changes, and they will take time to fully implement and have the intended effect. But we have the team in place to do it, and we're making meaningful headway.
We've also launched new pricing and packaging as we entered the third quarter. We simplified and standardized our offering for both our customers and sales agents.
In video, we made the product competitive by increasing our HD offering and provided the right box and the right TV set in each transaction. We also simplified our Internet offering in 2 tiers and increased our base Internet speed to 30 megabits, which is 10x faster than the typical DSL speed and faster than U-verse can currently go.
We priced our lead triple play offer, which includes a fully featured phone offering in a way that includes more value than our customers can get elsewhere. In addition, we changed how we go to market with this superior offering by modifying our channel mix and messaging and changing our sales compensation plans to drive the desired selling activities.
The key objectives of our new offering are to: one, drive deeper penetration of our services into the home with a simple compelling offer structure; secondly, to drive higher ARPU per connect which will increase over time with built-in, multi-year price dips; third, our transaction cost per customer will be lowered; and finally, we'll extend the life of our customers through lower churn. All of these objectives are designed to increase operating cash flow and drive return on investment.
At this point, we're where we expected to be, and I'm pleased with some of the early stats. For example, we've seen our triple play percentage of new connects increase by 70%. And as of the end of the quarter, 17% of our base is now on our new pricing and packaging, which in a single quarter is ahead of where we expected to be.
Through a new customer acquisition and migration of legacy customers, we're seeding the market with a better video product, with an upfront capital investment which pays for itself immediately or after a promotional period. That improvement in video doesn't immediately show when you only look at growth -- video growth in the third quarter. Our expanded basic subscriber losses actually improved by 30,000 year-over-year because we're only actively marketing expanded basic.
We lost 17,000 expanded basic customers in Q3 '12 versus losing 47,000 in the same quarter last year. We've added a graph on Slide 4 of the presentation posted this morning which shows how previous selling -- reception basic masks the underlying improvement.
While the big opportunity for Charter remains in our core operations, our offerings and the service we provide, we continue to develop new products in parallel. That includes delivering content on devices inside and outside the home; in proving user interfaces, both on legacy and on new devices; in creating the capabilities to control and modify and deliver those interfaces from the cloud. We'll have more to announce on product developments as they're ready for broader rollout.
We're developing those product improvements in the context of buying set-top boxes at significantly lower prices which we can use to grow Charter. And we intend to progressively move to an all-digital platform over the next 2 years, starting with seeding with boxes -- the market with boxes today, turning off analog channels to reclaim bandwidth and eventually switching off the inferior analog product altogether.
So we're making improvements across the organization and changing the way we do business. There is a lot of change, and I'm pleased with the way our employees have responded. Ultimately, we'll be a highly effective service organization with a superior product offering. And we're taking actions designed to deliver meaningful value to customers and superior return on investment to our shareholders.
And before I turn the call over to Chris to cover the third quarter in more detail, I'd like to highlight that our commercial services continue to do well, grew revenue by more than 20% year-on-year for the sixth consecutive quarter, demonstrating strength in this business. We continue to see a big opportunity in front of us here.
And now, Chris Winfrey?
Christopher L. Winfrey
Thanks, Tom, and good morning, everyone. Our third quarter results are tracking with the strategy Tom just laid out. Adjusted EBITDA declined slightly, and CapEx increased as a function of the plans we're implementing.
Looking at residential volume and revenue per customer on Slide 4. The customer relationships increased 19,000 compared to a loss of 10,000 in Q3 of 2011. In PSU terms, we grew by 48,000 in the third quarter compared to virtually 0 a year ago. Our video losses were 10,000 higher than prior year. Our expanded basic trend improved, with limited basic customers representing over 3 quarters of the decline this year compared to 25% in the prior year.
We added 69,000 Internet customers compared to 53,000 last year. And phone PSUs, the most visible beneficiary of our new pricing packaging, increased by 52,000 in Q3, nearly 5x the gain of 11,000 in the year-ago quarter, all of which was expected given the changes we're making.
Total revenue per residential customer relationship was $105.39 in the quarter, down from Q2 ARPU of $106. The overall ARPU reflected entry-level pricing; and despite a meaningful increase in triple play selling, still reflects continued sales of single play Internet.
So those are the early statistics, but there's more to the numbers. We no longer actively market analog, and we also saw a temporary drop in direct sales as we retool that channel. We acquired customers who are more profitable, with a deeper product and CPE penetration which will lower future transaction cost and propensity to churn.
Triple play increased by 70% to 26% of new connects in Q3 at an entry-level ARPU of approximately $120 and removed a portion of our existing base up the value chain to make existing relationships more profitable.
So the revenue benefit is not yet in the financials and won't be for a few quarters. What we do expect to highlight in the coming quarters are ARPU per residential customer, not product ARPU, and the percentage customers taking bundled products, particularly triple play; and early on, the portion of our customer base in the new pricing and packaging with a richer, fuller offering, which will result in fewer transactions and lower churn. As Tom mentioned already, it's 17% of our base.
Turning to Slide 5 in the presentation. Third quarter revenue grew 3.7% year-on-year. Video revenues declined 0.5% due to a decrease in residential basic video customers year-on-year, partially offset by price increases and higher DVR and HD revenues. Internet revenues were 7.6%, driven by the addition of more than 300,000 customers over the past year.
And phone revenues were down 3.7%, despite the 6.5% customer gain in the past 12 months, somewhat irrelevant going forward due to triple play revenue allocation, which is why we'll stop reporting product ARPUs after Q4 and while we're providing some additional color on bundling splits. And don't forget, we're selling in at promotional rates today with lower onetime fees, including install with the new pricing and packaging.
Adjusted EBITDA was down $3 million year-over-year. But before I go through the expense drivers, I want to tie the PSU and revenue development to our growth investments.
As shown on Slide 6, third quarter capital expenditures totaled $488 million, an increase of $184 million versus the year-ago quarter, driven by higher CPE, support capital and commercial spend. We spent over 1/2 our capital, or $255 million, on CPE in the quarter, essentially split into 4 buckets of spend. Nearly 40% of the spend in the CPE category during Q3 was to capitalize new install labor for residential and commercial, which is included in the MCTA-CPE category. We also built CPE inventory, which accounted for approximately 30% of the $255 million to ensure adequate stocking levels to execute on our new strategies. We can think of these dollars as really onetime working capital and timing.
We also invested in CPE for new customer acquisition and upgrades to existing customers, and this accounted for roughly 15% of the quarterly CPE spent. And finally, we're installing more CPE into our existing video customers' homes as they migrate to our new pricing and packaging and take a richer video product from us, which accounted for the remaining roughly 15% of the CPE expenditure.
So the link I'm really trying to make here is to show why that current CPE spend isn't immediately flowing to revenue. All of the CPE spend in each type of box deployment has a clear ROI attached to it, even at promotional rates. And I'm confident you'll see that spend flow through the revenue and cash flow. I'm going to show you that development over time.
To round our capital expenditures in addition to higher CPE, we increased capital to grow commercial, reflected primarily in scalable infrastructure on line extensions in our CapEx categories, and we increased commercial to $82 million in the third quarter or $34 million more than last year. And support capital expenditure also increased due to fleet replacement, which is primarily timing-related.
Our current estimate for 2012 CapEx is $1.6 billion to $1.7 billion. We expect to be on a different part of the investment curve than our peers for the next few years, but we think our growth can be more efficient given significant reductions in CPE pricing.
Now back to adjusted EBITDA on Slide 7. Adjusted EBITDA decreased 0.5% year-on-year as revenue growth of 3.7% was offset by increased expenses. Total operating costs increased 6%, and the key cost drivers were programming, which was $27 million or 5.7%; and we increased labor cost for preventive maintenance to identify potential failure points in advance and improve customer service.
And while we expect marketing, reconnect and preventive maintenance to continue at elevated levels for some time, this is all discretionary spend; and it's designed to drive revenue, better service, improve retention and ultimately, higher cash flow for home passed.
So our collective investments, including capital expenditure, are shown on Slide 8, where free cash flow was negative $17 million in Q3. From a balance sheet perspective, we had $715 million of liquidity at September 30 in pro forma for announced transactions. And during the quarter, we continue to be active in the debt markets, balancing our maturity profile and bringing down our weighted average cost of interest.
In the quarter, we issued $1.25 billion of 5.25% senior unsecured notes in August, and we announced a redemption of $678 million of CCH II 13.5% notes, which we completed on October 10. We've initiated the call for the remaining $468 million outstanding in November.
Pro forma for retiring those 13.5% notes, our weighted average interest rate will be 5.9%, our cash interest run rate will be just under $770 million, down some $175 million from just the third quarter of 2011.
So most of the heavy lifting on the capital structure is complete, but we'll continue to be opportunistic in extending and balancing our maturity profiles as opportunities arise. We ended the quarter with pro forma leverage of 4.8x, which is above our target leverage range of 4 to 4.5x. As I've said before, we can be plus or minus a half turn either way, to be opportunistic as we were with buybacks last year which enables strategic activity, including the current investment levels to position Charter for growth. I'm very comfortable with our current leverage, liquidity and our maturity profiles.
And now, back to Tom.
Thomas M. Rutledge
Thanks, Chris. So in closing, we're pleased with our progress in the results at this stage of implementation. There's more work to be done, but we're energized by the opportunity to drive long-term growth at Charter.
Operator, let's open the call for questions, please.
Question-and-Answer Session
Operator
[Operator Instructions] Your first question comes from the line of Jason Bazinet.
Jason B. Bazinet - Citigroup Inc, Research Division
On CapEx, I think the market is sort of aware of the guidance, the $1.6 billion to $1.7 billion. But I think that some of the commentary you gave today may have been new to the market, sort of higher CapEx, I think you said over the next few years. And I was just wondering if you could add a little bit of color, because Charter's sort of CapEx to rev ratio has always run sort of a bit above peers. So I don't know if you're talking sort of absolute levels or sort of changes as a percent of revenue relative to where we are in 2012.
Thomas M. Rutledge
Jason, we didn't hear the beginning of your question, but I think...
Jason B. Bazinet - Citigroup Inc, Research Division
Well, yes, just on CapEx. So I think the guidance, everyone's aware of the $1.6 billion to $1.7 billion. But I thought it was new when you said that capital intensity maybe on I think you said a different trajectory over the next few years. I was just wondering if you could add some color to that.
Christopher L. Winfrey
Yes. Look, I think the point we're trying to make is that we're elevated today, and we expect to be elevated for some period of time. And that really reflects the growth opportunities that exist at Charter and the fact that we'll be going all digital over the next 2 years, so it's a part of the CPE spend. And the good news is better CPE spend at a much lower price than where the market has historically bought those boxes. And so the capital spend that we have, we expect to be more efficient. But if you just take a look at the third quarter spend and even on the second quarter spend, you can see the uplift in CPE. And what we're trying to do today is provide a little bit of color on that for what is actually deploying to labor that flows into CPE for MCTA categories. And importantly, what's actually driving new acquisition and migrations, which is the 15% and the 15%, respectively. And onetime inventory buildup that I've talked about both on Q2 as well as in Q3. And we think we're comfortable now in just talking about what to be able to position the company to deploy the boxes, the box strategy that we have.
Jason B. Bazinet - Citigroup Inc, Research Division
So the right way to think about it is the more successful you are on the top line hitting your objectives, sort of the longer elevated CapEx will endure that sort of take hold?
Thomas M. Rutledge
Yes, that's right. In terms of comparing to peers, it's also a growth story as well. Charter's underpenetrated, has a bigger growth opportunity. And most of the capital is actually success-based, variable capital. And so you're right. To the extent that our growth exceeds our peers, our capital will exceed our peers.
Operator
Your next question comes from the line of Craig Moffett.
Craig Moffett - Sanford C. Bernstein & Co., LLC., Research Division
Tom, back when you were at Cablevision, you used to talk a lot about the long-term capital intensity of cable. And I think you talked about the prospect that capital intensity could, for that system, get below 10%. How do you think about long-term capital intensity at Charter? You got more head-ins and a more diffused geographic footprint. Do you have a long-term vision for where you think capital intensity can get to?
Thomas M. Rutledge
Yes. And I do think that in general, the cable business becomes more capital-efficient through time. It does not require another plant upgrade, which was always a concern in the industry in terms of capital intensity, and as obviously as digital set-top boxes and CPE in general continue to come down in price. And we have a strategy of buying CPE from world-class vendors and trying to get our CPE in a position where we can buy them, buy CPE from multiple providers, and therefore, get competitive pricing. And because of general price trends in general on electronics, the ability to continue to upgrade the cable system electronically and take its capacity up becomes less capital-intensive through time. The big capital dollars on this business were for the erection of the physical plant. And so as our business changes, as it moves toward IP, we can take our business and change our business in a continuously improving sort of capital-intensity profile. And that's where you are in the curve in terms of how penetrated you are, and how much growth you have will affect your capital intensity for variable capital. But the fundamentals of the business are continuing to improve from a total capital-intensity perspective.
Operator
Your next question comes from the line of Stefan Anninger.
Stefan Anninger - Cr?dit Suisse AG, Research Division
Just to stay on the theme of capital expenditures and capital intensity. On the one hand, it sounds like you're spending more on CPE for some of the initiatives you've talked about. But at the same time, it sounds like you're saying that you may be able to save on CPE on a per-unit basis, partly perhaps because of more competition at the equipment provider level. But it also sounds like you may be implying thinner boxes in the home, boxes that may be won't have storage, et cetera, which would imply perhaps remote storage DVRs and other functionality in the cloud. I guess my question is, what gives you confidence that at this point or in the near future, you're network will be ready to provide a very robust service that could, without latency, et cetera, provide the kind of functionality into the home without a drive in the home that consumers would be pleased with?
Christopher L. Winfrey
Right. Well, I wouldn't say that we have an immediate capability at Charter to go to network DVR or other cloud-based services like it, which could take what is now a fairly expensive CPE and move it into a more efficient cloud-based delivery process. That said, we are already getting better pricing on our set-top boxes going forward. And there is an opportunity that ultimately get to a thinner environment, but also the price of the current thickness of boxes is coming down, so that the capital intensity for each dollar of revenue at this part of the curve is actually less than it was a few years ago. So that's already being realized, but you can see where it continues to improve. For instance, smart TVs or iPads with cable television on the iPad is a television and a set-top box embedded in the TV, the iPad itself. So there's a case where you can connect cable service, a fully featured cable product to an iPad, and there's no CPE provided by the cable company. The set-top box is part of the processing power of the device itself. And smart TVs have a similar capability. So as we move to a server-based architecture and serve IP devices like iPads and other tablets, smart TVs, the capital intensity of each one of those connections from a cable operator's perspective goes down. So we're on that part of the curve. And so our growth -- our revenue growth per set ought to be lower than those that have been realized over the past few years by both Charter and all the rest of the industry.
Operator
Your next question comes from the line of Phil Cusick.
Philip Cusick - JP Morgan Chase & Co, Research Division
Switching gears a little bit. Tom, can you talk about any interest in M&A as you sort of rebuild the core business? It seems like there's a lot going on in the company overall. Is there room for distractions like mergers or even property swaps at this point? Or is it something that sort of pushes off?
Thomas M. Rutledge
Well, we're focused on our opportunity, and we have a big opportunity. And we have a lot of unsold passings with -- in front of us and a cable plant in front of them that's fully functional. So that's the big opportunity in Charter. And so we're not distracted by anything other than the opportunity in front of us.
Philip Cusick - JP Morgan Chase & Co, Research Division
And if something were available? Is there a level of interest there?
Thomas M. Rutledge
Well, our level of interest would be related to the value of the opportunity in front of us. And we'd weigh that if in fact that became available.
Operator
Your next question comes from the line of Ben Swinburne.
Benjamin Swinburne - Morgan Stanley, Research Division
Chris, I want to ask you 2 questions, one about ARPU and the other on just the CapEx accounting, if you could clarify for us. I think you mentioned ARPU per new triple play connect at $120, and ARPU per customer relationship was sort of flat year-on-year. I know there's a lot of moving pieces on ARPU right now. There were a couple of things you guys talked about last call like home networking, I think installation fees. Just if you could help -- kind of give us the puts and takes on ARPU in the quarter, and then how we sort of bridge from the current number to the kind of new connect number over time? And I just have a quick CapEx question. Is there any difference between cash and accrual capital as you build this inventory? In other words, how tied is the CapEx on a quarterly basis to what's actually happening from an installation perspective?
Christopher L. Winfrey
Yes, so maybe I'll take the second one first. Under U.S. GAAP for cable companies, under the pronouncements that exist, capital -- what I would normally call working capital for inventory for CPE is capitalized up front. And so it does create a difference between how that capital was used and deployed versus how it's accounted for. And so the purpose of what I was doing in the prepared remarks today was to identify that portion, which is really a working capital item, which is building up your inventory and your supply chain in a way that you can deploy more boxes per transaction, because we did that in Q2 and Q3. In a normalized environment, the reason you wouldn't have heard too much about this in the past, is the normalized environment it's normally a bit of a wash, a little bit in one quarter and up the next. But in this environment where we're stocking the entire supply system to be able to deploy that many more boxes, it's relevant when you think about CPE. So there's onetime, and you'll see some fluctuations on it. I think we've got the large amounts of it behind us. Under IFRS or other accounting standards, that's not the case. And you would actually reflect CapEx as if it was deployed, and what I was describing with would be working capital. And that's why I kind of referred to it as working capital. On ARPU -- so that's the technical accounting of today. On ARPU, the waterfall is long, what you're trying to do. Some would avoid getting into all of that and try to keep it fairly simple. You have a few different levers that are taking place. One is that our triple play is year 1 promotional pricing, and it's coming in at an average of $120, which will step up over time, as will all of the different bundles that we're selling into today. So you have a promotional rate and you have a higher amount of sales going in at that higher-than-average ARPU today, albeit at a promotional rate for triple play. You have the lower amount of install at onetime fees. You have still a strong single play Internet sell-in that's taking place, and that forms part of the mix there as well. And net-net for all those puts and takes, even at promotional pricing, we're relatively flat year-over-year with a much improved customer base in terms of product set that they have and the position to be able to step up and rate over time. And so I think if we're able to do that despite the promotional rates and the fact that we're putting more triple play in and putting more boxes into the home, we're actually in a very good position both from a revenue standpoint, as well as an OpEx standpoint and from a capital efficiency through lower churn over time. That's without going line by line, that's really the right way to think about ARPU.
Operator
Your next question comes from the line of Doug Mitchelson.
Douglas D. Mitchelson - Deutsche Bank AG, Research Division
You've covered the CapEx questions, unfortunately, so I think I'll turn to competition and EBITDA margins. Tom, are you seeing anything notable from competitors at this stage, especially post implementing your expansive changes? And would something like faster U-verse speeds be a concern? For example, I imagine AT&T will make some noise Wednesday at their Analyst Day. And then I've got a question for Chris.
Thomas M. Rutledge
Well, we haven't actually seen any change in the competitive environment. Cablevision has a pretty -- Charter has a footprint that has about 33% overlap with the competitive telco. So the vast majority of our footprint is competitive against satellite and DSL. And we're superior in almost our entire footprint. When we're up against FiOS, we have I'd say a comparable product. But when we're against AT&T in the U-verse area, we have a superior product. And when we're against satellite DSL, we have a superior product. Yes, if they take their speeds up, it will be a more competitive environment, but we have the ability to go much faster and farther than we've already gone with very little additional capital investment.
Douglas D. Mitchelson - Deutsche Bank AG, Research Division
And then for Chris, I know a lot of changes are taking place, but if operating execution is successful, it would seem Charter would shift from an initial investment phase or margins compressed to a faster growth phase where margins expand. So is that correct? Do you think -- do you see the potential for Charter to put up margin expansion at some point in the future? And at what point should investors start to model that in?
Christopher L. Winfrey
So I think the -- when you think about EBITDA margin, it's really -- the answer to your question would be when the growth starts to slow. The faster your grow, the more pressure there is on EBITDA margin as a percentage. You're spending more on sales and marketing, reconnect all the different areas that are driving that growth. And so while you're growing and particularly, when you're growing faster, you'll see compression on EBITDA margin. So I think not to turn the question back, but I will, which is when do you think the growth will slow? And that's when you see -- you should start to see margins return to a normal rate.
Douglas D. Mitchelson - Deutsche Bank AG, Research Division
So the philosophy is correct, but the hope is they don't grow for a long time, right?
Christopher L. Winfrey
That's right.
Thomas M. Rutledge
As long as you have an accelerating growth rate.
Operator
Your next question comes from the line of Frank Louthan.
Frank G. Louthan - Raymond James & Associates, Inc., Research Division
Yes. So you're giving -- obviously putting more investment in the network. Can you frame it sort of in terms of historical cable? It seems like the -- the Street seems to believe that I've talked to investors, you're just a little bit stuck sort of a few years behind some of the peers. At what point can this CapEx push kind of put you on parity or put you ahead? And then specifically, to the commercial side, what are your thoughts on any needs for traditional maybe cloud-based products or so forth? Is that something you're looking to build or possibly see a tuck-in acquisition?
Christopher L. Winfrey
Tom, do you want to answer the commercial question first?
Thomas M. Rutledge
Sure, I'll answer the commercial side of that question. Regarding cloud-based services, we see plenty of opportunity with the base services we now offer to all segments. We are very underpenetrated in the business market. Now I believe a number of years out, as our penetration increases, we want to continue to grow at healthy rates that we will need some of the supplemental services. And we offer some of the basic cloud services today. But I think our current product portfolio is very adequate, given our penetration level and the opportunity ahead of us right now.
Christopher L. Winfrey
And with -- Frank, with regard to your question about capital in general and where we stand, as I was saying earlier, a lot -- most of our capital going forward is related to our opportunity to grow. And to the extent that we grow faster than other parts of the industry, we would have more capital relative to revenue than other companies that were growing less rapidly. That said, because Charter is historically underpenetrated based on its history and it has a big growth opportunity in front of it, to the extent that it achieves its growth objectives, each dollar of growth will be served with less capital than has already been invested previously by other companies because the curve in terms of cost per CPE unit continues to go down the price curve. And so we're getting both more advanced technology and lower prices in the kinds of CPE we're buying for the growth that we're presenting in front of us. And so in that sense, we're more capital efficient for dollar generated of revenue going forward than has historically been achieved in the industry. But to the extent we have more growth in the industry, we're going to have more capital.
Frank G. Louthan - Raymond James & Associates, Inc., Research Division
And so in terms of kind of when investors can see that you've kind of reached the endgame there, do you look at certain industry benchmark penetration levels or products? And when you get there, we should expect that to slowdown a little bit or where are you? Is it a 2-year gap relative to the industry, 18-month gap, 3-year gap, something like that?
Thomas M. Rutledge
Well, the best performing company in the industry generates about $450 of cash flow EBITDA for home passed, and Charter is the worst-performing company in the industry with about $225 of EBITDA per home passed. So that opportunity, $225, the doubling of our EBITDA in total would catch us up to the best-performing company in the industry.
Operator
Your next question comes from the line of James Ratcliffe.
James M. Ratcliffe - Barclays Capital, Research Division
Looking at ARPU again, you said 17% of the subscriber base at the end of quarter was on the new package -- pricing package structure. How are they getting there? I mean, how many of those are customers who are new to the system and then basically they're coming onto the new plans versus existing customers for either proactively migrating or for retention being migrated? And how do we think about apples-to-apples what the pricing for an existing customer looks like if there's any step down on that or as you sort of move through the back book?
Thomas M. Rutledge
Yes, I'm not sure I'm going to break out all of those pieces for you, but it's all of the above. We're acquiring new customers. We're migrating customers. But generally, our pricing strategy is to step up existing customers when they move into pricing packaging and not price them down and to price in news acquisition subscribers at higher prices than we historically sold them in at. We are modifying our installation prices, which are onetime charges, and they are reflected in some of the revenue growth and ARPU numbers that you see. But in terms of the monthly recurring price, except for a few exceptions, which are minor, relatively speaking, our objective is to price higher. Now the way we do that is add more value. The product is worth more. It has a lot more TV channels on the video product. They're in HD. There's 2-way interactivity as part of the service offering. The videos -- the data speeds have gone up dramatically to 30 megabits at minimum. And the voice feature -- the voice service is more fully featured than it was previously. So the full package is worth more, and we charge more for it.
James M. Ratcliffe - Barclays Capital, Research Division
Great. I actually have one other on advertising. I mean looking historically last presidential election, you sort of stepped up $6 million, $7 million 3Q to 4Q, more like $10 million in 2010. I mean how do we think about that this year both in terms of your relative exposure to targeted areas and also your improvement ability to actually capture the ad spend with more targeted cable ads?
Thomas M. Rutledge
We have a fairly undeveloped advertising infrastructure in terms of advanced features. When we have had a very good advertising year in terms of political advertising, and it's up dramatically as a result of political advertising. The future of Charter is such that we have a tremendous opportunity to create targeted advertising products. And I would say to date, we have hardly any of that in our revenue opportunity or in our actual produced revenue. So we're putting some capital, and this is not a very capital-intensive part of the business, into that capability and looking at trying to accelerate nonpolitical growth in advertising through the implementation of advanced services.
Operator
Your next question comes from the line of Lance Vitanza.
Shagun Singh Chadha - CRT Capital Group LLC, Research Division
This is Shagun for Lance. I have a housekeeping question. Was there a timing shift in the payment of cash interest expense given the recent refinancing?
Christopher L. Winfrey
Yes, and it was significant. The right way to think about this -- look, there's been multiple refinancing, so you can follow up with Robin after the call to go through [indiscernible] that because it's all publicly inside of the Q. But there have multiple refinancing. Each one of those have had different payment date terms. There is a significant difference, not only in effective rate that we have inside the quarter, but also in the timing of payments, all of which you can get off the maturity schedule that we had at each quarter. But the right way to think about this is what I mentioned in the prepared remarks is that our interest expense is reduced dramatically, it's down into the 770 range or just below that. We can all swap cost [indiscernible] interest expense. And the interest rate is 5.9% now pro forma for the transactions. And then the schedule that you have inside of the presentation, if you look at the back of the presentation, you can actually map out how those payments will be taking place in the future.
Shagun Singh Chadha - CRT Capital Group LLC, Research Division
Okay. I'll look into it. The other question I had was regarding -- so on the phone and the Internet side, it looks like you're adding subscribers while sacrificing on price. Can you comment on that? And then finally, the last part of the question is on video. How much pricing did you take in the quarter? And how do you see the pricing environment going forward?
Thomas M. Rutledge
So we didn't have a video rate increase in the quarter. And product ARPU for phone, given that result being sold inside of a bundle, it's somewhat irrelevant. I mean, the reality is that it's had a discounted price to achieve a higher total ARPU on the sell-in. You can call it $0, which is not what we're doing, but just for the sake of argument. And that would be meaningless in terms of how you think about the revenue stream for the company. And so that's why we're focused on total product ARPU.
Shagun Singh Chadha - CRT Capital Group LLC, Research Division
Okay. And then how much pricing on the video side did you take in the quarter? Can you comment on that?
Christopher L. Winfrey
We did not take rate increases on video inside the quarter.
Robin Gutzler
[Operator Instructions]
Operator
Your next question is from Amy Yong.
Amy Yong - Macquarie Research
[indiscernible] video customer growth in the quarter, I think it grew on a sequential basis. I mean, how do you reconcile that with your bundling offers? I mean, is this just more high-speed data and phone net adds?
Thomas M. Rutledge
Amy, you got cut off at the very beginning of your question. We've been having those problems on this call. Can you just start with that question from the beginning which got chopped off?
Amy Yong - Macquarie Research
Yes. Can you just talk a little bit about the non-video customer growth in the quarter? I think it grew on a sequential basis. So how do you reconcile that against your bundling efforts?
Thomas M. Rutledge
Well, I think that our bundling efforts are making the headway that we hope to at this time. Charter has an excellent data service and excellent reputation in the provision of data services. Last year, PC Magazine found us to be the fastest data service in the country. And so we continue to do really well in the marketplace with our data service, and it continues to work well. And our challenge with video is that we have not had a great video service, and we've reengineered the whole company in terms of its video product. And now we're in market with it, and it's beginning to, we think, resonate. And our performance year-over-year is better than it was, and we hope that it continues to get better.
Operator
Your next question comes from the line of Vijay Jayant.
Vijay A. Jayant - ISI Group Inc., Research Division
Given your new strategy, I'm sure there's certain cost that you're undertaking that are temporary in nature because of training and reshuffling the management structure and so forth. Is there any color you can give us, how much that is? And when can that sort of come off to get a better sense of margins going forward?
Thomas M. Rutledge
Yes, I don't -- we've got a lot of activity in terms of the way we're organizing the company, and a lot of those things are in process. And I don't really want to forecast out numerous quarters into the future, but our business will normalize.
Christopher L. Winfrey
Vijay, to the point we were making earlier, the faster you grow, the more you have investment growth on the CapEx side, as well as on the OpEx side as well.
Vijay A. Jayant - ISI Group Inc., Research Division
And given this new growth strategy, any color on return on capital now, given that you probably will have optimal CapEx and less free cash flow in the shorter term? Is that sort of a push forward too? I mean, is there a chance we could have return on capital in 2013 of any form?
Christopher L. Winfrey
Look, we're still -- for this year, we're still very much positive free cash flow. And we're at 4.8x, and we're very comfortable with that. The reason that we're at 4.8x really stems back to 2 things. One is that we've done significant buybacks all throughout the course of last year, but particularly towards the end of the year. And then the significant amount of refinancing activity that we had, which has premiums attached to it to be able to buy down our interest cost with attractive paybacks. And so those have been the real 2 drivers when you think about the leverage ratio. It's actually been less about CapEx spend because we've been producing positive free cash flow. So the way that we've always thought about return on capital is first and foremost, the investment opportunities that are inside the business because they tend to have the highest ROI. You can see that flowing through to this year when we've identified those opportunities and started to execute on those. And then over time, this leverage trends down and free cash flow ticks up. To the extent that's taking place and when, and you're into your target leverage range and you'll be looking at all those opportunities, whether it's buying your own stock or somebody else's through M&A, if you don't have a better use of capital, you get down to the bottom of your range or below, and you don't have pending opportunity to take a look at returning that cash to shareholders as well. So nothing has really changed on that front. We're just applying one of the ways that we can deploy capital today and investing inside the business.
Operator
Your final question comes from the line of Bryan Kraft.
Bryan D. Kraft - Evercore Partners Inc., Research Division
Chris and Tom, I was wondering if you could shed a little light on the sequential increase in the line called All Other Operating Expense. Is that a temporary increase or is this a step up that will carry into subsequent periods? And also, do you think marketing cost now is at the right level? Or is that something that you should increase as you aim to grow units faster?
Thomas M. Rutledge
So on the other operating cost, we break out into SG&A and to operating expenses inside the MD&A. And you have seen inside that category includes programming, so that's the biggest driver. And then particularly labor and to drive some of the reconnect activities that we've been talking about both in a quarter and year-to-date basis. That includes internal and external labor. And then the preventive maintenance as well that we've highlighted. And that's probably the biggest driver year-over-year is the preventive maintenance outside of programming.
Thomas M. Rutledge
And with regard to marketing, we've stepped up our marketing, and we've actually reallocated our marketing. And the way we think about marketing dollars is if we can generate a higher response rate from more marketing, we do it and if that makes sense from an economic perspective. So we're right now marketing at the level which we think makes the most economic sense, given the response rate and our ability to handle the response rate and operate the business. But it's one of those things that if it works, and you have the ability to modulate your marketing in such a way that you can drive revenues successfully, then you spend what you need to spend to maximize your return. And that's our strategy. So we don't just turn it on and off with the hope that it works or doesn't, nor do we use it to make numbers in a particular quarter. We look at it as an investment tool and as a tool that generates response rates, that generate orders, that generate customers and rates of return and spend accordingly.
Robin Gutzler
Thank you, everyone, for joining us today. I think that's all.
Operator
Thank you. This does concludes today's conference call. You may now disconnect.
sunspots pac 12 tournament sun storm tri international criminal court ios 5.1 apple tv update
No comments:
Post a Comment
Note: Only a member of this blog may post a comment.