Cable One, Inc. Q3 FY2023 Earnings Call

Thank you for waiting. My name is Eric, and I will be your conference operator today. I would like to welcome everyone to the Cable One Third Quarter 2023 Earnings Call. I will now turn the call over to Jordan Morkert, Vice President of Investor Relations. Please go ahead.

Good afternoon, and welcome to Cable One's Third Quarter 2023 Earnings Call. We're glad to have you join us as we review our results. Before we proceed, I would like to remind you that today's discussion contains forward-looking statements relating to future events that involve risks and uncertainties. You can find factors that could cause Cable One's actual results to differ materially from the forward-looking statements discussed during today's call in today's earnings release and in our recent SEC filings. Cable One is under no obligation and expressly disclaims any obligation, except as required by law, to update or alter 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 or GAAP. The reconciliations of non-GAAP financial measures discussed on this call to the most directly comparable GAAP measures can be found in our earnings release or on our website at ir.cableone.net. Joining me on today's call is our President and CEO, Julie Laulis; and Todd Koetje, our CFO. With that, let me turn the call over to Julie.

Thank you, Jordan, and good afternoon, everyone. We appreciate you joining us for today's call. Before we get into third quarter results, I'd like to touch on a few unique strengths of our business. More than a decade ago, we strategically pivoted our focus from linear video to broadband connectivity and business services, well in advance of our peers. Since that time, we have made significant investments in our network with the intent of anticipating and exceeding the evolving connectivity needs of our customers and communities. Fast forward to today, and we are proud to have engineered a robust and reliable network with enough capacity to handle up to five times our customers' current peak usage as well as a growing set of service offerings for residential customers and businesses of all sizes. Equally as important is the footprint in which we deliberately chose to operate, which consists primarily of small cities and large towns across rural America. We continue to enjoy the relatively less competitive environment in these markets, and our position is further solidified by our incumbent status, enabling ongoing network upgrades at a fraction of the cost of new entrants. Above all, our strength lies with our dedicated associates, the majority of whom live and work in the communities we serve. Our associates are deeply invested in ensuring their cities and towns thrive, not just because it's good for business, but because they have a personal stake in driving progress and making a positive difference in their communities. They are the driving force behind our unique culture and consequently, our tangible results. These are just a few key differentiators that reinforce our confidence in the long-term future of Cable One. Looking ahead, we see significant runway for expanding our broadband reach, and we recognize the need to strike the right balance between ARPU and subscriber growth. As part of our forward-looking vision, we will continue to assess the next generation of products and services based on insights into customer needs. Our sights are set on continuing to compete fiercely while capturing new and profitable market segments. We are confident this strategy will position us to grow well into the future. Concurrently, we are navigating the final stages of decline in our video product. Having predicted this decline over a decade ago, we have less exposure to the video business today. As we draw down on our remaining video subscribers, we are preparing for an environment without a video business, including planning for a reduction in our remaining non-programming support costs. It's with these foundational strengths and forward-looking strategies in line that we share our latest performance results. In the third quarter, we delivered residential broadband revenue growth of 5.8% from the prior year, while our commercial Internet business grew even more rapidly. Adjusted EBITDA growth of 2.4% from the prior year with a margin expansion of 180 basis points to 54.7%. Capital expenditure decreased by 22.6% year-over-year, resulting in adjusted EBITDA less CapEx of $152.2 million, an increase of 22.6% year-over-year. In the third quarter, we demonstrated strong free cash flow conversion as a result of multiple years of efficient capital investment and significant network capacity, even in a more muted economic environment. Looking at residential broadband, we saw a decrease of approximately 1,300 customers in the third quarter as compared to the second quarter of 2023. While we continue to experience the side effects of a subdued home move environment and some competitive pressures, there were signs of improvement as our overall connects increased relative to the past three quarters, coupled with churn continuing near pre-pandemic loads. As I mentioned at the top of the call, one of our best opportunities over the long term is driving higher broadband penetration in our markets. We are better aligning ourselves to this growth opportunity by supplementing our prioritization of premium customers with a focus on new customer segments within our existing footprint. In practice, this could mean ongoing product enhancements at higher price points for our premium customers while targeting unique product offers and service models to more value-conscious customers to grow this segment profitably. For example, during the last month of the quarter, we introduced a short-term promotion of $25 for 100 Mbps designed to attract value-focused market segments. That test promotion drove incremental new connects, while we saw the vast majority of new connects by product tiers with faster speeds and higher price points than the promotional offer. We will continue to test and learn while targeting different market segments, maintaining a methodical approach that prioritizes profitable long-term results. Our high sell-in underscores the sustained demand for our premium speed tiers, a key factor in the 6.5% year-over-year increase in residential broadband ARPU. While pleased with this ARPU growth, our priority is a balance of subscribers and ARPU, with a current focus on expanding our subscriber base. Turning to business services, revenues fell slightly by 0.4% year-over-year. When excluding video and phone, the connectivity side of the business is strong, showing growth in the quarter that outpaced even that of our residential broadband revenue. Despite facing economic pressures related to higher interest rates, our business services team continues to showcase resilience. Amid these challenges, our teams are relentlessly committed to evolving our data and fiber offerings, streamlining our operations and setting new standards in customer satisfaction through white glove service. As an illustration of our proactive approach, we are in advanced stages to upgrade wholesale fiber networks to 10 gigabits with several customers, a strategic move designed to extend contracts and boost long-term revenues. Moreover, with the recent launch of Business Wi-Fi Plus, we are reinforcing our commitment to using technology to enhance customer experiences. An always-on mesh Wi-Fi solution tailored for small to medium-sized businesses, Business Wi-Fi Plus guarantees uninterrupted coverage, keeping businesses and their customers securely connected while delivering optimal speed and performance. Moving to a key driver of our success, our dependable advanced network infrastructure, we continue to see and meet the strong appetite for data with average customer demand reaching an all-time high of 646 gigabytes per month. Equally telling, more than 20% of our residential customers now exceed 1 terabyte of usage each month, an increase of 18% from the same period last year. Our average network utilization during peak hours remained steady with downstream and upstream of 20% and 19%, respectively. The ample network capacity enabled by years of network investments fuels our confidence in our ability to stay well ahead of the consumption curve in a highly capital-efficient manner. Looking at wired competition, while we see competition continue to grow, in a majority of our markets, we do not compete against an Internet service provider that offers 100 meg speeds or higher. Regardless of speeds or technology, we operate with a mindset that every market is highly competitive. We will meet that competition by turning the focus to our customers and our communities, ensuring we provide the trusted service our customers have come to expect from Cable One. Industry reports on mobile fixed wireless indicate that net adds may have peaked. As previously indicated, we have not experienced a material impact on our customer churn due to mobile fixed wireless competition. There likely is some impact on net adds as switchers from DSL or new entrants try fixed wireless as an initial solution. In the long run, we are confident that our fixed network will maintain superiority in terms of both speed and reliability while also delivering a substantial cost advantage relative to the significant capacity it can generate. With that said, we are well positioned to meet the growing data demands of customers efficiently and economically now and in the future. In the third quarter, we continued to execute against our digital transformation and integration roadmaps. The expansion of our advanced customer contact center platform in Sparklight, following its initial launch in the Fidelity footprint, is driving greater efficiencies for our associates, enhancing performance across all key contact center metrics, including time to answer, service levels, and associate productivity. We saw similar efficiencies for our Fidelity and CableAmerica brands as we transition them onto our financial ERP, moving us one step closer to a unified platform for all brands. These ongoing platform consolidations are reducing costs and enhancing operational efficiencies by merging overlapping systems into a single coherent structure. As we move closer to full integration of our brands, we continue to evaluate all opportunities to increase agility and eliminate pain points in pursuit of associate and customer goodness. We also remain committed to assessing the various government funding opportunities. We're exploring underserved areas adjacent to our markets, where our current infrastructure offers a significant edge for network extension. Our strategy is twofold. We opportunistically pursue grants that align with our return on investment criteria and advocate for allocating public resources to genuinely unserved or underserved communities. We recently demonstrated this commitment in one of our states where we defeated an attempt to provide government subsidies in an area where we already provide robust upstream and downstream bandwidth. Turning to our unconsolidated investments. Residential and business data customers collectively expanded by roughly 12,800 or 2.7% sequentially from Q2 of 2023. These figures do not include the activities of Metronet or Ziply, where our investments are less significant. These results are a testament to the effectiveness of the straightforward strategy employed by our seasoned business partners, delivering premium broadband services across rural America. Before handing the call over to Todd, I'd like to take a moment to welcome Matthew Armstrong, who was recently appointed to the newly-created role of Senior Vice President, Residential Services. Earlier this fall, we restructured residential services as a business unit, similar to the business services side of the house. Matthew is responsible for the overall strategy and day-to-day operations of the residential services division, which includes marketing, brand, and communications. Matthew previously worked at Cable One from 2010 to 2014. In his prior role as Vice President of Strategic Planning and Finance, he led the pivotal effort to shift Cable One's focus to residential Internet and business services and away from video. Before coming back to Cable One, Matthew worked at several startup ventures, including serving as Co-Founder and CEO of a startup in San Francisco. I'm confident he will be a tremendous asset as we double down on our work to grow subscribers and strengthen our competitive advantage. As disclosed earlier this week, we recently implemented other key changes to our leadership team that align with our focus on customer growth, digital transformation, and a superior customer and associate experience. And now, Todd, will provide a full recap of our third quarter financial performance.

Thanks, Julie. Starting with revenue. Total revenues for the third quarter of 2023 were $420.3 million compared to $424.7 million in the third quarter of 2022, a 1% decrease. The decrease was primarily due to a continued decline in lower-margin residential and business video revenues. The growth of our foundational product lines in residential and commercial broadband continue to propel our business forward. As the demand for reliable high-speed broadband expands across all customer segments, so does confidence in our continued success and ability to strike the right long-term balance between subscriber and ARPU growth. For Q3 2023, our residential data revenues expanded 5.8% year-over-year when compared to Q3 2022. Despite a decline of 0.4% in our total business services revenues year-over-year, data services within this segment experienced meaningful growth in the quarter. This growth is noteworthy as our reported business services still encompass video and voice revenues, bearing similarities to our residential segment dynamics. Operating expenses were $109.7 million or 26.1% of revenues in the third quarter of 2023 compared to $120.5 million or 28.4% of revenues in the comparable quarter of the prior year, a 230 basis point improvement, driven largely by a $14.8 million decrease in video programming and franchise costs. Selling, general and administrative expenses were $92.7 million for the third quarter of 2023 compared to $86 million in the prior year quarter. SG&A as a percentage of revenue was 22.1% for the third quarter of 2023 compared to 20.3% for Q3 of 2022. The year-over-year increase was primarily driven by increased labor and marketing expense. Adjusted EBITDA was $230 million for the third quarter, an increase of 2.4% when compared to the third quarter of 2022. Our adjusted EBITDA margin for the third quarter of 2023 was 54.7%, a 180 basis point improvement compared to the prior year quarter and a sequential increase of 20 basis points as we continue to drive growth in our higher-margin advanced broadband products. Capital expenditures totaled $77.8 million for the third quarter of 2023, which equates to 33.8% of adjusted EBITDA compared to $100.5 million or 44.7% in the prior year quarter. During the third quarter, we invested $9.5 million of CapEx for new market expansion initiatives and $4 million for integration activities. Our year-over-year decrease in capital expenditures stemmed from our strategic working capital optimization initiatives and our proactive long-term network investment strategy. Adjusted EBITDA less capital expenditures was $152.2 million for the third quarter of 2023, an increase of 22.6% from the prior year quarter and 1.6% on a sequential quarterly basis as we benefit from ongoing capital efficiency and strong free cash flow conversion. As we continue to evolve and adapt to our changing landscape, our approach to capital allocation remains grounded in our core principles: to invest prudently in state-of-the-art, reliable broadband infrastructure and expanding our reach in and around the areas we already serve. We will also continue to balance strategic acquisition and investment opportunities with a very disciplined and long-term-oriented balance sheet management philosophy. In the third quarter of 2023, we distributed $16.7 million in dividends, and we repurchased nearly 24,000 shares of our common stock for $16.5 million. We also repaid $54.6 million of debt in the quarter, $50 million of which was a voluntary repayment of our outstanding revolver balance. Subsequent to quarter end, we repaid an incremental $50 million in debt, bringing this voluntary reduction to $150 million in the last five months. As of September 30, we had approximately $240 million of cash and cash equivalents on hand. Our debt balance was approximately $3.7 billion, consisting of approximately $1.8 billion in term loans, $920 million in convertible notes, $650 million in unsecured notes, $388 million of revolver borrowings and $5 million of finance lease liabilities. We also had $612 million available for additional borrowings under our $1 billion committed revolving credit facility. Our weighted average cost of debt for the quarter was just under 4.3%. Our net leverage ratio was 3.8x, and the vast majority of our borrowings are either fixed issuance or have been synthetically fixed under long-term contracts, considerably mitigating our exposure to the prevailing rate environment. As mentioned in last quarter's call, our equity investment in Wisper was redeemed for total cash proceeds of nearly $36 million, and our investment in the Tristar SPAC was divested for total cash proceeds of nearly $21 million during the third quarter. Our investment strategy remains focused on pursuing opportunities in rural broadband that deliver growth and returns exceeding our benchmarks and aligning with many of the brightest minds and proven operators within the communications sector. We're committed to long-term value creation with these investments, whether through strategic monetization or future integrations. Finally, as a reminder, we posted trending sheets on our Investor Relations website, making it easier to see several quarters' worth of sequential changes in many of our key operating and financial metrics. All figures are presented on a consolidated as-reported basis. With that, we are now ready for questions.

Your first question comes from Brandon Nispel with KeyBanc Capital Markets.

Julie, I have a question for you. High-speed data penetration has now declined for four consecutive quarters. Could you share your thoughts on the longer-term opportunity and your strategy for attracting subscribers back through new pricing, packaging, and promotional offers? Additionally, I would appreciate it if you could elaborate on how the quarter developed in terms of net additions for high-speed data. You mentioned the promotional offer of 100 Mbps for $25. Can you discuss what influenced that decision? Also, if you could provide insights on how Q4 is shaping up, that would be helpful.

I can't comment on how others track their homes passed, but we are very diligent about it. As the number of homes passed increases, even if our subscriber count remains the same or grows slightly, penetration will decline. Our homes passed database is updated with new build extensions or when we have opportunities to extend our reach, and in those areas, the homes are recorded in our database and billing platform before they can be sold. Therefore, I expect the penetration issue to resolve itself over time. Regarding our long-term penetration growth opportunity, we believe there is significant potential for expansion, and we are actively working on that. You inquired about new growth, and over the past two and a half months, we have been intensely focused on competing aggressively across our entire market by segmenting it and tailoring our approach to different customer types. In short, we are realigning ourselves for growth and have discussed refining our average revenue per user and growth metrics. Currently, we are prioritizing growth in units. In the third quarter, we saw an acceleration in customer connections as we approached the end of the quarter and headed into the fourth quarter. I attribute this to our willingness to experiment and remain agile with various strategies, which are starting to yield positive results. I feel optimistic about our fourth quarter.

Your next question comes from the line of Phil Cusick with JPMorgan.

This is Nik on for Phil. I know you guys have touched on how fixed wireless hasn't really been a churn issue, but I was hoping you could touch on the kind of churn you may see from fiber and fiber overbuilders entering your markets. And to that extent, when you have visibility into an overbuilder in your market, how do you evaluate what your competitive response might be, whether that's promotions more on the gross add front or maybe something more targeted for retention of the base?

So I believe your first question was about overall churn due to competition, regardless of its source. We monitor competition closely and code the reasons why customers leave us at a detailed level, assuming minimal human error. I'm not certain what you specifically meant regarding fiber churn, but let me address the next part, and you can clarify for me afterward. Evaluating our response comprehensively depends on several factors, such as the size of the market, its location, the local economy, the presence of overbuilders, their financing, and their pricing strategies. We have an excellent network, but it’s worth noting that some of our markets are undergoing upgrades. Therefore, we take a comprehensive approach to our evaluation. What specific information do you need to hear?

Yes. Obviously, you mentioned that with fixed wireless, there isn't much churn in your customer base. However, when a competitor enters the fiber market, are you experiencing significant churn? Are you concerned about your efforts to promote and retain your subscribers in those areas?

Overall, our churn rates are at pre-pandemic lows, indicating that we have very low churn across the entire MSO, including in competitive markets. This suggests that, contrary to common expectations, we are not losing customers despite the competition. I have personally reached out to customers who have switched to other providers to understand their reasons for leaving, and in those conversations, it often comes down to wanting to try something new. Customers mentioned that they hadn’t experienced issues and were curious about alternative options, especially when approached by a direct salesperson. Throughout my 24 years with the company, we’ve faced competition for decades. I can recall a specific instance when a fiber overbuilder and a traditional HFC overbuilder entered a market. Initially, we did lose some customers, but that situation eventually stabilized, and we resumed growth. It’s uncertain how things will unfold in the future, but that has been our historical experience.

Got it. And if I could just push my luck here, anything you can give us on maybe the magnitude of net adds in the quarter from the 100 meg offer?

Net adds, no. But I can tell you that the 100 meg offer was an initiative aimed at value-conscious customers. While we don't lose our existing customers by and large to fixed wireless broadband, they are targeting their customers and bundling them at a low price. So we went to market with this. Our connects were robust and the majority, far and away, two-thirds of the customers connected at higher speed, higher-priced tiers than that 100 megs for $25. So it was basically a call to action, the phones rang and then people elected into higher tiers.

Your next question comes from the line of Greg Williams with TD Cowen.

Julie, you mentioned that wireline competition is growing. Could you provide more specifics on that? Previously, you indicated that 25% of your coverage had a wireline 1 gig offer. I believe you also mentioned that if fixed wireless was included, that number was 35%. What are those figures currently, and what do you anticipate they might reach in the future? I’m considering Verizon's launch of their BC category and C-band in rural areas, which could impact your markets. My second question pertains to the success you've had with the $25 offer and your strategy for moving downstream. As you mentioned in your remarks, you're now able to provide premium services to premium customers. Is there a possibility to raise prices for higher-tier services to support the lower-end business case? We’d like to understand the overall ARPU effect of these offers.

In relation to wireline competition, most of our markets lack a wired competitor that can provide speeds of 100 megabits or more. The majority of the time, our overlap with T-Mobile is currently 36% of the market, while Verizon stands at about 12%. Our effectiveness with what you might refer to as value-conscious customers is illustrated by the 100 meg offer. We plan to explore additional options but will do so only if they are profitable. Our goal is to ensure long-term profitability rather than make short-term decisions that could negatively impact us in the future. The market is exhibiting notable differences, as we observe significant price sensitivity with higher-end products, evidenced by increased sales despite a recent rate adjustment and no customer churn. However, there is also a strong reaction to the $25 offer for 100 meg. This indicates a polarization in consumer preferences. Therefore, we need to adopt a more tailored broadband strategy, focusing on market segmentation to effectively stimulate new growth.

Your next question comes from the line of Frank Louthan with Raymond James.

Great. And maybe I missed this in the call, but the $25 offer, when did that start in the quarter? And is that kind of the way you'll be able to get to positive subs for the year? And then can you give us a little color on the nature of the homes that you're passing? You're adding quite a few each quarter. Are these competitive areas? Are they just kind of filling in holes in your footprint? And what's your expectation for penetration in those homes longer term? Can those areas you're targeting get better penetration than your base? Or a little lower? How should we think about it?

That's a great question, Frank. The $25 offer began at the start of September and was meant to last until the end of that month. However, we were overwhelmed with demand, and our phones were ringing off the hook. We didn’t notice any negative effects from that promotion, as people weren't shifting away from their regular purchases, so we extended it until the end of October before discontinuing it. We're back to our standard pricing now. I don't believe that relying on such promotions is a sustainable way to drive growth; it was merely a tactic to highlight an attractive price in the market. Regarding the homes we’re reaching, we’re not covering all of our markets, but we do have some areas with new builds, which are showing slight slowdowns due to the economy and high interest rates. Additionally, in areas with competitors who aren't serving customers well—possibly due to high prices or unreliable service—we plan to expand by overbuilding in those regions. It's important to note that even though our Average Revenue Per User (ARPU) is high, it doesn’t necessarily mean our prices are high for customers. Our ARPU is largely influenced by customer choices, such as opting for a 37% gig service or additional features. Our base rate is very competitive, especially compared to pricing in metropolitan areas. For penetration expectations, I anticipate at least 40% in our market expansion efforts, while in our new build areas, I expect it to be close to the penetration levels of each specific system, which can vary significantly.

Your next question comes from the line of Craig Moffett with MoffettNathanson.

Two quick questions, if I could. First, I wonder if you could just reflect on wireless again. I know you've said that it was not part of your plan. But it's been such a large part of what the other cable operators are doing, I'm wondering if you're kind of still interested in at least exploring wireless options. And then second, I wonder if you could just talk about the trajectory of capital intensity. As you think about DOCSIS 4 and plant upgrades, how low could capital intensity go? Or how much further could it come down?

Craig, it's Todd. On the wireless side, we've talked about this before. I don't think anybody would disagree that the two primary connectivity mediums for consumers will be very reliable, fixed broadband that we provide and then very reliable wireless mobile connectivity. We do evaluate it. There's plenty of folks in the space that have launched that we monitor very closely, that we evaluate both the performance and wireless ads as well as what that would potentially do to improve on the data side of the equation. And those are very important elements of that. As we've also said in the past, important elements of customer satisfaction and how we want our customer experience to be is very, very reliable connectivity. And we also continue to monitor how that reliability will improve from a wireless and a mobile perspective in our markets, because we do feel like that's an extremely important catalyst as we continue to look at that. But nothing right now that says economically or from a customer demand perspective that, that's a product we have to have. From a capital intensity perspective, it's a sequential quarter of decline in CapEx. We've talked about some of the shorter-term elements associated with that, which was our working capital optimization strategies that we can continue to execute upon. Some of the slower builds that give us a little bit more efficiency there, and some of the integration and upgrade investments that we've been making that can start to taper a little bit. But long term, we've talked about our capital intensity as a percentage of our EBITDA being in that mid- to high 30% area.

Your next question comes from the line of Steven Cahall with Wells Fargo.

Julie, thanks for all the commentary on how you're thinking about balancing ARPU growth and subscriber growth. I think that's the biggest one that we're debating as well. I was wondering if we could go a little deeper into it about just how you're looking to deploy some of the tactics that you talked about. So we saw the new, more inexpensive program at the end of Q3. Last year, net adds started to kind of flip negative in Q4. It was unexpected sequentially from Q3. As you deployed these new tactics, do you think you could start to get back to positive net add growth by the fourth quarter, or we should be thinking about that as a little more of just your long-term trend and long-term strategy? And then secondly, the ACP program is having some political debate around it. I'm just wondering if you can shed any light as to if you have any material customer exposure to ACP, and if you do, if you have some contingency plans for ways to keep engaged with those customers should it change.

Yes. So the end of the third quarter was a success in my mind and that continues. I expect to grow in the fourth quarter, period. ACP, we only have 35,000 customers, given we have over 1 million customers, teeny tiny. Teeny tiny. And those customers were customers of ours before. They just start using the $35 or $75 of their own Tribal lands to supplement what they're paying for. So even if it goes away, our number of customers is minimal. And I think they'll still be customers. Maybe they'll downgrade, but I think they'll still be customers.

Steve, I would add, there's maybe always political jockeying around things like that, especially as we head into an election year. I would be pretty surprised if broadband for all demographics and for all customers is something that gets a meaningful amount of adjustment to it. Maybe some tweaks here and there. But we do not feel like we have a lot of exposure as it relates to the repayment of that, with that very small subset that Julie alluded to.

Thank you. Ladies and gentlemen, at this time, there are no further questions. I will now turn the call back over to Julie Laulis for closing remarks. Please go ahead.

Thank you, Eric. So as we wrap up, I just want to extend a heartfelt thank you to our Cable One associates. It is their commitment that really sets us apart in providing exceptional neighborly service. And additionally, for those that are interested, Todd and Jordan will represent Cable One at the upcoming Raymond James and Wolfe conferences this December in New York. We welcome the opportunity to engage with many of you there. Thank you, everyone, for your time and attention today. We appreciate your continued support and interest in Cable One.

Thank you. Ladies and gentlemen, that concludes today's call. Thank you all for joining, and you may now disconnect your lines.