Charter Q2 net loss widens; company says it will act on '05 converts, balance sheet, but gives no details

By Paul Deckelman

New York, Aug. 9 - Charter Communications Inc. reported a wider second-quarter net loss Monday, although it said that revenues were improved as subscriber gains in its high-speed data and telephony services partly offset larger losses among basic analog cable service subscribers.

Charter executives told analysts and investors on a morning conference call following the release of the second-quarter numbers that even having successfully done some $10 billion in refinancing transactions over the past 12 months - including a nearly $2 billion debt exchange last year and a massive $8 billion transaction that closed in late April - the St. Louis-based cable operator remains "highly leveraged."

They acknowledged that the presence on its balance sheet of $588 million of 5¾% convertible senior notes due on Oct. 1, 2005 remains an issue that "must be addressed" - although they offered no specifics about how this might be done.

They said the fourth-largest U.S. cable operator was looking at different means of de-leveraging, such as asset sales or possibly even including merger and acquisition transactions - under the right circumstances - but again they offered no hard details.

Charter saw quarterly revenues of $1.239 billion, an increase of $71 million or 6% over pro forma year-ago revenues of $1.168 billion and an increase of 2% over second quarter actually reported revenues of $1.217 billion (the discrepancy is due to substantial asset divestitures that have taken place since then). It said that the revenue gains were principally the result of growth in high-speed data sales as well as increased commercial revenues.

Charter posted a net loss of $416 million ($1.39 a share) versus a year-earlier net loss of $38 million (13 cents a share). The second-quarter results were affected by charges connected with its settlement of numerous class-action suits against the company by disgruntled investors, as well as by the parent company absorbing substantially all net losses before taxes that in the past were allocated to minority interest, because minority interest in its Charter Communications Holding Co., LLC was substantially eliminated as of last Dec. 31. That alone resulted in an additional $200 million of net loss for the three months ended June 30. The year-ago figures meanwhile look better by comparison because they include an income tax gain of $98 million (33 cents a share).

EBITDA at $480 million

Of more interest to debt investors, adjusted EBITDA for the quarter firmed to $480 million from $473 million on a pro forma basis, although it was off $17 million (4%) on an actually reported basis.

Reported unlevered free cash flow was $280 million in the second quarter, down from pro forma unlevered free cash flow of $316 million and as-reported unlevered free cash flow of $337 million in the year-ago quarter due to increased capital expenditures. Second-quarter free cash flow was negative $60 million, versus pro-forma positive $42 million and actually reported positive $56 million a year ago, due to higher capex and interest costs.

Cash interest paid out increased to $340 million in the latest quarter from $274 million a year ago, an increase of $66 million or 24%. The company counted among the factors the effects of refinancing $15 million of convertible notes and the changeover of previously zero-coupon senior discount notes to cash-pay.

As of the end of the second quarter, Charter had $18.4 billion of outstanding debt against $124 million cash on hand.

Long-term debt as of June 30 consisted of $5.4 billion of credit facility debt, which was refinanced in April, $12.3 billion of high-yield notes and $744 million of convertible senior notes. The company had net availability of funds under its Charter Communications Operating LLC subsidiary's credit facility of $977 million.

The centerpiece of the company's balance-sheet improvement efforts during the quarter was the massive refinancing that was completed on April 27. Charter at that time amended the $5.1 billion of existing Charter Operating credit facilities to expand those facilities to $6.5 billion. Charter then used the additional credit facility proceeds, along with the proceeds from the concurrent issuance of $1.5 billion of new bonds ($1.1 billion of 8% second lien senior notes due 2012 and $400 million of 8 3/8% senior notes due 2014) to refinance the bank debt of several Charter subsidiaries - CC VI Operating, LLC, Falcon Cable Communications, LLC, and CC VIII Operating, LLC. The amended facility, combined with the issuance of the new notes, provided the company with $8 billion of financing to effectively replace the $9 billion that was available under the credit facilities prior to the refinancing. As a result of that refinancing, Charter says it now has increased borrowing availability and greater operating flexibility through the consolidation of its bank facilities, less restrictive covenants and deferred maturities.

Apart from its Charter Communications Inc. 5¾% convertibles maturing in October 2005, the nearest significant maturities it faces are $156 million of Charter Communications Inc. 4¾% converts due on June 1, 2006 and $451 million of Charter Communications Holdings 8¼% senior notes due April 1, 2007.

"Very, very active" looking at capital structure

Charter's president and chief executive officer, Carl E. Vogel, said in answer to an analyst's query in the question-and-answer period that followed the formal company presentation of results, that following the completion of the April refinancing, and apart from several privately negotiated exchanges of common stock for a total of $30 million face amount of the 5¾% converts, on which the company recorded a $15 million loss, "we haven't made any further movement on the capital structure at this point. As I also mentioned, it's certainly something [on] top of [our] mind."

He said that the company's executive vice president for strategy and finance, Derek Chang - who emerges as an increasingly important member of Charter's management structure with the impending departure by Aug. 20 of chief financial officer Michael P. Huseby - "is very, very active in looking at alternatives as we speak."

Vogel sought to reassure the investment community that Huseby's planned departure to take the CFO position at Charter rival Cablevision Corp. "will have no impact on our continued desire to make progress in de-leveraging and maximizing shareholder value," given that Chang "is keenly focused on improving our balance sheet and liquidity . . . We recognize that leverage remains an issue and the '05 converts represent a near-term maturity that we must and will address. We [will] work diligently with our board to address the balance sheet."

"Discussion" on Allen's preferreds

Vogel, in answer to a question, said that there had been no recent changes in the status of preferred shares held by Charter's principal investor, billionaire financier Paul Allen.

"There has been discussion among the parties," Vogel said, "but there really isn't anything more to report at this point."

Allen was the subject last week of renewed market rumors - which apparently proved to be unfounded - that he might be investing as much as another $1.5 billion into company, either alone or possibly in consort with one or more market heavy hitters such as the billionaire tech investor and sports team owner Mark Cuban.

M&A would make "a lot of sense"

If such an equity infusion were to ever materialize, it could theoretically help to pave the way for Charter jumping into the merger and acquisition game as a back-handed way of improving its balance sheet (by acquiring assets capable of generating sufficient earnings to bring down the company's leverage ratios, even given that such acquisition transactions would likely be funded at least in part by debt).

Vogel, asked by an analyst whether he still viewed M&A as a viable balance-sheet improvement tactic, as he has in the past, said that "in terms of M&A as a way to de-lever the balance sheet, certainly we still think that is a good strategy.

"Obviously that would require an adjustment of our current balance sheet and an infusion of equity. So there are a lot of complications to executing against that strategy, but it's certainly something that I have continued to say makes a lot of sense for Charter, that would allow us to improve our footprint, improve our balance sheet, and at least strategically [is] a good thing to do."

The Adelphia call

The CEO continued: "We will certainly look at that, and I, as I'm sure others have, gotten their call from the appropriate investment bankers that are managing the Adelphia [Communications Corp. bankruptcy asset-sale] process."

But Chang was more skeptical about the likelihood that Charter might be buying assets from the reorganizing Greenwood Village, Colo.-based rival cabler, cautioning that "there's not a lot out there, other than Adelphia, which really gives you the scale that allows you to do something material on that kind of [de-leveraging] thing. With the Adelphia situation, in all honesty, being somewhat uncertain as to when it actually happens, how it actually happens - and if it actually happens - it's not something that we are counting on as our 'one bullet' in terms of de-leveraging the balance sheet. We are working on many other alternatives along those lines."

Looking at asset sales

Among the alternatives Chang and his team are considering is further asset sales of their own as a means of cutting debt, although these also impact negatively on leverage calculations in the long run by cutting company revenues and earnings.

"We are in a phase where we are doing some limited asset sales, but mostly ones that potentially help our operating performance, where we feel that we just don't have the scale in a certain area, or frankly, the operating and management to deal with some of our far-flung assets," Chang told conference call participants. "Going forward, though, we will continue to look and keep tabs on the market to see what potentially makes sense. If indeed the valuation is there, there's always a possibility that we could use asset sales as a way of continuing to improve our balance sheet."

Charter has already pulled off one big asset sale so far this year, selling certain cable systems in Florida, Pennsylvania, Maryland, Delaware and West Virginia to Atlantic Broadband Finance, LLC in a deal that closed on March 1, and the sale of an additional cable system in New York to Atlantic Broadband the following month. Subject to post-closing contractual adjustments, Charter anticipates total proceeds from the sale of those systems of $733 million. Proceeds received to date have been used to repay borrowings under its credit facilities.

May repeat debt-for-debt swap

Another option Chang is looking at, he told an analyst who asked, is doing another debt-for-debt swap, like the one Charter did last fall, in which it brought down its interest costs and extended its maturities by swapping new 10¼% notes due 2010 for a total of $1.9 billion of its then-outstanding senior notes and convertibles.

"That's certainly something that we continue to consider, along with several other of our options with respect to the balance sheet, and I know there's a lot of desire from all of you for us to get moving on this particular front and we understand that," the executive said. "There's certainly a desire on our own part to do so. So we are gonna be moving forward, hopefully."

Vogel said that company efforts to fix up the balance sheet "could only be helped" by several developments on the legal front, including Charter's settlement of outstanding issues with the Securities and Exchange Commission, which had been probing Charter's accounting practices since November 2002, and its settlement of a slew of resulting class-action suits which had been brought against the company by disgruntled investors who claimed they had been misled as to the true state of Charter's financial health by the official communications emanating from St. Louis.

On July 27, Charter and the SEC came to an agreement, under which the company neither admitted not denied wrongdoing, was not fined by the agency, and agreed to entry of an administrative order prohibiting any future violations of the securities laws and requiring certain other remedial internal practices and public disclosures.

Last Thursday, Charter announced that it had reached a settlement with the plaintiffs in the various class-action suits - 14 of them, all told - under which Charter will pay them $144 million of cash and stock, and also commit to a variety of corporate governance changes, internal practices and public disclosures, some of which have already been undertaken. The $64 million cash component of the settlement is being paid by Charter's insurance carriers.

Vogel also announced Monday that Charter has been informed by the U.S. Attorney's Office in St. Louis - scrutinizing Charter since August 2002 - that the company itself is not a target of the investigation, nor are any current officers or directors. Several former Charter executives, however, were charged last year with conspiracy and mail and wire fraud. The indictments alleged improper accounting and reporting practices focusing on revenue from digital set-top terminal suppliers and inflated customer account numbers.

Vogel said that the company was "very pleased" to be able to put these matters behind it, noting that the settlements remove "perceived limitations on our ability to issue securities or pursue other options to improve our financial position and competitive position. We've come a long way over the past two years."

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