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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Ladies and gentlemen thank you for standing by. Welcome to the GCI Liberty 2018 First Quarter Earnings Call. During the presentation all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded. May 9.
I would now like to turn the conference over to Courtney Chun, Senior Vice President of Investor Relations. Please go ahead ma'am.
Thank you.
Before we begin, we'd like to remind everyone that this call includes certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 including statements about business strategies, market potential, stock repurchases, future financial performance, matters relating to Universal Service Administrative Company and rural health care program, market and regulatory conditions, future impact of accounting changes, new service and product launches and other matters that are not historical facts.
These forward-looking statements involve many risks and uncertainties that could cause actual results to differ materially from those expressed or implied by such statements including without limitation possible changes in market acceptance of new products or services, market conditions conducive to stock repurchases, the availability of acquisition opportunities, competitive issues, regulatory issues and continued access to capital on terms acceptable to GCI Liberty. These forward-looking statements speak only of the date of this call and GCI Liberty expressly disclaim any obligation or undertaking to disseminate any updates or revisions to any forward-looking statement contained herein reflect any change in GCI Liberty expectations with regard thereto or any change in event conditions or circumstances on which any such statement is based.
On today's call, we will discuss certain non-GAAP financial measures including adjusted OBIDA. The required definitions and reconciliations including preliminary note and schedules 1, 2, 3 can be found in the earnings press release issued today which is available on our Web site.
This call also may include certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 regarding Liberty Broadband. These forward-looking statements involve many risks and uncertainties that could cause actual results to differ materially from those expressed or implied by such statements. These forward-looking statements speaks only as of the date of the call and Liberty Broadband expressly disclaims any obligation or undertaking to disseminate any updates or revisions any forward-looking statements contained herein to reflect any change in Liberty Broadband expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.
Now, I'd like to introduce Greg Maffei, our President and CEO.
Thank you, Courtney.
Good afternoon to all of you. Today speaking on the call, you have myself, GCI Liberty's CFO, Mark Carleton and GCI CFO, Pete Pounds. Other executives including GCI's CEO, Ron Duncan will be available during the Q&A, will also be available during the Q&A into questions related if there are any to Liberty Broadband.
We were pleased to complete the GCI transaction and split off of GCI Liberty on March 9. Earlier this week, we also approved the reincorporation of GCI Liberty in Delaware and expect to complete that transaction by the end of the day tomorrow.
Turning to GCI itself, this is our IR call since we completed the transaction and likely and place where introduction promoted to GCI Alaska's largest communications partner. We're going to spend quite a lot of time today on GCI with commentary about pro forma's about changes in events, transaction itself and the operating business.
The geography of Alaska that represents a unique set of opportunities and challenges for GCI. The biggest challenge has been the state of the economy up there. However, we are beginning to see some green shoots in 2018 and are hopeful to see job growth in 2019 partly influenced by the rising oil price.
We're also importantly seeing positive signs as it relates to fiscal policy from the state government up there both Pete and Ron Duncan have much more to say on that topic, your client.
On the opportunity front, GCI is truly a quiet player with an impressive a lot of business revenue. The other aspects of business are similar to many of the domestic cable companies with which you are familiar. Companies working to upgrade its network and the products offered including video choices to simplify and provide consistency in its products and pricing and streamline its operations to decrease costs. GCI is focused on driving sustained and improved free cash flow which we hope to take advantage of recognizing the discount that exists in the GCI Liberty structure from Liberty Broadband and even more to charter itself.
As we mentioned at our in November Investor Day, GCI Liberty enjoys a double discount on Charter the look through charter prices trading at a discount of approximately 20%, if you look at GCI and you should expect that we will work to take advantage of that discount over time.
Looking briefly at Liberty Broadband, clearly the market had a negative reaction to Charters first quarter results and we think it was largely an overreaction. While the low margin video environment is evolving and we face challenges in that, the financial results of Charter were actually quite solid. Sales were up at Charter across all products particularly Time Warner and Bright House markets. Strong net income and adjusted EBITDA growth occurred, the spectrum pricing and packaging offers are resonating with customers. At the end of the first quarter 55% of the residential Time Warner Cable and Bright House customers were on spectrum pricing and packaging.
The integration is largely on track going largely as expected. We always knew the path would not be linear. The issue with the elevated non-pay churn through the integration of our service environments and the Time Warner legacy markets was largely self-inflicted and excluding this impact legacy Time Warner Cable residential Internet net adds would have improved year-over-year and video losses would have included meaningfully.
Non-pay churn will still be somewhat elevated in Q2, but should be back to more normal levels by beginning of Q3. Other important initiatives are progressing at Charter including raising minimum speeds in our all digital rollout and we believe we're on track for long-term growth and increasing amounts of free cash flow.
With that, let me turn over to Mark Carleton to discuss the GCI Liberty financials in more detail.
Thank you, Greg. Throughout our comments today we'll refer to GCI as the operating business and GCI Liberty as the parent company. At quarter end, GCI Liberty had consolidated cash of $403 million, which includes $46 million of cash at GCI. Value with the public equity method securities at GCI Liberty as of today's close was approximately $5.4 billion, which includes our interest in Charter Liberty Broadband and Lending Tree. GCI Liberty has drawn $1 billion mortgage margin loan against this Liberty Broadband shares.
At quarter end, GCI Liberty had a total principal amount of debt of $2.6 billion which includes the aforementioned margin loan and $1.6 billion of debt including capital leases and communications tower obligations at GCI. GCI leverage is defined in its credit agreement with 4.9x compared to a maximum allowable leverage of 5.95x. There are two financial obligations at GCI Liberty worth noting.
First as part of the GCI acquisition, GCI Liberty issued preferred stock in the amount of $175 million, preferred stock a 21-year term $25 dollars per share liquidation preference and a third vote per share with no early redemption feature. On reincorporation in the Delaware, coupon will increase from 5% to 7% back effective after the next interest payment date on July 15.
Second following the GCI Liberty split-off, GCI Liberty have an indemnification obligation to hear a retailing with respect to the Charter exchangeable debentures that were redistributed to [indiscernible] retail prior to the split-off. Based on the trading price of the debentures, less the cash reattributed associated with the debentures. The amount of this indemnification obligation was $253 million as of quarter-end and more information is available in today's earnings press release on that indemnification arrangement.
Please note that our Q1 financial statements for GCI Liberty only included results of GCI from March 9 onward. We have included detailed pro forma financial information in our earnings release as if the acquisition that occurred on January 1, 2017 for ease of comparability.
Our reported results were also impacted by the adoption of new accounting standards and the impacts of purchase accounting. On a pro forma basis GCI had revenue of $216 million operating income of $6 million and adjusted OBIDA of $70 million. These represent declines of $9 million, $3 million and $3 million respectively, which Pete will discuss in more detail.
Today's call will focus primarily on the operating results of GCI, but we encourage you to review the publicly reported results over equity method investments as well.
With that, I will hand it over to Pete Pounds for additional comments on GCI. Pete?
Thank you, Mark.
Well, I learned a number of accounting concepts in school and two of those were stretched too or beyond the breaking point during the quarter.
The first is comparability and the second is consistency. The number of items that changed during the quarter was exceptional due to the perfect storm of changing accounting standards and the GCI Liberty transaction.
Those changes are as follows: first, the implementation of ASC 606 modified some revenue streams on long-term contracts and caused us to capitalize and then amortize commission expense for our sales representatives. Second, it was only a 23-day quarter due to the transaction closing March 9 that meaningfully impacts the income statement for the quarter, but does not impact the pro forma numbers. Third, purchase accounting which scrambles the egg pretty significantly on the balance sheet and also affects the income statement in ways that I will detail later. Fourth, the change from EBITDA to OBIDA to conform to the standard Liberty presentation, this change is relatively small in dollar terms.
Finally, pro forma numbers that take all of the changes mentioned and apply them retroactively to Q1 2017, so that you can compare the year-over-year numbers.
I mentioned these for ease of comparability with our prior year reported numbers. But for those of you who are new to the GCI story starting with pro forma 2017 numbers, we include in our press release that will provide a clear picture going forward and will be how we measure the business in 2018 and beyond.
I won't promise to clear up all of those issues on the call here, but I'll do my level best to share my insights into the quarter and we'll be working with the Liberty IR team and you with any follow up questions that are sure to arise.
First material updates, rural health care, as we noted in the press release the FCC gave notice that the funding for the rural health care customers was oversubscribed for the fiscal year ended June 30, 2018, like it was the previous year.
For the year ended June 30, 2017, the oversubscription caused a funding reduction of 7.5% by the FCC. This was a surprise to both the telecom and healthcare customers given the high cost of service in Alaska, this caused a significant burden on our customers and we elected to forgive 100% of the FCC funding shortfall.
For the funding year ended June 30, 2018, GCI customers are subject to a 15.6% reduction in financial support. For our GAAP financial statements, we recorded $6 million reserve in purchase accounting based on prior year experience and our best estimate at this time. This also reduced our Q1 pro forma revenue by $6 million. However, this is an open item and the ultimate number will and in all likelihood be different from the current estimate.
We are working with our health care customers. Our congressional delegation and the FCC to come up with a solution that works for all parties and continues to provide incentives to deliver 21st century broadband services to remote Alaska.
Moving to the Alaska economy. At the risk of being the economist who calls 10 of the next five economic recoveries, it feels like 2018 is the year that we will get back to flat by year-end with the potential for modest growth in 2019 using jobs as the metric for economic health. We are currently seeing slowing losses in important jobs like oil and gas, construction and professionals. This is not growth mind you, but a slowing of losses. There are two things that give me modest optimism for the near future and more robust optimism for the intermediate to long-term.
First, the state legislature just passed Senate Bill 26 yesterday which is expected to be signed by Governor Walker. This bill establishes a structured draw from the earnings of our $65 billion permanent fund to fund state government. This structure draw will provide businesses with substantially greater confidence in the state fiscal situation reducing the risk of doing business in Alaska thus encouraging investment.
The second item is oil prices and oil discoveries. In the last year, the price of oil is up approximately 50% to about $70 per barrel. On a standalone basis this is good news for state revenues and when coupled with the increased exploration. This is great for the state.
Over the next five to seven years, these new discoveries will move from design and permitting to construction and finally to production. All of these activities are a positive for the state but the benefits are generally back end loaded with production being the most important to our economy and design and permitting the least.
We now have a very favorable regulatory environment with the possibilities in NPRA and [indiscernible] opening up.
Now for a billing system update, we believe that we are on track for a summer conversion of our two primary billing systems under one unified platform. We have both revenue and cost opportunities that will be open to us with the new platform. This unified billing system will improve the customer experience and reduce consumer plan complexity. Additionally, it will create efficiencies for GCI through autopay and no print invoices ultimately leading to cost savings.
We are currently getting great reviews from the customer service representatives that have been trained on the system and are looking forward to this improvement in customer care and billing.
Financial overview, my commentary to follow refers to pro forma GCI financials for those comparing these results to legacy GCI disclosures, I will summarize the key differences at the end. In consumer, we were pleased that consumer revenues remained stable in the first quarter in spite of the recession. The mix of revenues was also favorable with losses in low margin video business being more than offset by gains in our products with better margins. We continue to expand our gigabit cable markets and now provide gigabit data offerings to 77% of Alaskans.
Business; Business revenues were significantly affected by the $6 million reserve related to the RHC program. Additionally, our low margin time and materials business revenue decreased about $2.5 million. DCI business is focusing more and more on monthly recurring revenue streams. On that note, we successfully negotiated all of our education contracts that were up for renewal this year, which will result in higher revenues from these customers starting July 1 of 2018.
Costs and expenses, we've made some improvements in our cost structure in the first quarter partially driven by our mix of revenues. As I've mentioned before, we gained revenue and lost revenue in all the right places. High margin revenue was generally higher and low margin revenue was generally lower. In addition to the improved mix of revenues, we had real efficiencies in the business and better procurement practices that are leading to an improved cost structure. We continue to make headway in simplifying our network and our processes both of which lead to cost savings.
Now I'll turn quickly to an explanation of accounting changes for those comparing figures to legacy GCI disclosures. Revenues were affected by a combination of ASC 606 and purchase accounting, which together decreased revenue by about $3 million and operating income and OBIDA by about $2 million for both Q1 2017 and the current quarter.
Most of the revenue decline was due to purchase accounting changes to deferred revenue but there was also nearly $1 million per quarter reduction in revenues that relates to showing USF surcharge receipts net as opposed to gross as stipulated in ASC 606.
If you look at our previously reported results for Q1 2017 and compare that to Q1 2017 pro forma operating income and adjusted OBIDA, you'll note that operating income decreased by about $7 million largely due to purchase accounting amortization and adjusted OBIDA grew by about 600,000. There was $2 million decline due to the reduction in non-cash revenue from accounting changes in GCI business that I mentioned offset by other purchase accounting impacts as follows that added $3 million back to Q1 2017 pro forma operating income and OBIDA.
First, commission accounting from capitalized commissions paid to customer service representative as a result of implementing the new revenue standard. And second, above market leases, during the process of determining purchase accounting it was deemed that we had certain leases that we were paying above market rates on. These leases were put onto the books as a deferred liability for the portion that was deemed to be above market and it had the effect of reducing costs associated with those leases.
While both of these cost items still existed in Q1 of 2018, the benefit of them had begun to decline particularly on the commission side. The net benefit of these two non-cash items in Q1 2018 was only $1 million as compared to approximately $3 million benefit in Q1 of '17.
Wrapping up, looking forward, we're confident in the cost savings initiatives we have in place to drive margin expansion at GCI and ultimately grow free cash flow. We believe there is light at the end of the tunnel in the Alaska economy. We were pleased to complete the GCI Liberty transactions in March and look forward to continuing to update you on the GCI story.
Now I'll hand the call back to Greg.
Thanks Mark and Pete to the listening audience. We appreciate your continued interest in GCI Liberty. And operate, with that I'd like to open up for questions.
Thank you. [Operator Instructions] And we'll take our first question from Barton Crockett from B. Riley FBR.
Hey, guys. This is Zack Silver on for Barton. The first question I have for Ron and Pete, if you were to hypothetically become a part of a larger cable operator, could you help us frame what sort of synergies you could realize immediately and that maybe ballpark the amount of those synergies. And then, on the flip side of that for you guys what are you seeing out there. I'm sorry, I can hear me. Can you hear me?
Yes.
Yes. And then, just on the flip side of that. What are you guys seeing on the M&A front in Alaska? Thanks.
Okay. Let's take them in reverse order because I'm -- Alaska first that kind of guy. I don't think there is much opportunity of any significance for us in M&A in Alaska just because we're already so large relative to the size of the state that there really isn't a material acquisition that would drive anything for us on that front. I think when Liberty purchased us it was because of our substantial statewide footprint and our presence in the marketplace. I don't think there's a whole lot of cleanup that could be done up here.
I don't want to get too hypothetical and I'm certainly not going to put numbers on it because I think the numbers would depend on the specifics of any situation, but if you look at GCI, you have a classic small cable operator and we have all of the overhead costs that go with that. We have the inefficiencies of trying to produce systems for a relatively small customer base and we are close to Alaskan line if not the Alaskan line when it comes to negotiating programming contracts. So we have programming margins or video margins if you can even consider the margins that look a whole lot different than they would for somebody with more negotiating power.
So if GCI were to be reinvented as a larger cable company, I think what you'd see first of all is a very material change in the programming cost, which would probably affect the whole competitive status of our video business, which is our most challenged business today and secondly numerous operating efficiencies just from spreading systems over a larger base.
Thank you very much.
And we'll take our next question from James Ratcliffe from Evercore ISI.
Hi. Thanks for taking the question. One GCI and one GCI Liberty, if I could. I just following up on the previous question regarding cost -- are there opportunities to leverage relationship with your cousins at Charter even if you're not part of the same organization to jointly purchase a programming or equipment and the like and take advantage of the scale that brings. And secondly, you've got that -- I think it's now 7% preferred it's out there, that's probably toward the higher end of your cost and the training below particularly, any restrictions in your ability to bring those in? Thanks.
I will take the GCI question, and then, certainly defer to Mark and Greg for the question on the preferred structure. We are looking at what can be done to leverage the cousin relationship as you call it to advantage us on the cost side. Unfortunately cousins are not good enough to qualify directly under somebody else's programming contracts. But the relationships that our new cousin has if you will probably are useful in helping us to improve the nature of our contractual relationships. It may be an easier win on the equipment side than on the programming side but we are looking at both of those. We're obviously now part of a family that has a much bigger broader and more important reach in our industry and we'd be foolish not to use those opportunities to try to reduce our costs.
And on that preferred stock there is no early redemption on the preferred stock. You know pursuant to its terms.
Is there anything restricting if you want to just repurchase them in the marketplace?
There is no restrictions on that.
Great. Thank you.
And we'll take our next question from Richard Greenfield from BTIG.
Hello?
Can hear you Rich.
Hello? Oh, sorry, a quick question for Greg Maffei, kind of want to tie this back to the Continental side of the equation for just a second. There's been a lot changing in the kind of the U.S. cable industry. Comcast obviously trying to make what appears to be a pretty bold move to diversify away from not just the U.S. going over to Europe, but also into the content business. As you look at the -- what is increasingly a competitive landscape with YouTube TV and Hulu basically people almost losing money if not actually losing money on every subscriber they take on. How do you think about Charters overall positioning in your management team, Charters ability to attack those issues?
Rich I think that Charter has a very attractive pipe into the home. And if you look historically over time what products got sold into that home had changed. But the strategic value of that pipe and the overall revenue or contribution margin we can make per customer path, I don't think it's going down, it's going up.
Video margins have been attacked for a long time and been on the decline, but broadband margins have been rising and broadband passing or broadband connections rising. For a while VoIP was an incredibly hot product and that started to wane as you see other things happen in the marketplace and I suspect over time mobile or some combination of mobile that uses are pipe will become an increasingly important part of the product mix.
So I remain optimistic that that pipe is only going to increase in value over time. The exact mix of which products and which services are distributed down and I think that's going to change. I'm convinced that the margins in the product -- in the pipe overall are going up.
And do you need to be part of a larger company or can you actually persevere in the current structure?
Well, I don't think we need to be part of a larger company. I think we have quite a lot of scale in our territory. Now, if you're asking me do I think to go and compete in another playground which is saying global content? Yes, I don't think we're particularly well positioned to do that, but that doesn't seem to be part of our strategy. So what is being pursued by Disney is quite different in what they have as a strategic advantage in that trying to capitalize on it. It's quite different than what we -- I believe are strategic advantages.
Thanks for taking the question. I appreciate the answers.
And we'll take Barry Sine from Dawson James.
Yes. Good afternoon. Just zeroing in on the rural healthcare issue, is there any better long-term solution, so you've effectively provided the same services, but you're forgiving revenue. Can you cut back on services or is there some other revenue source perhaps in state. And are you looking at this issue from a D.C. lobbying standpoint as well?
There is presently an FCC proceeding that is doing just that it's looking at how to restructure the program to possibly update a cap that is seriously out-of-date that is the issue that leads to the funding shortfall and to re-evaluate perhaps how to prioritize payments within the program.
So yes, we're optimistic that there is a better way going forward, but there are regulatory processes that have to occur between here and there. We're also dealing with a short-term issue of how to resolve the effects of the cap for this year and that's got a lot of moving parts in it. And I don't think we're in a position to make a prediction about how those parts are going to move in tandem, but we believe there is both the long-term and short-term solution.
Okay. And then for the quarter GCI business data revenue is down about $7 million. I think you said about $6 million of that was due to this rural healthcare. Apart from that obviously you have a new competitor, I don't know how big they are now Quintillion is operating or how much they're overlapping with your tariff footprint.
I don't think that you're seeing any of the change in business revenue occurring from Quintillion. Quintillion is a bit of a fiasco on its own as you probably are aware given the right in the midst of a massive fraud. And we're not seeing much presence from them in the marketplace right now. I think it remains to be seen how that's -- how that's going to shake up.
And Barry one of the other items making up the revenue decline there really the other piece of significance is the time and materials revenues which are down and we're really focusing on loans that are recurring revenues.
Okay. And then on the billing system last time you guys had a call was November and you talked about Polaris Phase 1 for 1Q. You're now talking about 3Q. Is that just a difference in terminology and is this the final upgrade and will this give you everything for example fully integrated billing that you've been looking for?
There is no billing system on the planet that will be the final upgrade and that will give you everything that you're looking for. I can guarantee that in spite of the prohibition on forward-looking statements. There is a slip as you correctly noted we're now targeting early 3Q for our turn-up, but we're still expecting to have the function out -- the first phase functionality that we expected to have all along. So no real change there other than a bit of a delay in the turn-up.
And on your wireless subscribers, obviously that's declining. In the past you've talked about some -- a large portion of that was due to people migrating out of the state of Alaska due to the employment situation and that you thought you were actually perhaps even gaining market share from AT&T and Verizon. Could you give us an update on that and give us some color on what you're porting looks like for wireless subscribers?
We believe that we are gaining market share very slightly in a declining market. We've seen very substantial out migration in the market up here over the last two years. As Pete mentioned at the start of the call in his comments, there is some cause for optimism that we may be near the bottom of that. Obviously, what it takes to turn around and get real growth in all of our businesses is for those jobs and for the people who left the state to come back.
Okay. And then maybe for Pete, on the EBITDA margin now OBIDA in the past you've talked about a low 30% to mid-30% EBITDA margin for GCI as we look at GCI inside of the new GCI Liberty, you're able to move I guess some public company costs added GCI up to the parent. How should we think about your margin capability especially with the cost reductions you have in the works?
Barry I wouldn't look for meaningful change. Keeping in mind that a 1% change of EBITDA change or OBIDA margins on a roughly $900 million revenue stream amounts to $9 million. And basically our public company costs are not $9 million a year. So that really doesn't meaningfully impact the number.
Okay. And my last question. Again on the your November call, we had talked about the post transaction landscape and what this might mean for GCI as a platform for expansion go and do some other things the new company obviously is much better capitalized. The GCI team is quite entrepreneurial, it had a great success in Alaska, but you might be running out of sandbox there. So any thoughts on what you might do under this new structure perhaps Pacific Northwest or other areas.
I would defer that to Greg and let him talk about what the future looks like.
I think we recognize as you do the entrepreneurial nature and the capabilities of the GCI management team and to the degree that there were acquisitions or add-ons that were attractive we'd certainly pursue them. One of the questions would be whether they are more natural for GCI over Charter coming out of the way.
And we'll take our last question from Andrew Walker from Rangeley Capital.
Hey guys. Thanks for taking the last question. Just looking at GCI on the CapEx side. I think you were coming off a little higher CapEx cycle over the past couple of years and obviously as a quad player, you're a little different than most of the domestic cable companies. Could you walk us through kind of what the near and medium term outlook for CapEx at GCI looks like?
Sure. I will let Pete take you through the components and I would just note that our CapEx is related to the health of the marketplace and one of the reasons for the reduction in CapEx over the last several years has been in response to the fact that we're playing in a market that is currently economically challenged that needs some policy changes in order to as Pete originally said increase the confidence of people making investment up here. But with that he can give you a real quick summary of the major elements of our CapEx for this year in terms of what we'll be investing in.
Yes. And this CapEx is really for this year, we're not making any announcements for any future year, but we currently have guidance for $170 million and really looking at that just over 20% of that is dedicated to our wireless build out that's increasing the coverage in a number of sites as well as increasing the bandwidth that's available at existing sites, so providing better service for our customers there.
Closing in on 50% of our capital is really for what I would call maintenance capital that's the type of capital that you need to spend just to keep EBITDA relatively flat, excuse me, OBIDA is the new word. So to keep OBIDA relatively flat, we need to spend roughly half that amount on CapEx. And really the other piece that is a little higher than what we would normally expect to see does relate to IT systems, that's the new billing system and other measures that will improve the efficiency here.
Perfect. Thanks guys.
Thank you to all our listeners and questions today. Thank you for your continued, new interest and I guess in some cases in GCI Liberty and we look forward to talking to you next quarter call. Thanks.
That concludes today's conference. Thank you for your participation. You may now disconnect.