UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________
FORM 10-K
______________
(Mark One)
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the fiscal year ended December 31, 2019
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For the Transition Period From to
Commission File Number:001-33664
Commission File Number:
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | ||
(Address of Principal Executive Offices) | (Zip Code) | ||
(203 ) 905-7801
(Registrant's telephone number, including area code)
Securities registered pursuant to section 12(b) of the Act:
Title of each class | Trading Symbol(s) | Name of each exchange on which registered |
Securities registered pursuant to section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrants have submitted electronically and posted on their corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrants were required to submit and post such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.:
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No x
The aggregate market value of the registrant of outstanding Class A common stock held by non-affiliates of the registrant at June 30, 2019 was approximately $65.3 billion, computed based on the closing sale price as quoted on the NASDAQ Global Select Market on that date. For purposes of this calculation only, directors, executive officers and the principal controlling shareholders or entities controlled by such controlling shareholders of the registrant are deemed to be affiliates of the registrant.
There were 209,975,963 shares of Class A common stock outstanding as of December 31, 2019. There was 1 share of Class B common stock outstanding as of the same date.
Documents Incorporated By Reference
Information required by Part III is incorporated by reference from Registrant’s proxy statement or an amendment to this Annual Report on Form 10-K to be filed by April 30, 2020.
CHARTER COMMUNICATIONS, INC.
FORM 10-K — FOR THE YEAR ENDED DECEMBER 31, 2019
FORM 10-K — FOR THE YEAR ENDED DECEMBER 31, 2019
TABLE OF CONTENTS
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This annual report on Form 10-K is for the year ended December 31, 2019. The United States Securities and Exchange Commission (“SEC”) allows us to “incorporate by reference” information that we file with the SEC, which means that we can disclose important information to you by referring you directly to those documents. Information incorporated by reference is considered to be part of this annual report. In addition, information that we file with the SEC in the future will automatically update and supersede information contained in this annual report. In this annual report, “Charter,” “we,” “us” and “our” refer to Charter Communications, Inc. and its subsidiaries.
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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS:
This annual report includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), regarding, among other things, our plans, strategies and prospects, both business and financial including, without limitation, the forward-looking statements set forth in Part I. Item 1. under the heading “Business” and in Part II. Item 7. under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this annual report. Although we believe that our plans, intentions and expectations reflected in or suggested by these forward-looking statements are reasonable, we cannot assure you that we will achieve or realize these plans, intentions or expectations. Forward-looking statements are inherently subject to risks, uncertainties and assumptions, including, without limitation, the factors described in Part I. Item 1A. under “Risk Factors” and in Part II. Item 7. under the heading, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this annual report. Many of the forward-looking statements contained in this annual report may be identified by the use of forward‑looking words such as “believe,” “expect,” “anticipate,” “should,” “planned,” “will,” “may,” “intend,” “estimated,” “aim,” “on track,” “target,” “opportunity,” “tentative,” “positioning,” “designed,” “create,” “predict,” “project,” “initiatives,” “seek,” “would,” “could,” “continue,” “ongoing,” “upside,” “increases,” “focused on” and “potential,” among others. Important factors that could cause actual results to differ materially from the forward-looking statements we make in this annual report are set forth in this annual report and in other reports or documents that we file from time to time with the SEC, and include, but are not limited to:
• | our ability to sustain and grow revenues and cash flow from operations by offering video, Internet, voice, mobile, advertising and other services to residential and commercial customers, to adequately meet the customer experience demands in our service areas and to maintain and grow our customer base, particularly in the face of increasingly aggressive competition, the need for innovation and the related capital expenditures; |
• | the impact of competition from other market participants, including but not limited to incumbent telephone companies, direct broadcast satellite ("DBS") operators, wireless broadband and telephone providers, digital subscriber line (“DSL”) providers, fiber to the home providers and providers of video content over broadband Internet connections; |
• | our ability to obtain programming at reasonable prices or to raise prices to offset, in whole or in part, the effects of higher programming costs (including retransmission consents); |
• | our ability to develop and deploy new products and technologies including mobile products and any other consumer services and service platforms; |
• | any events that disrupt our networks, information systems or properties and impair our operating activities or our reputation; |
• | the effects of governmental regulation on our business including costs, disruptions and possible limitations on operating flexibility related to, and our ability to comply with, regulatory conditions applicable to us as a result of the Time Warner Cable Inc. and Bright House Networks, LLC transactions; |
• | general business conditions, economic uncertainty or downturn, unemployment levels and the level of activity in the housing sector; |
• | the ability to retain and hire key personnel; |
• | the availability and access, in general, of funds to meet our debt obligations prior to or when they become due and to fund our operations and necessary capital expenditures, either through (i) cash on hand, (ii) free cash flow, or (iii) access to the capital or credit markets; and |
• | our ability to comply with all covenants in our indentures and credit facilities, any violation of which, if not cured in a timely manner, could trigger a default of our other obligations under cross-default provisions. |
All forward-looking statements attributable to us or any person acting on our behalf are expressly qualified in their entirety by this cautionary statement. We are under no duty or obligation to update any of the forward-looking statements after the date of this annual report.
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PART I
Item 1. Business.
Introduction
We are the second largest cable operator in the United States and a leading broadband communications services company providing video, Internet and voice services to approximately 29.2 million residential and small and medium business customers at December 31, 2019. We also offer mobile service to residential customers and recently launched mobile service to small and medium business customers. In addition, we sell video and online advertising inventory to local, regional and national advertising customers and tailored communications and managed solutions to larger enterprise customers. We also own and operate regional sports networks and local sports, news and community channels.
We own and operate a high-capacity, two-way telecommunications network which passes over 52 million households and small and medium businesses across the United States. Our core strategy is to use our network to deliver high quality products at competitive prices, combined with outstanding service. This strategy, combined with simple, easy to understand pricing and packaging, is central to our goal of growing our customer base while selling more of our core connectivity services, which include both fixed and mobile Internet, video and voice services, to each individual customer. We execute this strategy by managing our operations in a consumer-friendly, efficient and cost-effective manner. Our operating strategy includes insourcing nearly all of our customer care and field operations workforces, which results in higher quality service delivery. While an insourced operating model can increase the field operations and customer care costs associated with individual service transactions, the higher quality nature of insourced labor service transactions significantly reduces the volume of service transactions per customer, more than offsetting the higher investment made in each insourced service transaction. As we reduce the number of service transactions and recurring costs per customer relationship, we continue to provide our customers with products and prices that we believe provide more value than what our competitors offer. The combination of offering high quality, competitively priced products and outstanding service, allows us to both increase the number of customers we serve over our fully deployed network, and to increase the number of products we sell to each customer. This combination also reduces the number of service transactions we perform per relationship, yielding higher customer satisfaction and lower customer churn, resulting in lower costs to acquire and serve customers.
We have enhanced our service operations to allow our customers to (1) more frequently interact with us through our customer website and Spectrum TV application, online chat and social media, (2) have their services installed at the time and in the manner of their own choosing, including self-installation, and (3) receive a variety of video packages on an increasing number of connected devices including those owned by us and those owned by the customer. By offering our customers growing levels of choices in how they receive and install their services and how they interact with us, we are driving higher overall levels of customer satisfaction and reducing our operating costs and capital expenditures per customer relationship. Ultimately, our operating strategy enables us to offer high quality, competitively priced services profitably, while continuing to invest in new products and services.
The capability and functionality of our two-way network continues to grow in a number of areas, especially with respect to wireless connectivity. Our Internet service offers consumers the ability to wirelessly connect to our network using WiFi technology. We estimate that over 300 million devices are wirelessly connected to our network through WiFi. Initially, our wireless strategy focused on offering wireless connectivity solutions inside the home and business using WiFi. Through our mobile virtual network operator (“MVNO”) reseller agreement with Verizon Communications Inc. ("Verizon"), we are now able to offer Internet connectivity to our customers beyond the home via our Spectrum Mobile product. We are also actively testing and evaluating opportunities for our customers to wirelessly connect to our network using a combination of licensed and unlicensed radio spectrum to deliver fixed and mobile service directly from our distributed, high capacity network.
Our principal executive offices are located at 400 Atlantic Street, Stamford, Connecticut 06901. Our telephone number is (203) 905-7801, and we have a website accessible at www.charter.com. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, and all amendments thereto, are available on our website free of charge as soon as reasonably practicable after they have been filed. The information posted on our website is not incorporated into this annual report.
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Corporate Entity Structure
The chart below sets forth our entity structure and that of our direct and indirect subsidiaries. The chart does not include all of our affiliates and subsidiaries and, in some cases, we have combined separate entities for presentation purposes. The equity ownership percentages shown below are approximations. Indebtedness amounts shown below are principal amounts as of December 31, 2019. See Note 9 to the accompanying consolidated financial statements contained in “Part II. Item 8. Financial Statements and Supplementary Data,” which also includes the accreted values of the indebtedness described below.
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Products and Services
We offer our customers subscription-based video services, Internet services, and voice and mobile services. Our services are offered to residential and commercial customers on a subscription basis, with prices and related charges based on the types of service selected, whether the services are sold as a “bundle” or on an individual basis, and based on the equipment necessary to receive our services. Bundled services are available to substantially all of our passings, and approximately 57% of our residential customers subscribe to a bundle of services including some combination of our video, Internet and/or voice products.
The following table summarizes our customer statistics for video, Internet, mobile and voice as of December 31, 2019 and 2018 (in thousands except per customer data and footnotes).
Approximate as of | |||||||
December 31, | |||||||
2019 (a) | 2018 (a) | ||||||
Customer Relationships (b) | |||||||
Residential | 27,277 | 26,270 | |||||
Small and Medium Business | 1,958 | 1,833 | |||||
Total Customer Relationships | 29,235 | 28,103 | |||||
Residential Primary Service Units ("PSUs") | |||||||
Video | 15,620 | 16,104 | |||||
Internet | 24,908 | 23,625 | |||||
Voice | 9,443 | 10,135 | |||||
Monthly Residential Revenue per Residential Customer (c) | $ | 112.63 | $ | 111.56 | |||
Small and Medium Business PSUs | |||||||
Video | 524 | 502 | |||||
Internet | 1,756 | 1,634 | |||||
Voice | 1,144 | 1,051 | |||||
Monthly Small and Medium Business Revenue per Customer (d) | $ | 169.90 | $ | 174.88 | |||
Mobile Lines | 1,082 | 134 | |||||
Enterprise PSUs (e) | 267 | 248 | |||||
(a) | We calculate the aging of customer accounts based on the monthly billing cycle for each account. On that basis, as of December 31, 2019 and 2018, customers include approximately 154,200 and 217,600 customers, respectively, whose accounts were over 60 days past due, approximately 13,500 and 24,000 customers, respectively, whose accounts were over 90 days past due, and approximately 10,000 and 19,200 customers, respectively, whose accounts were over 120 days past due. |
(b) | Customer relationships include the number of customers that receive one or more levels of service, encompassing video, Internet and voice services, without regard to which service(s) such customers receive. Customers who reside in residential multiple dwelling units (“MDUs”) and that are billed under bulk contracts are counted based on the number of billed units within each bulk MDU. Total customer relationships exclude enterprise and mobile-only customer relationships. |
(c) | Monthly residential revenue per residential customer is calculated as total residential video, Internet and voice annual revenue divided by twelve divided by average residential customer relationships during the respective year. Monthly residential revenue per residential customers excludes mobile revenue and customers. |
(d) | Monthly small and medium business revenue per customer is calculated as total small and medium business annual revenue divided by twelve divided by average small and medium business customer relationships during the respective year. Monthly small and medium business revenue per small and medium customer excludes mobile revenue and customers. |
(e) | Enterprise PSUs represent the aggregate number of fiber service offerings counting each separate service offering at each customer location as an individual PSU. |
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Residential Services
Video Services
Our video customers receive a package of programming which generally includes a digital set-top box that provides an interactive electronic programming guide with parental controls, access to pay-per-view services, including video on demand (“VOD”) (available to nearly all of our passings) and the ability to view certain video services on third-party devices inside and outside the residence. Customers have the option to purchase additional tiers of services including premium channels which provide original programming, commercial-free movies, sports, and other special event entertainment programming. Substantially all of our video programming is available in high definition. We also offer certain video packages containing a limited number of channels via our cable television systems.
In the vast majority of our footprint, we offer VOD service which allows customers to select from over 60,000 titles at any time. VOD programming options may be accessed for free if the content is associated with a customer’s linear subscription, or for a fee on a transactional basis. VOD services are also offered on a subscription basis included in a digital tier premium channel subscription or for a monthly fee. Pay-per-view channels allow customers to pay on a per-event basis to view a single showing of a one-time special sporting event, music concert, or similar event on a commercial-free basis.
Our goal is to provide our video customers with the programming they want, when they want it, on any device. Digital video recorder (“DVR”) service enables customers to digitally record programming and to pause and rewind live programming. Customers can also use our Spectrum TV application on Internet Protocol ("IP") devices to watch over 375 channels of cable TV in home and approximately 275 channels out of home and view VOD programming. Customers are increasingly accessing their subscription video content through connected IP devices via our IP network. In 2019, we launched cloud DVR service which allows customers to schedule, record and watch their favorite programming anytime from connected IP devices as well as SpectrumTV.com. Our video customers also have access to programmer authenticated applications and websites (known as TV Everywhere services) such as HBO Go, Fox Now, Discovery Go and ESPN. We deploy Spectrum Guide®, our network or “cloud-based” user interface, to new video customers in the majority of our service areas. Spectrum Guide runs on traditional set-top boxes but offers a look and feel similar to that of our Spectrum TV application. Spectrum Guide also provides access to third-party video applications such as Netflix.
Internet Services
Our Spectrum pricing and packaging (“SPP”) offers an entry level Internet download speed of at least 200 megabits per second (“Mbps”) in approximately 60% of our footprint and 100 Mbps across approximately 40% of our footprint, which among other things, allows several people within a single household to stream high definition (“HD”) television video content while simultaneously using our Internet service for other purposes. Additionally, leveraging DOCSIS 3.1 technology, we offer 940 Mbps speed service ("Spectrum Internet Gig") in nearly all of our footprint. Finally, we offer a security suite with our Internet services which, upon installation by customers, provides protection against computer viruses and spyware and includes parental control features.
We offer an in-home WiFi product that provides customers with high performance wireless routers to maximize their in-home wireless Internet experience. At the end of 2019, we launched our advanced in-home WiFi product in select service areas and we plan to continue to roll this product out to our entire footprint throughout 2020 and 2021. Advanced in-home WiFi provides connected device visibility, management and control to customers in a single application and to customer service agents to help support our customers. Advanced in-home WiFi is built on a software platform that will allow us to integrate and launch additional network based security and control features.
Voice Services
We provide voice communications services using voice over Internet protocol ("VoIP") technology to transmit digital voice signals over our network. Our voice services include unlimited local and long distance calling to the United States, Canada, Mexico and Puerto Rico, voicemail, call waiting, caller ID, call forwarding and other features and offers international calling either by the minute, or through packages of minutes per month. For customers that subscribe to both our voice and video offerings, caller ID on TV is also available in most areas.
Mobile Services
At the end of the second quarter of 2018, we launched our mobile product, Spectrum Mobile, to residential customers under our MVNO reseller agreement with Verizon. We currently offer our Spectrum Mobile service to residential customers subscribing to
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our Internet service and recently launched mobile service to small and medium business customers. In the second quarter of 2019, we expanded our Spectrum Mobile bring-your-own-device ("BYOD") program across all sales channels to include a broader set of devices which we believe lowers the cost for consumers of switching mobile carriers, and reduces the short-term working capital impact of selling new mobile devices on installment plans. We believe Spectrum-branded mobile services will drive more sales of our core products, create longer customer lives and increase profitability and cash flow over time. As we continue to grow our mobile services, including 5G in 2020, we expect that Spectrum Mobile will require an initial funding period to grow the product as well as negative working capital impacts from the timing of device-related cash flows when we sell the handset or tablet to customers pursuant to equipment installment plans.
We plan to use our WiFi network in conjunction with additional unlicensed, and potentially licensed, spectrum to improve network performance and expand capacity to offer consumers a superior mobile service at a lower total cost to us. Further, we have experimental wireless licenses from the Federal Communications Commission ("FCC") that we are utilizing to test next generation mobile services in several service areas around the country. We intend to consider and pursue opportunities in the mobile space which may include the acquisition of licensed spectrum and may include entering into or expanding joint ventures or partnerships with wireless or cable providers which may require significant investment.
Commercial Services
We offer scalable broadband communications solutions for businesses and carrier organizations of all sizes, selling Internet access, data networking, fiber connectivity to cellular towers and office buildings, video entertainment services and business telephone services.
Small and Medium Business
Spectrum Business® offers Internet, voice and video services to small and medium businesses over our hybrid fiber coaxial network. In addition, in 2019, we began offering our Spectrum Mobile service to small and medium business customers. Spectrum Business includes a full range of video programming and entry-level Internet speeds of 200 Mbps downstream and 10 Mbps upstream in virtually all of our markets. Additionally, customers can upgrade their Internet speeds by purchasing Internet Ultra (400 Mbps downstream) or Internet Gig (940 Mbps downstream). Spectrum Business also includes a set of business services including static IP and business WiFi, e-mail and security, and multi-line telephone services with more than 30 business features including web-based service management, that are generally not available to residential customers.
Enterprise
Spectrum Enterprise offers more tailored communications products and managed service solutions to larger businesses, as well as high-capacity last-mile data connectivity services to mobile and wireline carriers on a wholesale basis. Spectrum Enterprise's product portfolio includes fiber Internet access, voice trunking services, unified messaging/unified communications (“UM/UC”), Ethernet services that privately and securely connect geographically dispersed client locations, and video solutions designed to meet the needs of hospitality, education, and healthcare clients. In addition, in 2019, Spectrum Enterprise launched an innovative Hybrid Software-Defined Wide Area Network ("SD-WAN") that enables businesses to leverage the performance of Ethernet, the ubiquity of Internet connectivity and the flexibility of a software-defined solution to solve a wide array of business communications and networking challenges. Spectrum Enterprise combines its large, serviceable footprint and robust portfolio of fiber lit buildings with a sizeable partner network to effectively serve enterprise customers nationally. These customers can benefit from obtaining advanced services from a single provider, receiving a consistent solution while simplifying procurement and potentially reducing their costs.
Advertising Services
Our advertising sales division, Spectrum Reach®, offers local, regional and national businesses the opportunity to advertise in individual and multiple service areas on cable television networks and digital outlets. We receive revenues from the sale of local advertising across various platforms for networks such as MTV, CNN and ESPN. In any particular service area, we typically insert local advertising on 40 to 90 channels. Our large footprint provides opportunities for advertising customers to address broader regional audiences from a single provider and thus reach more customers with a single transaction. Our size also provides scale to invest in new technology to create more targeted and addressable advertising capabilities.
Available advertising time is generally sold by our advertising sales force. In some service areas, we have formed advertising interconnects or entered into representation agreements with other video distributors, including, among others, Verizon, AT&T Inc. (“AT&T”) and Comcast Corporation, under which we sell advertising on behalf of those operators. In other service areas, we enter into representation agreements under which another operator in the area will sell advertising on our behalf. These
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arrangements enable us and our partners to deliver linear commercials across wider geographic areas, replicating the reach of local broadcast television stations to the extent possible. In addition, we enter into interconnect agreements from time to time with other cable operators, which, on behalf of a number of video operators, sells advertising time to national and regional advertisers in individual or multiple service areas.
Additionally, we sell the advertising inventory of our owned and operated local sports and news channels, of our regional sports networks that carry Los Angeles Lakers’ basketball games and other sports programming and of SportsNet LA, a regional sports network that carries Los Angeles Dodgers’ baseball games and other sports programming.
In 2019, we began expanding our deployment of household addressability, which allows for more precise targeting within various parts of our footprint. We also began the roll-out of our Ad Portal, which allows small businesses to purchase local cable advertising and/or creative services via our web portal with no sales personnel interaction at a fee within their budgets. Both products will be more widely deployed in 2020. They join our fully deployed Audience App, which uses our proprietary set-top box viewership data (all anonymized and aggregated) to optimize linear inventory, in our suite of advanced advertising products available to the marketplace.
Other Services
Regional Sports and News Networks
We have an agreement with the Los Angeles Lakers for rights to distribute all locally available Los Angeles Lakers’ games through 2033. We broadcast those games on our regional sports network, Spectrum SportsNet. American Media Productions, LLC ("American Media Productions"), an unaffiliated third party, owns SportsNet LA, a regional sports network carrying the Los Angeles Dodgers’ baseball games and other sports programming. In accordance with agreements with American Media Productions, we act as the network’s exclusive affiliate and advertising sales representative and have certain branding and programming rights with respect to the network. In addition, we provide certain production and technical services to American Media Productions. The affiliate, advertising, production and programming agreements continue through 2038. We also own 26.8% of Sterling Entertainment Enterprises, LLC (doing business as SportsNet New York), a New York City-based regional sports network that carries New York Mets’ baseball games as well as other regional sports programming.
We manage 28 local news channels, including Spectrum News NY1® and LA1, 24-hour news channels focused on New York City and Los Angeles. Our local news channels provide 24/7 hyperlocal content, focusing on news, programming and storytelling that addresses the deeper needs and interests of the diverse communities and neighborhoods we serve.
Pricing of Our Products and Services
Our revenues are principally derived from the monthly fees customers pay for the services we provide. We typically charge a one-time installation fee which is sometimes waived or discounted in certain sales channels during certain promotional periods.
Our Spectrum pricing and packaging ("SPP") generally offers a standardized price for each tier of service, bundle of services, and add-on service in a service area. We believe SPP:
• | offers a higher quality and more value-based set of services relative to our competitors, including faster Internet speeds, more HD channels, lower equipment fees and a more transparent pricing structure; |
• | offers simplicity for customers to understand our offers, and for our employees in service delivery; |
• | drives our ability to package more services at the time of sale, thus increasing revenue per customer; |
• | drives higher customer satisfaction, lower service calls and churn; and |
• | allows for gradual price increases at the end of promotional periods. |
We sell video and Internet packages with the option to add on voice and mobile services at attractive pricing. Our mobile customers can choose one of two simple ways to pay for data. Customers can choose an unlimited data plan or a by-the-gig data usage plan. Both plans include free nationwide talk and text and customers can easily switch between mobile data plans during the month. Customers can also purchase mobile devices and accessory products and have the option to pay for devices under interest-free monthly installment plans.
Our Network Technology
Our network includes three key components: a national backbone, regional/metro networks and a “last-mile” network. Both our national backbone and regional/metro network components utilize a redundant IP ring/mesh architecture. The national backbone
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component provides connectivity from regional demarcation points to nationally centralized content, connectivity and services. The regional/metro network components provide connectivity between the regional demarcation points and headends within a specific geographic area and enable the delivery of content and services between these network components.
Our last-mile network utilizes a hybrid fiber coaxial cable (“HFC”) architecture, which combines the use of fiber optic cable with coaxial cable. In most systems, we deliver our signals via fiber optic cable from the headend to a group of nodes, and use coaxial cable to deliver the signal from individual nodes to the homes served by that node. For our fiber Internet, Ethernet, carrier wholesale, Session Initiation Protocol ("SIP") and Primary Rate Interface ("PRI") Spectrum Enterprise customers, fiber optic cable is extended from individual nodes to the customer’s site. For certain new build and MDU sites, we increasingly bring fiber to the customer site. Our design standard allows spare fiber strands to each node to be utilized for additional residential traffic capacity, and enterprise customer needs as they arise. We believe that this hybrid network design provides high capacity and signal quality.
HFC architecture benefits include:
• | bandwidth capacity to enable traditional and two-way video and broadband services; |
• | dedicated bandwidth for two-way services; and |
• | signal quality and high service reliability. |
Our systems provide an all-digital platform, leveraging DOCSIS 3.1 technology and bandwidth of 750 megahertz or greater to approximately 100% of our estimated passings. This bandwidth capacity enables us to offer two-way signal capabilities necessary to provide HD television, interactive video services such as VOD, high-speed Internet and voice services. An all-digital platform leveraging DOCSIS 3.1 technology enables us to offer a larger selection of HD channels, Spectrum Internet Gig and better picture quality while providing greater plant security and enabling lower installation and disconnect service truck rolls. We believe this architecture also allows us to continue to enhance our network to enable multi-gigabit services with low latency at a lower incremental capital cost relative to our competitors.
Management, Customer Operations and Marketing
Our operations are centralized, with senior executives located at several key corporate offices, responsible for coordinating and overseeing operations, including establishing company-wide strategies, policies and procedures. Sales and marketing, network operations, field operations, customer operations, engineering, advertising sales, human resources, legal, government relations, information technology and finance are all directed at the corporate level. Regional and local field operations are responsible for customer premise service transactions and maintaining and constructing that portion of our network which is located outdoors.
We continue to focus on improving the customer experience through enhanced product offerings, reliability of services, and delivery of quality customer service. As part of our operating strategy, we insource most of our customer operations workload. Our in-house call centers handle over 90% of our total customer service calls. We manage our customer service call centers centrally to ensure a consistent, high quality customer experience. In addition, we route calls by call type to specific agents that only handle such call types, enabling agents to become experts in addressing specific customer needs, creating a better customer experience. We implemented a new call center agent desktop interface tool in 2019 which enables virtualization of all call centers thereby better serving our customers. Virtualization allows calls to be routed across our call centers regardless of the location origin of the call, reducing call wait times, and saving costs. We continue to migrate our call centers to full virtualization and expect all our call centers to be fully virtualized by 2020.
We also provide customers with the opportunity to interact with us through a variety of forums in addition to telephonic communications, including through our customer website, mobile device applications, online chat and social media. Our customer websites and mobile applications enable customers to pay their bills, manage their accounts, order new services and utilize self-service help and support.
We sell our residential and commercial services using a national brand platform known as Spectrum, Spectrum Business and Spectrum Enterprise. These brands reflect our comprehensive approach to industry-leading products, driven by speed, performance and innovation. Our marketing strategy emphasizes the sale of our bundled services through targeted direct response marketing programs to existing and potential customers, and increases awareness and the value of the Spectrum brand. Our marketing organization creates and executes marketing programs intended to grow customer relationships, increase the number of services we sell per relationship, retain existing customers and cross-sell additional products to current customers. We monitor the effectiveness of our marketing efforts, customer perception, competition, pricing, and service preferences, among other factors, in order to increase our responsiveness to our customers and to improve our sales and customer retention. The marketing organization manages all sales channels including inbound, direct sales, on-line, outbound telemarketing and stores.
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Programming
We believe that offering a wide variety of video programming choices influences a customer’s decision to subscribe and retain our cable video services. We obtain basic and premium programming, usually pursuant to written contracts from a number of suppliers. Media corporation consolidation has, however, resulted in fewer suppliers and additional selling power on the part of programming suppliers. Although an insignificant amount of our programming budget, recently we have begun entering into agreements to co-produce or exclusively license original content which give us the right to provide our customers with certain exclusive content for a period of time.
Programming is usually made available to us for a license fee, which is generally paid based on the number of customers to whom we make that programming available. Programming license fees may include “volume” discounts and financial incentives to support the launch of a channel and/or ongoing marketing support, as well as discounts for channel placement or service penetration. For home shopping channels, we typically receive a percentage of the revenue attributable to our customers’ purchases. We also offer VOD and pay-per-view channels of movies and events that are subject to a revenue split with the content provider.
Our programming costs have increased in excess of customary inflationary and cost-of-living type increases. We expect programming costs per customer to continue to increase due to a variety of factors including, annual increases pursuant to our programming contracts, contract renewals with programmers and the carriage of incremental programming, including new services and VOD programming. Increases in the cost of sports programming and the amounts paid for broadcast station retransmission consent have been the largest contributors to the growth in our programming costs over the last few years. Additionally, the demands of large media companies who link carriage of their most popular networks to carriage and cost increases of their less popular networks and who require us to carry their most popular networks to a large percentage of our video subscribers, has limited our flexibility in creating more tailored and cost-sensitive programming packages for consumers.
Federal law allows commercial television broadcast stations to make an election between “must-carry” rights and an alternative “retransmission-consent” regime. When a station opts for retransmission-consent, we are not allowed to carry the station’s signal without that station’s permission. Continuing demands by owners of broadcast stations for cash payments at substantial increases over amounts paid in prior years in exchange for retransmission consent will increase our programming costs or require us to cease carriage of popular programming, potentially leading to a loss of customers in affected service areas.
Over the past several years, increases in our video service rates have not fully offset the increases in our programming costs, and with the impact of increasing competition and other marketplace factors, we do not expect the increases in our video service rates to fully offset the increase in our programming costs for the foreseeable future. Although we pass along a portion of amounts paid for retransmission consent to the majority of our customers, our inability to fully pass programming cost increases on to our video customers has had, and is expected in the future to have, an adverse impact on our cash flow and operating margins associated with our video product. In order to mitigate reductions of our operating margins due to rapidly increasing programming costs, we continue to review our pricing and programming packaging strategies.
Our programming contracts are generally for a fixed period of time, usually for multiple years, and are subject to negotiated renewal. The contracts set to expire in any particular year vary. We will seek to renew these agreements on terms that we believe are favorable. There can be no assurance, however, that these agreements will be renewed on favorable or comparable terms. To the extent that we are unable to reach agreements with certain programmers on terms that we believe are reasonable, we have been, and may in the future be, forced to remove such programming channels from our line-up, which may result in a loss of customers.
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Regions
We operate in geographically diverse areas which are organized in regional clusters. These regions are managed centrally on a consolidated level. Our eleven regions and the customer relationships within each region as of December 31, 2019 are as follows (in thousands):
Regions | Total Customer Relationships | |
Carolinas | 3,020 | |
Central | 3,058 | |
Florida | 2,619 | |
Great Lakes | 2,270 | |
Northeast | 3,068 | |
Northwest | 1,626 | |
New York City | 1,381 | |
South | 2,094 | |
Southern Ohio | 2,313 | |
Texas | 3,070 | |
West | 4,716 | |
Competition
Residential Services
We face intense competition for residential customers, both from existing competitors and, as a result of the rapid development of new technologies, services and products, from new entrants. We face triple play competition, consisting of wireline multichannel video, wireline Internet, and wireline voice service, from three primary competitors, AT&T, Frontier Communications Corporation (“Frontier”) and Verizon. As of December 31, 2019, AT&T, Frontier and Verizon offered these triple play packages in approximately 33%, 7% and 5% of our operating areas, respectively. AT&T also owns DIRECTV, and as a combined company provides video service (via IP or satellite) and voice service (via fixed or wireless) across our entire footprint.
Video Competition
Our residential video service faces competition from DBS service providers, which have a national footprint and compete in all of our operating areas. DBS providers offer satellite-delivered pre-packaged programming services that can be received by relatively small and inexpensive receiving dishes. DBS providers offer aggressive promotional pricing, exclusive programming (e.g., NFL Sunday Ticket) and video services that are comparable in many respects to our residential video service. Our residential video service also faces competition from large telecommunications companies, primarily AT&T U-verse, Frontier fiber optic service (“FiOS" or "Fios") and Verizon Fios, which offer wireline video services in significant portions of our operating areas.
Our residential video service also faces growing competition from a number of other sources, including companies that deliver linear network programming, movies and television shows on demand and other video content over broadband Internet connections to televisions, computers, tablets and mobile devices. These competitors include virtual multichannel video programming distributors (“V-MVPDs”) such as AT&T TV NOW, Sling TV, YouTube TV and Hulu Live. Other online video business models and products have also developed, some offered by programmers that have not traditionally sold programming directly to consumers, including, (i) subscription video on demand (“SVOD”) services such as Netflix, Apple TV+, Amazon Prime, Hulu Plus, Disney+, HBO Now, CBS All Access, Starz and Showtime Anytime, (ii) ad-supported free online video products, including YouTube and Pluto TV, some of which offer programming for free to consumers that we currently purchase for a fee, (iii) pay-per-view products, such as iTunes and Amazon Instant, and (iv) additional offerings from mobile providers which continue to integrate and bundle video services and mobile products. Historically, we have generally viewed SVOD online video services as complementary to our own video offering, and we have developed a cloud-based guide that is capable of incorporating video from online video services currently offered in the marketplace. As the proliferation of online video services grows, however, services from V-MVPDs and new direct to consumer offerings, as well as piracy and password sharing, negatively impact the number of customers purchasing our video product.
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Internet Competition
Our residential Internet service faces competition from fiber-to-the-home ("FTTH"), fiber-to-the-node ("FTTN"), DSL and wireless broadband offerings, as well as from a variety of companies that offer other forms of online services, including fixed wireless and satellite-based broadband services. AT&T, Frontier FiOS and Verizon’s Fios are our primary FTTH competitors. Given the FTTH deployments of our competitors, launches of broadband services offering 1 gigabit per second (“Gbps”) speed have recently grown. Several competitors, including AT&T, Frontier FiOS, Verizon's Fios, WideOpenWest Finance, LLC ("WOW") and Google Fiber, deliver 1 Gbps broadband speed in at least a portion of their footprints which overlap our footprint. DSL service is often offered at prices lower than our Internet services, although typically at speeds much lower than the minimum speeds we offer as part of SPP. Various mobile phone companies offer wireless Internet services delivered over networks which they continue to enhance to deliver faster speeds. AT&T, Verizon, Sprint Corporation ("Sprint") and T-Mobile US, Inc. ("T-Mobile") all began deploying fifth generation (5G) mobile services in 2019, although generally in limited geographies, with plans to expand 5G more broadly in 2020. In April 2018, Sprint and T-Mobile announced their intent to merge. If the transaction closes, the resulting company would be one of the nation’s largest mobile carriers bringing increased competition with a stated intent of pursuing broad 5G network deployment and offering fixed wireless broadband service. Some mobile phone companies offer unlimited data packages to customers. In addition, a growing number of commercial areas, such as retail malls, restaurants and airports, offer WiFi Internet service. Numerous local governments are also considering or actively pursuing publicly subsidized WiFi Internet access networks. These options offer alternatives to cable-based Internet access.
Voice Competition
Our residential voice service competes with wireless and wireline phone providers, as well as other forms of communication, such as text messaging on cellular phones, instant messaging, social networking services, video conferencing and email. We also compete with “over-the-top” phone providers, such as Vonage, Skype, magicJack, Google Voice and Ooma, Inc., as well as companies that sell phone cards at a cost per minute for both national and international service. The increase in the number of different technologies capable of carrying voice services and the number of alternative communication options available to customers as well as the replacement of wireline services by wireless have intensified the competitive environment in which we operate our residential voice service. Our mobile service competes with other mobile providers such as Verizon, AT&T, T-Mobile and Sprint, as well as various regional wireless service providers. We also compete for retail activations with other resellers that buy bulk wholesale service from wireless service providers for resale.
Regional Competitors
In some of our operating areas, other competitors have built networks that offer video, Internet and voice services that compete with our services. For example, in certain service areas, our residential video, Internet and voice services compete with Google Fiber, Cincinnati Bell Inc., Hawaiian Telcom (owned by Cincinnati Bell Inc.), RCN Telecom Services, LLC, Grande Communications Networks, LLC and WOW.
Additional Competition
In addition to multi-channel video providers, cable systems compete with other sources of news, information and entertainment, including over-the-air television broadcast reception, live events, movie theaters and the Internet. Competition is also posed by fixed wireless and satellite master antenna television systems, or SMATV systems, serving MDUs, such as condominiums, apartment complexes, and private residential communities.
Business Services
We face intense competition across each of our business services product offerings. Our small and medium business video, Internet, networking and voice services face competition from a variety of providers as described above. Our enterprise solutions also face competition from the competitors described above as well as application-service providers and other telecommunications carriers, such as metro and regional fiber-based carriers.
Advertising
We face intense competition for advertising revenue across many different platforms and from a wide range of local and national competitors. Advertising competition has increased and will likely continue to increase as new advertising avenues seek to attract the same advertisers. We compete for advertising revenue against, among others, local broadcast stations, national cable and broadcast networks, radio stations, print media and online advertising companies and content providers.
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Seasonality and Cyclicality
Our business is subject to seasonal and cyclical variations. Our results are impacted by the seasonal nature of customers receiving our cable services in college and vacation service areas. Our revenue is subject to cyclical advertising patterns and changes in viewership levels. Our advertising revenue is generally higher in the second and fourth calendar quarters of each year, due in part to increases in consumer advertising in the spring and in the period leading up to and including the holiday season. U.S. advertising revenue is also cyclical, benefiting in even-numbered years from advertising related to candidates running for political office and issue-oriented advertising. Our capital expenditures and trade working capital are also subject to significant seasonality based on the timing of subscriber growth, network programs, specific projects and construction.
Regulation and Legislation
The following summary addresses the key regulatory and legislative developments affecting the cable industry and our services for both residential and commercial customers. Cable system operations are extensively regulated by the federal government (primarily the FCC), certain state governments and many local governments. A failure to comply with these regulations could subject us to substantial penalties. Our business can be dramatically impacted by changes to the existing regulatory framework, whether triggered by legislative, administrative, or judicial rulings. Congress and the FCC have frequently revisited the subject of communications regulation and they are likely to do so again in the future. We could be materially disadvantaged in the future if we are subject to new laws, regulations or regulatory actions that do not equally impact our key competitors. We cannot provide assurance that the already extensive regulation of our business will not be expanded in the future. In addition, we are already subject to Charter-specific conditions regarding certain business practices as a result of the FCC’s approval of the merger in 2016 with Time Warner Cable Inc. ("TWC") and acquisition of Bright House Networks, LLC ("Bright House").
Video Service
Must Carry/Retransmission Consent
There are two alternative legal methods for carriage of local broadcast television stations on cable systems. Federal “must carry” regulations require cable systems to carry local broadcast television stations upon the request of the local broadcaster. Alternatively, federal law includes “retransmission consent” regulations, by which popular commercial television stations can prohibit cable carriage unless the cable operator first negotiates for “retransmission consent,” which may be conditioned on significant payments or other concessions. Popular stations invoking “retransmission consent” have been demanding substantial compensation increases in their recent negotiations with cable operators, thereby significantly increasing our operating costs.
Pole Attachments
The Communications Act of 1934, as amended (the "Communications Act") requires most utilities owning utility poles to provide cable systems with access to poles and conduits and also subjects the rates charged for this access to either federal or state regulation. The federally regulated rates now applicable to pole attachments used for cable, Internet, and telecommunications services are substantially similar. The FCC's approach does not directly affect the rate in states that self-regulate, but many of those states have substantially the same rate for all communications attachments.
Some municipalities have enacted “one-touch” make-ready pole attachment ordinances, which permit third parties to alter components of our network attached to utility poles in ways that could adversely affect our businesses. Some of these ordinances have been challenged with differing results. In 2018, the FCC adopted “one-touch” make-ready (“OTMR”) rules that will apply in states where pole attachments are FCC regulated, and they may impact many of our existing pole attachments. Various utilities have sought review of the OTMR rules in federal court.
Cable Rate Regulation
Pursuant to federal law, a cable system's video offerings are universally exempt from rate regulation, except for a cable system’s minimum level of video programming service, referred to as “basic service,” and associated equipment. FCC regulations require a local franchise authority interested in regulating rates for basic service and associated equipment to first make an affirmative showing that there is no “effective competition” (as defined under federal law) in the community. Given the competitive nature of our markets, the FCC recently rescinded certifications for the relatively few communities where we had been subject to rate regulation. It is possible that the competitive situation could change, and that some local franchising authorities may be certified to regulate rates in the future, and existing and potential laws and regulations may affect our marketing practices (including our disclosure and itemization of subscriber fees).
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Other FCC Regulatory Matters
The Communications Act and FCC regulations cover a variety of additional areas, including, among other things: (1) licensing of systems and facilities; (2) equal employment opportunity obligations; (3) customer service standards; (4) technical service standards; (5) mandatory blackouts of certain network and syndicated programming; (6) restrictions on political advertising; (7) restrictions on advertising in children’s programming; (8) ownership restrictions; (9) maintenance of public files; (10) emergency alert systems; (11) inside wiring and exclusive contracts for MDU complexes; (12) disability access, including requirements governing video-description and closed-captioning; (13) competitive availability of cable equipment; (14) the provision of up to 15% of video channel capacity for commercial leased access by unaffiliated third parties; and (15) public, education and government entity access requirements. Each of these regulations restricts our business practices to varying degrees and may impose additional costs on our operations. Further, the FCC regulates spectrum usage and other communications enterprises in ways that could impact our operations. For example, the FCC is currently considering proposals to reallocate certain spectrum for new wireless communications purposes, which could be disruptive to the satellite platform we rely upon to provide our video services. The FCC is also preparing to make additional spectrum available for commercial services, which we might use to deliver services in the future. Our ability to access and use such spectrum is uncertain and may be limited by further FCC auction or allocation decisions.
It is possible that Congress or the FCC will expand or modify its regulation of cable systems in the future, and we cannot predict at this time how that might impact our business.
Copyright
Cable systems are subject to a federal compulsory copyright license covering carriage of television and radio broadcast signals. The copyright law provides copyright owners the right to audit our payments under the compulsory license, and the Copyright Office is currently considering modifications to the license’s royalty calculations and reporting obligations. The possible modification or elimination of this license is the subject of continuing legislative proposals and administrative review and could adversely affect our ability to obtain desired broadcast programming.
Franchise Matters
Our cable systems generally are operated pursuant to nonexclusive franchises, permits, and similar authorizations granted by a municipality or other state or local government entity in order to utilize and cross public rights-of-way.
Cable franchises generally are granted for fixed terms and in many cases include monetary penalties for noncompliance and may be terminable if the franchisee fails to comply with material provisions. The specific terms and conditions of cable franchises vary significantly between jurisdictions. They generally contain provisions governing cable operations, franchise fees, system construction, maintenance, technical performance, customer service standards, supporting and carrying public access channels, and changes in the ownership of the franchisee. Although local franchising authorities have considerable discretion in establishing franchise terms, certain federal protections benefit cable operators. For example, federal law imposes a 5% cap on franchise fees. In August 2019, the FCC clarified that in-kind contribution requirements set forth in cable franchises are subject to the statutory cap on franchise fees, and it reaffirmed that state and local authorities are barred from imposing duplicative franchise and/or fee requirements on franchised cable systems providing non-cable services. An appeal of the FCC’s order is pending in federal court.
A number of states have adopted franchising laws that provide for statewide franchising. Generally, state-wide cable franchises are issued for a fixed term, but streamline many of the traditional local cable franchise requirements and eliminate local negotiation.
The Communications Act provides for an orderly franchise renewal process in which granting authorities may not unreasonably deny renewals. If we fail to obtain renewals of franchises representing a significant number of our customers, it could have a material adverse effect on our consolidated financial condition, results of operations, or our liquidity. Similarly, if a franchising authority’s consent is required for the purchase or sale of a cable system, the franchising authority may attempt to impose more burdensome requirements as a condition for providing its consent.
Internet Service
The FCC originally classified broadband Internet access services, such as those we offer, as an “information service,” which exempted the service from traditional communications common carrier laws and regulations. In 2015, the FCC reclassified broadband Internet access services as “telecommunications service” and, on that basis, imposed a number of “net neutrality” rules governing the provision of broadband service. In 2017, the FCC reversed its 2015 decision. The Commission's 2017 Order restored the “information service” classification and eliminated the 2015 rules, other than a transparency requirement, which
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created an obligation to disclose performance statistics and other service information to consumers. The 2017 FCC decision also ruled that state regulators may not impose obligations similar to federal network neutrality obligations that the FCC eliminated.
In 2019, the U.S. Court of Appeals for the District of Columbia upheld the FCC’s information service reclassification, but vacated the FCC’s blanket prohibition of state utility regulation of broadband services. The court left open the possibility that individual state laws could be deemed preempted on a case by case basis if it is shown that they conflict with federal law. We understand that this decision may be subject to further judicial review. Several states (including California) have already adopted state obligations, and additional states may consider the imposition of new regulations on our Internet services, such as rules similar to the network neutrality requirements that were eliminated by the FCC. California’s legislation has been challenged in court, and we cannot predict how the challenge to California’s legislation or challenges to any future state legislation will be resolved. As recent history has shown, it is possible that the FCC might further revise its approach to broadband Internet access, or that Congress might enact legislation affecting the rules applicable to the service. The application of new legal requirements to our Internet services could adversely affect our business.
In recent years, the FCC has demonstrated an interest in accelerating advancements in, and deployment of, wired and wireless broadband infrastructure, including advanced 5G wireless service. For example, the FCC and some state regulatory commissions direct certain subsidies to telephone and other companies deploying broadband to areas deemed to be “unserved” or “underserved.” We have opposed such subsidies when directed to areas that we serve. However, continued regulatory efforts to accelerate competitive wireline and wireless broadband deployment, including reforms that create regulatory imbalances, could adversely affect our business.
Aside from the FCC’s generally applicable regulations, we have made certain commitments to comply with the FCC’s order in connection with the FCC’s approval of the merger with TWC and acquisition of Bright House (discussed below).
Wireline Voice Service
The FCC has never classified the VoIP telephone services we offer as “telecommunications services” that are subject to traditional federal common carrier regulation, but instead has imposed some of these requirements on a case-by-case basis, such as requirements relating to 911 emergency services (“E911”), Communications Assistance for Law Enforcement Act ("CALEA") (the statute governing law enforcement access to and surveillance of communications), Universal Service Fund contributions, customer privacy and Customer Proprietary Network Information protections, number portability, network outage reporting, rural call completion, disability access, regulatory fees, back-up power obligations, and discontinuance of service. It is possible that the FCC or Congress will impose additional requirements on our VoIP telephone services in the future.
Although we believe that VoIP telephone services should be governed only by federal regulation, some states have attempted to subject cable VoIP services to state level regulation, and at least one state has asserted jurisdiction over our VoIP services. We prevailed on a legal challenge to that state’s assertion of jurisdiction, which was affirmed by a federal appellate court, but that ruling is limited to the seven states in that circuit. Although we have registered with, or obtained certificates or authorizations from the FCC and the state regulatory authorities in those states in which we offer competitive voice services in order to ensure the continuity of our services, it is unclear whether and how these and other ongoing regulatory matters ultimately will be resolved. State regulatory commissions and legislatures in other jurisdictions may continue to consider imposing regulatory requirements on our fixed telephone services.
Mobile Service
Our Spectrum Mobile service offers mobile Internet access and telephone service. We provide this service as an MVNO using Verizon’s network and our network of Spectrum Wi-Fi hotspots. As an MVNO, we are subject to many of the same FCC regulations that apply to facilities-based wireless carriers, as well as certain state or local regulations, including (but not limited to): E911, local number portability, customer privacy, CALEA, universal service fund contribution, and hearing aid compatibility and safety and emission requirements for mobile devices. Spectrum Mobile’s broadband Internet access service is also subject to the FCC’s transparency rule. The FCC or other regulatory authorities may adopt new or different regulations for MVNOs and/or mobile service providers in the future, or impose new taxes or fees applicable to Spectrum Mobile, which could adversely affect the service offering or our business generally.
Privacy and Information Security Regulation
The Communications Act limits our ability to collect, use, and disclose customers’ personally identifiable information for our video, voice, and Internet services. We are subject to additional federal, state, and local laws and regulations that impose additional restrictions on the collection, use and disclosure of consumer information. All broadband providers are also obliged by CALEA
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to configure their networks in a manner that facilitates the ability of state and federal law enforcement, with proper legal process authorized under the Electronic Communications Privacy Act, to obtain records and information concerning our customers, including the content of their communications. Further, the FCC, Federal Trade Commission (“FTC”), and many states regulate and restrict the marketing practices of communications service providers, including telemarketing and sending unsolicited commercial emails. The FTC currently has the authority, pursuant to its general authority to enforce against unfair or deceptive acts and practices, to protect the privacy of Internet service customers, including our use and disclosure of certain customer information.
Our operations are also subject to federal and state laws governing information security. In the event of an information security breach, such rules may require consumer and government agency notification and may result in regulatory enforcement actions with the potential of monetary forfeitures. The FCC, the FTC and state attorneys general regularly bring enforcement actions against companies related to information security breaches and privacy violations.
Various security standards provide guidance to telecommunications companies in order to help identify and mitigate cybersecurity risks. One such standard is the voluntary framework released by the National Institute for Standards and Technologies (“NIST”) in 2014 and updated in 2018, in cooperation with other federal agencies and owners and operators of U.S. critical infrastructure. The NIST cybersecurity framework provides a prioritized and flexible model for organizations to identify and manage cyber risks inherent to their business. It was designed to supplement, not supersede, existing cybersecurity regulations and requirements. Several government agencies have encouraged compliance with the NIST cybersecurity framework, including the FCC, which is also considering expansion of its cybersecurity guidelines or the adoption of cybersecurity requirements.
Many states and local authorities have considered legislative or other actions that would impose restrictions on our ability to collect, use and disclose, and safeguard certain consumer information, particularly with regard to our broadband Internet business. For example, the California Consumer Privacy Act and Maine’s Act to Protect Privacy of Online Customer Information are both scheduled go into effect in 2020. The California law will, under certain circumstances, regulate companies’ use and disclosure of the personal information of California residents and authorizes enforcement actions by the California Attorney General and private class actions for data breaches. The Maine law regulates how Internet service providers use and disclose customers’ personal information and requires Internet service providers to take reasonable measures to protect customers’ personal information. We expect state and local efforts to regulate consumer privacy to continue in 2020. Additionally, several state legislatures are considering the adoption of new data security and cybersecurity legislation that could result in additional network and information security requirements for our business. We expect such state activity to increase as a result of the recent U.S. Court of Appeals decision that, while affirming the FCC’s reclassification of Internet access as an “information service,” vacated the FCC’s blanket prohibition of state regulation of broadband service and instead left open the possibility that individual state laws could be deemed preempted on a case by case basis if it is shown that they conflict with federal law. There are also bills pending in both the U.S. House of Representatives and Senate that could impose new privacy and data security obligations. We cannot predict whether any of these efforts will be successful or preempted, or how new legislation and regulations, if any, would affect our business.
Commitments Related to the 2016 Merger with TWC and Acquisition of Bright House
In connection with approval of the 2016 merger with TWC and acquisition of Bright House (the "Transactions"), federal and state regulators imposed a number of post-transaction conditions on us including but not limited to the following.
FCC Conditions
• | Offer settlement-free Internet interconnection to any party that meets the requirements of our Interconnection Policy (available on Charter’s website) on terms generally consistent with the policy for seven years (with a possible reduction to five years from FCC approval in 2016); |
• | Deploy and offer high-speed broadband Internet access service to an additional two million locations over five years; |
• | Refrain from charging usage-based prices or imposing data caps on any fixed mass market broadband Internet access service plans for seven years (with a possible reduction to five); |
• | Offer 30/4 Mbps discounted broadband where technically feasible to eligible customers throughout our service area for four years from the offer’s commencement; and |
• | Continue to provide CableCARDs to any new or existing customer upon request for use in third-party retail devices for four years and continue to support such CableCARDs for seven years (in each case, unless the FCC changes the relevant rules). |
The FCC conditions also contain a number of compliance reporting requirements.
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DOJ Conditions
The Department of Justice (“DOJ”) Order prohibits us from entering into or enforcing any agreement with a video programmer that forbids, limits or creates incentives to limit the video programmer’s provision of content to online video distributors ("OVDs"). We will not be able to avail ourself of other distributors’ most favored nation (“MFN”) provisions if they are inconsistent with this prohibition. The DOJ’s conditions are effective for seven years after entry of the final judgment in 2016, although we may petition the DOJ to eliminate the conditions after five years.
State Conditions
Certain state regulators, including California, New York, Hawaii and New Jersey also imposed conditions in connection with the approval of the Transactions. These conditions include requirements related to:
• | Building out our network to certain households and business locations that are not currently served by cable within the designated states; |
• | Offering LifeLine service discounts and low-income broadband to eligible households served within the applicable states; |
• | Investing in service improvement programs and customer service enhancements and maintaining customer-facing jobs within the designated state; and |
• | Complying with reporting requirements. |
Employees
As of December 31, 2019, we had approximately 95,100 active full-time equivalent employees.
Item 1A. Risk Factors.
Risks Related to Our Business
We operate in a very competitive business environment, which affects our ability to attract and retain customers and can adversely affect our business, operations and financial results.
The industry in which we operate is highly competitive and has become more so in recent years. In some instances, we compete against companies with fewer regulatory burdens, access to better financing, greater personnel resources, greater resources for marketing, greater and more favorable brand name recognition, and long-established relationships with regulatory authorities and customers. Increasing consolidation in the telecommunications and content industries have provided additional benefits to certain of our competitors, either through access to financing, resources, or efficiencies of scale including the ability to launch new video services.
Our video service faces competition from a number of sources, including DBS services, as well as other companies that deliver linear network programming, movies and television shows on demand and other video content over broadband Internet connections to televisions, computers, tablets and mobile devices often with password sharing among multiple users and security that makes content susceptible to piracy. Newer products and services, particularly alternative methods for the distribution, sale and viewing of content will likely continue to be developed, further increasing the number of competitors that we face.
The increasing number of choices available to audiences, including low-cost or free choices, could negatively impact not only consumer demand for our products and services, but also advertisers’ willingness to purchase advertising from us. We compete for the sale of advertising revenue with television networks and stations, as well as other advertising platforms, such as radio, print and, increasingly, online media.
Our Internet service faces competition from the phone companies’ FTTH, FTTN, DSL and wireless broadband offerings as well as from a variety of companies that offer other forms of online services, including fixed wireless and satellite-based broadband services. Various mobile phone companies offer wireless Internet services delivered over networks which they continue to enhance to deliver faster speeds and some began deploying 5G mobile services in 2019 with plans to expand 5G more broadly in the 2020. Our voice and mobile services compete with wireless and wireline phone providers, as well as other forms of communication, such as text messaging on cellular phones, instant messaging, social networking services, video conferencing and email. Competition from these companies, including intensive marketing efforts with aggressive pricing, exclusive programming and increased HD broadcasting may have an adverse impact on our ability to attract and retain customers.
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Wireline and wireless overbuilds could also adversely affect our growth, financial condition, and results of operations, by creating or increasing competition. We are aware of traditional overbuild situations impacting certain of our service areas, however, we are unable to predict the extent to which additional overbuild situations may occur.
Our services may not allow us to compete effectively. Our failure to effectively anticipate or adapt to new technologies and changes in consumer expectations and behavior could significantly adversely affect our competitive position with respect to the leisure time and discretionary spending of our customers and, as a result, affect our business and results of operations. Competition may also reduce our expected growth of future cash flows which may contribute to future impairments of our franchises and goodwill and our ability to meet cash flow requirements, including debt service requirements. For additional information regarding the competition we face, see “Item 1. Business -Competition” and “-Regulation and Legislation.”
We face risks inherent in our commercial business.
We may encounter unforeseen difficulties as we increase the scale of our service offerings to businesses. We sell Internet access, data networking and fiber connectivity to office buildings and cellular towers, and video and business voice services to businesses. In order to grow our commercial business, we expect to continue to invest in technology, equipment and personnel focused on the commercial business. Commercial business customers often require service level agreements and generally have heightened customer expectations for reliability of services. If our efforts to build the infrastructure to scale the commercial business are not successful, the growth of our commercial services business would be limited. We depend on interconnection and related services provided by certain third parties for the growth of our commercial business. As a result, our ability to implement changes as the services grow may be limited. If we are unable to meet these service level requirements or expectations, our commercial business could be adversely affected. Competition continues to increase as well, as more companies deploy more fiber to more buildings, which may negatively impact our growth and/or put pressure on margins. Finally, we expect advances in communications technology, as well as changes in the marketplace and the regulatory and legislative environment. Consequently, we are unable to predict the effect that ongoing or future developments in these areas might have on our commercial businesses and operations.
Programming costs per video customer are rising at a much faster rate than wages or inflation, and we may not have the ability to reduce or moderate the growth rates of, or pass on to our customers, our increasing programming costs, which would adversely affect our cash flow and operating margins.
Video programming has been, and is expected to continue to be, our largest operating expense item. In recent years, the cable industry has experienced a rapid escalation in programming rates. Media corporation consolidation has resulted in fewer suppliers and additional selling power on the part of programming suppliers. We expect programming rates will continue to increase due to a variety of factors, including annual increases imposed by programmers with additional selling power as a result of media consolidation, increased demands by owners of broadcast stations for payment for retransmission consent or linking carriage of other services to retransmission consent, and additional programming, particularly new services. The inability to fully pass programming cost increases on to our customers has had, and is expected in the future to have, an adverse impact on our cash flow and operating margins associated with the video product. The contracts set to expire in any particular year vary. There can be no assurance that these agreements will be renewed on favorable or comparable terms. In addition, a number of programmers have begun to sell their services through alternative distribution channels, including IP-based platforms, which are less secure than our own video distribution platforms. There is growing evidence that these less secure video distribution platforms are leading to video product theft via password sharing among consumers. Password sharing may drive down the number of customers who pay for certain programming, putting programmer revenues at risk, and which in turn may cause certain programmers to seek even higher programming fees from us. The ability for consumers to receive the same content for free through such unauthorized channels has devalued our video product which could impact sales, customer retention and our ability to pass through programming costs to consumers, which increases the risk of non-renewal when programmers seek increases. To the extent that we are unable to reach agreement with certain programmers on terms that we believe are reasonable, we have been, and may be in the future, forced to remove such programming channels from our line-up, which may result in a loss of customers. Our failure to carry programming that is attractive to our customers could adversely impact our customer levels, operations and financial results. In addition, if our Internet customers are unable to access desirable content online because content providers block or limit access by our customers as a class, our ability to gain and retain customers, especially Internet customers, may be negatively impacted.
Increased demands by owners of some broadcast stations for carriage of other services or payments to those broadcasters for retransmission consent are likely to further increase our programming costs. Federal law allows commercial television broadcast stations to make an election between “must-carry” rights and an alternative “retransmission-consent” regime. When a station opts for the retransmission consent regime, we are not allowed to carry the station’s signal without that station’s permission. In some cases, we carry stations under short-term arrangements while we attempt to negotiate new long-term retransmission agreements. If negotiations with these programmers prove unsuccessful, they could require us to cease carrying their signals, possibly for an indefinite period. Any loss of stations could make our video service less attractive to customers, which could result in less
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subscription and advertising revenue. In retransmission-consent negotiations, broadcasters often condition consent with respect to one station on carriage of one or more other stations or programming services in which they or their affiliates have an interest. Carriage of these other services, as well as increased fees for retransmission rights, may increase our programming expenses and diminish the amount of capacity we have available to introduce new services, which could have an adverse effect on our business and financial results.
Our inability to respond to technological developments and meet customer demand for new products and services could adversely affect our ability to compete effectively.
We operate in a highly competitive, consumer-driven and rapidly changing environment. From time to time, we may pursue strategic initiatives, including, for example, our wireless strategy which includes the launch of our mobile product through an MVNO and testing the deployment of unlicensed and licensed spectrum for fixed and mobile wireless services. Our success is, to a large extent, dependent on our ability to acquire, develop, adopt, upgrade and exploit new and existing technologies to address consumers’ changing demands and distinguish our services from those of our competitors. We may not be able to accurately predict technological trends or the success of new products and services. If we choose technologies or equipment that are less effective, cost-efficient or attractive to customers than those chosen by our competitors, if we offer services that fail to appeal to consumers, are not available at competitive prices or that do not function as expected, or we are not able to fund the expenditures necessary to keep pace with technological developments, our competitive position could deteriorate, and our business and financial results could suffer.
The ability of some of our competitors to introduce new technologies, products and services more quickly than we do may adversely affect our competitive position. Furthermore, advances in technology, decreases in the cost of existing technologies or changes in competitors’ product and service offerings may require us in the future to make additional research and development expenditures or to offer, at no additional charge or at a lower price, certain products and services that we currently offer to customers separately or at a premium. In addition, the uncertainty of our ability, and the costs, to obtain intellectual property rights from third parties could impact our ability to respond to technological advances in a timely and effective manner.
Our inability to maintain and expand our upgraded systems and provide advanced services such as a state of the art user interface in a timely manner, or to anticipate the demands of the marketplace, could materially adversely affect our ability to attract and retain customers. In addition, as we launch our new mobile services using virtual network operator rights from a third party, we expect an initial funding period to grow a new product as well as negative working capital impacts from the timing of device-related cash flows when we provide the handset or tablet pursuant to equipment installation plans. Consequently, our growth, financial condition and results of operations could suffer materially.
We depend on third-party service providers, suppliers and licensors; thus, if we are unable to procure the necessary services, equipment, software or licenses on reasonable terms and on a timely basis, our ability to offer services could be impaired, and our growth, operations, business, financial results and financial condition could be materially adversely affected.
We depend on a limited number of third-party service providers, suppliers and licensors to supply some of the services, hardware, software and operational support necessary to provide some of our services. Some of our hardware, software and operational support vendors, and service providers represent our sole source of supply or have, either through contract or as a result of intellectual property rights, a position of some exclusivity. If any of these parties breaches or terminates its agreement with us or otherwise fails to perform its obligations in a timely manner, demand exceeds these vendors’ capacity, tariffs are imposed that impact vendors' ability to perform their obligations or significantly increase the amount we pay, they experience operating or financial difficulties, they significantly increase the amount we pay for necessary products or services, or they cease production of any necessary product due to lack of demand, profitability or a change in ownership or are otherwise unable to provide the equipment or services we need in a timely manner, at our specifications and at reasonable prices, our ability to provide some services might be materially adversely affected, or the need to procure or develop alternative sources of the affected materials or services might delay our ability to serve our customers. In addition, the existence of only a limited number of vendors of key technologies can lead to less product innovation and higher costs. These events could materially and adversely affect our ability to retain and attract customers and our operations, business, financial results and financial condition.
Our business may be adversely affected if we cannot continue to license or enforce the intellectual property rights on which our business depends.
We rely on patent, copyright, trademark and trade secret laws and licenses and other agreements with our employees, customers, suppliers and other parties to establish and maintain our intellectual property rights in technology and the products and services used in our operations. Also, because of the rapid pace of technological change, we both develop our own technologies, products and services and rely on technologies developed or licensed by third parties. However, any of our intellectual property rights, or
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the rights of our suppliers, could be challenged or invalidated, or such intellectual property rights may not be sufficient to permit us to take advantage of current industry trends or otherwise to provide competitive advantages, which could result in costly redesign efforts, discontinuance of certain product or service offerings or other competitive harm. We may not be able to obtain or continue to obtain licenses from these third parties on reasonable terms, if at all. In addition, claims of intellectual property infringement could require us to enter into royalty or licensing agreements on unfavorable terms, incur substantial monetary liability or be enjoined preliminarily or permanently from further use of the intellectual property in question, which could require us to change our business practices or offerings and limit our ability to compete effectively. Even unsuccessful claims can be time-consuming and costly to defend and may divert management’s attention and resources away from our business. Infringement claims continue to be brought frequently in the communications and entertainment industries, and we are also often a party to such litigation alleging that certain of our services or technologies infringe the intellectual property rights of others.
Various events could disrupt or result in unauthorized access to our networks, information systems or properties and could impair our operating activities and negatively impact our reputation and financial results.
Network and information systems technologies are critical to our operating activities, both for our internal uses, such as network management and supplying services to our customers, including customer service operations and programming delivery. Network or information system shutdowns or other service disruptions caused by events such as computer hacking, phishing, dissemination of computer viruses, worms and other destructive or disruptive software, “cyber attacks,” process breakdowns, denial of service attacks and other malicious activity pose increasing risks. Both unsuccessful and successful “cyber attacks” on companies have continued to increase in frequency, scope and potential harm in recent years. While we develop and maintain systems seeking to prevent systems-related events and security breaches from occurring, the development and maintenance of these systems is costly and requires ongoing monitoring and updating as techniques used in such attacks become more sophisticated and change frequently. We, and the third parties on which we rely, may be unable to anticipate these techniques or implement adequate preventive measures. While from time to time attempts have been made to access our network, these attempts have not as yet resulted in any material release of information, degradation or disruption to our network and information systems.
Our network and information systems are also vulnerable to damage or interruption from power outages, telecommunications failures, accidents, natural disasters (including extreme weather arising from short-term or any long-term changes in weather patterns), terrorist attacks and similar events. Our system redundancy may be ineffective or inadequate, and our disaster recovery planning may not be sufficient for all eventualities.
Any of these events, if directed at, or experienced by, us or technologies upon which we depend, could have adverse consequences on our network, our customers and our business, including degradation of service, service disruption, excessive call volume to call centers, and damage to our or our customers’ equipment and data. Large expenditures may be necessary to repair or replace damaged property, networks or information systems or to protect them from similar events in the future. Moreover, the amount and scope of insurance that we maintain against losses resulting from any such events or security breaches may not be sufficient to cover our losses or otherwise adequately compensate us for any disruptions to our business that may result. Any such significant service disruption could result in damage to our reputation and credibility, customer dissatisfaction and ultimately a loss of customers or revenue. Any significant loss of customers or revenue, or significant increase in costs of serving those customers, could adversely affect our growth, financial condition and results of operations.
Furthermore, our operating activities could be subject to risks caused by misappropriation, misuse, leakage, falsification or accidental release or loss of information maintained in our information technology systems and networks and those of our third-party vendors, including customer, personnel and vendor data. We provide certain confidential, proprietary and personal information to third parties in connection with our business, and there is a risk that this information may be compromised.
We process, store, and transmit large amounts of data, including the personal information of our customers. Ongoing increases in the potential for mis-use of personal information, the public’s awareness of the importance of safeguarding personal information, and the volume of legislation that has been adopted or is being considered regarding the protection, privacy, and security of personal information have resulted in increases to our information-related risks. We could be exposed to significant costs if such risks were to materialize, and such events could damage our reputation, credibility and business and have a negative impact on our revenue. We could be subject to regulatory actions and claims made by consumers in private litigations involving privacy issues related to consumer data collection and use practices. We also could be required to expend significant capital and other resources to remedy any such security breach.
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Our exposure to the economic conditions of our current and potential customers, vendors and third parties could adversely affect our cash flow, results of operations and financial condition.
We are exposed to risks associated with the economic conditions of our current and potential customers, the potential financial instability of our customers and their financial ability to purchase our products. If there were a general economic downturn, we may experience increased cancellations or non-payment by our customers or unfavorable changes in the mix of products purchased. This may include an increase in the number of homes that replace their video service with Internet-delivered and/or over-air content, as well as an increase in the number of Internet and voice customers substituting mobile data and voice products for wireline services, which would negatively impact our ability to attract customers, increase rates and maintain or increase revenue. In addition, our ability to gain new customers is dependent to some extent on growth in occupied housing in our service areas, which is influenced by both national and local economic conditions. Weak economic conditions may also have a negative impact on our advertising revenue. These events have adversely affected us in the past, and may adversely affect our cash flow, results of operations and financial condition if a downturn were to occur.
In addition, we are susceptible to risks associated with the potential financial instability of the vendors and third parties on which we rely to provide products and services or to which we outsource certain functions. The same economic conditions that may affect our customers, as well as volatility and disruption in the capital and credit markets, also could adversely affect vendors and third parties and lead to significant increases in prices, reduction in output or the bankruptcy of our vendors or third parties upon which we rely. Any interruption in the services provided by our vendors or by third parties could adversely affect our cash flow, results of operation and financial condition.
For tax purposes, Charter could experience a deemed ownership change in the future that could limit its ability to use its tax loss carryforwards.
Charter had approximately $7.5 billion of federal tax net operating loss carryforwards resulting in a gross deferred tax asset of approximately $1.6 billion as of December 31, 2019. These losses resulted from the operations of Charter Communications Holding Company, LLC ("Charter Holdco") and its subsidiaries and from loss carryforwards received as a result of the merger with TWC. Federal tax net operating loss carryforwards expire in the years 2020 through 2035. In addition, Charter had state tax net operating loss carryforwards resulting in a gross deferred tax asset (net of federal tax benefit) of approximately $257 million as of December 31, 2019. State tax net operating loss carryforwards generally expire in the years 2020 through 2039.
In the past, Charter has experienced ownership changes as defined in Section 382 of the Internal Revenue Code of 1986, as amended (the “Code”). In general, an ownership change occurs whenever the percentage of the stock of a corporation owned, directly or indirectly, by 5-percent stockholders (within the meaning of Section 382 of the Code) increases by more than 50 percentage points over the lowest percentage of the stock of such corporation owned, directly or indirectly, by such 5-percent stockholders at any time over the preceding three years. As a result, Charter is subject to an annual limitation on the use of its loss carryforwards which existed at November 30, 2009 for the first ownership change, those that existed at May 1, 2013 for the second ownership change, and those created at May 18, 2016 for the third ownership change. The limitation on Charter's ability to use its loss carryforwards, in conjunction with the loss carryforward expiration provisions, could reduce Charter's ability to use a portion of its loss carryforwards to offset future taxable income, which could result in Charter being required to make material cash tax payments. Charter's ability to make such income tax payments, if any, will depend at such time on its liquidity or its ability to raise additional capital, and/or on receipt of payments or distributions from Charter Holdco and its subsidiaries.
If Charter were to experience additional ownership changes in the future (as a result of purchases and sales of stock by its 5-percent stockholders, new issuances or redemptions of our stock, certain acquisitions of its stock and issuances, redemptions, sales or other dispositions or acquisitions of interests in its 5-percent stockholders), Charter's ability to use its loss carryforwards could become subject to further limitations.
If we are unable to retain key employees, our ability to manage our business could be adversely affected.
Our operational results have depended, and our future results will depend, upon the retention and continued performance of our management team. Our ability to retain and hire new key employees for management positions could be impacted adversely by the competitive environment for management talent in the broadband communications industry. The loss of the services of key members of management and the inability or delay in hiring new key employees could adversely affect our ability to manage our business and our future operational and financial results.
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Risks Related to Our Indebtedness
We have a significant amount of debt and expect to incur significant additional debt, including secured debt, in the future, which could adversely affect our financial health and our ability to react to changes in our business.
We have a significant amount of debt and expect to (subject to applicable restrictions in our debt instruments) incur additional debt in the future as we maintain our stated objective of 4.0 to 4.5 times Adjusted EBITDA leverage (our net debt divided by our last twelve months Adjusted EBITDA). As of December 31, 2019, our total principal amount of debt was approximately $78.4 billion with a leverage ratio of 4.5 times Adjusted EBITDA.
Our significant amount of debt could have consequences, such as:
• | impact our ability to raise additional capital at reasonable rates, or at all; |
• | make us vulnerable to interest rate increases, in part because approximately 14% of our borrowings as of December 31, 2019 were, and may continue to be, subject to variable rates of interest; |
• | expose us to increased interest expense to the extent we refinance existing debt with higher cost debt; |
• | require us to dedicate a significant portion of our cash flow from operating activities to make payments on our debt, reducing our funds available for working capital, capital expenditures, and other general corporate expenses; |
• | limit our flexibility in planning for, or reacting to, changes in our business, the cable and telecommunications industries, and the economy at large; |
• | place us at a disadvantage compared to our competitors that have proportionately less debt; and |
• | adversely affect our relationship with customers and suppliers. |
To the extent our current debt amounts increase more than expected, our business results are lower than expected, or credit rating agencies downgrade our debt limiting our access to investment grade markets, the related risks that we now face will intensify. In addition, our variable rate indebtedness may use London Interbank Offering Rate (“LIBOR”) as a benchmark for establishing the rate. The United Kingdom’s Financial Conduct Authority, which regulates LIBOR, has announced that it intends to stop encouraging or compelling banks to submit rates for the calculation of LIBOR rates after 2021 (the “FCA Announcement”). The FCA Announcement indicates that the continuation of LIBOR on the current basis is not guaranteed after 2021 and, based on the foregoing, it appears likely that LIBOR will be discontinued or modified by 2021. The effects of the FCA Announcement cannot be entirely predicted, but could include an increase in the cost of our variable rate indebtedness.
The agreements and instruments governing our debt contain restrictions and limitations that could significantly affect our ability to operate our business, as well as significantly affect our liquidity.
Our credit facilities and the indentures governing our debt contain a number of significant covenants that could adversely affect our ability to operate our business, our liquidity, and our results of operations. These covenants restrict, among other things, our and our subsidiaries’ ability to:
• | incur additional debt; |
• | repurchase or redeem equity interests and debt; |
• | issue equity; |
• | make certain investments or acquisitions; |
• | pay dividends or make other distributions; |
• | dispose of assets or merge; |
• | enter into related party transactions; and |
• | grant liens and pledge assets. |
Additionally, the Charter Communications Operating, LLC ("Charter Operating") credit facilities require Charter Operating to comply with a maximum total leverage covenant and a maximum first lien leverage covenant. The breach of any covenants or obligations in our indentures or credit facilities, not otherwise waived or amended, could result in a default under the applicable debt obligations and could trigger acceleration of those obligations, which in turn could trigger cross defaults under other agreements governing our long-term indebtedness. In addition, the secured lenders under our notes and the Charter Operating credit facilities could foreclose on their collateral, which includes equity interests in our subsidiaries, and exercise other rights of secured creditors.
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Risks Related to Ownership Position of Liberty Broadband Corporation and Advance/Newhouse Partnership
Liberty Broadband and Advance/Newhouse Partnership (“A/N”) have governance rights that give them influence over corporate transactions and other matters.
Liberty Broadband currently owns a significant amount of Charter Class A common stock and is entitled to certain governance rights with respect to Charter. A/N currently owns Charter Class A common stock and a significant amount of membership interests in our subsidiary Charter Communications Holdings, LLC (“Charter Holdings”), that are convertible into Charter Class A common stock and is entitled to certain governance rights with respect to Charter. Members of the Charter board of directors include a director who is also an officer and director of Liberty Broadband and directors who are current or former officers and directors of A/N. Mr. Greg Maffei is the President and Chief Executive Officer of Liberty Broadband. Steven Miron is the Chief Executive Officer of A/N and Michael Newhouse is an officer or director of several of A/N’s affiliates. As of December 31, 2019, Liberty Broadband beneficially held approximately 25% of Charter’s voting stock (including shares owned by GCI Liberty, Inc. ("GCI Liberty," formerly known as Liberty Interactive Corporation) over which Liberty Broadband holds an irrevocable voting proxy) and A/N beneficially held approximately 13% of Charter’s voting stock. Pursuant to the stockholders agreement between Liberty Broadband, A/N and Charter, Liberty Broadband currently has the right to designate up to three directors as nominees for Charter’s board of directors and A/N currently has the right to designate up to two directors as nominees for Charter’s board of directors. Each of A/N and Liberty Broadband is entitled to nominate at least one director to each of the committees of Charter's board of directors, subject to applicable stock exchange listing rules and certain specified voting or equity ownership thresholds for each of A/N and Liberty Broadband, and provided that the Nominating and Corporate Governance Committee and the Compensation and Benefit Committee each have at least a majority of directors independent from A/N, Liberty Broadband and Charter (referred to as the “unaffiliated directors”).
In connection with the merger with TWC, Liberty Broadband and GCI Liberty entered into a proxy and right of first refusal agreement, pursuant to which GCI Liberty granted Liberty Broadband an irrevocable proxy to vote all Charter Class A common stock owned beneficially or of record by GCI Liberty, with certain exceptions. In addition, at the closing of the acquisition of Bright House, A/N and Liberty Broadband entered into a proxy agreement pursuant to which A/N granted to Liberty Broadband a 5-year irrevocable proxy (which we refer to as the “A/N proxy”) to vote, subject to certain exceptions, that number of shares of Charter Class A common stock and Charter Class B common stock, in each case held by A/N (such shares are referred to as the “proxy shares”), that will result in Liberty Broadband having voting power in Charter equal to 25.01% of the outstanding voting power of Charter, provided, that the voting power of the proxy shares is capped at 7.0% of the outstanding voting power of Charter. In December of 2019, Liberty Broadband’s voting power in Charter exceeded 25.01% and, therefore, as of December 31, 2019, the A/N proxy had no impact on Liberty Broadband’s voting power. The stockholders agreement and Charter’s amended and restated certificate of incorporation fixes the size of the board at 13 directors. Liberty Broadband and A/N are required to vote (subject to the applicable voting cap) their respective shares of Charter Class A common stock and Charter Class B common stock for the director nominees nominated by the nominating and corporate governance committee of the board of directors, including the respective designees of Liberty Broadband and A/N, and against any other nominees, except that, with respect to the unaffiliated directors, Liberty Broadband and A/N must instead vote in the same proportion as the voting securities are voted by stockholders other than A/N and Liberty Broadband or any group which includes any of them are voted, if doing so would cause a different outcome with respect to the unaffiliated directors. In addition, because Liberty Broadband’s voting power exceeds its voting cap of 25.01%, Liberty Broadband must vote and exercise rights to consent with respect to voting securities held in excess of the voting cap in the same proportion as all other votes cast by stockholders other than A/N and Liberty Broadband with respect to the applicable matter. As a result of their rights under the stockholders agreement and their significant equity and voting stakes in Charter, Liberty Broadband and/or A/N, who may have interests different from those of other stockholders, will be able to exercise substantial influence over certain matters relating to the governance of Charter, including the approval of significant corporate actions, such as mergers and other business combination transactions.
The stockholders agreement provides A/N and Liberty Broadband with preemptive rights with respect to issuances of Charter equity in connection with certain transactions, and in the event that A/N or Liberty Broadband exercises these rights, holders of Charter Class A common stock may experience further dilution.
The stockholders agreement provides that A/N and Liberty Broadband will have certain contractual preemptive rights over issuances of Charter equity securities in connection with capital raising transactions, merger and acquisition transactions, and in certain other circumstances. Holders of Charter Class A common stock will not be entitled to similar preemptive rights with respect to such transactions. As a result, if Liberty Broadband and/or A/N elect to exercise their preemptive rights, (i) these parties would not experience the dilution experienced by the other holders of Charter Class A common stock, and (ii) such other holders of Charter Class A common stock may experience further dilution of their interest in Charter upon such exercise.
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Risks Related to Regulatory and Legislative Matters
Our business is subject to extensive governmental legislation and regulation, which could adversely affect our business.
Regulation of the cable industry has increased cable operators’ operational and administrative expenses and limited their revenues. Cable operators are subject to numerous laws and regulations including those covering the following:
• | the provision of high-speed Internet service, including net neutrality and transparency rules; |
• | the provision of voice communications; |
• | cable franchise renewals and transfers; |
• | the provisioning and marketing of cable equipment; |
• | customer and employee privacy and data security; |
• | copyright royalties for retransmitting broadcast signals; |
• | when a cable system must carry a particular broadcast station and when it must first obtain retransmission consent to carry a broadcast station; |
• | the provision of video channel capacity to unaffiliated commercial leased access programmers; |
• | limitations on our ability to enter into exclusive agreements with multiple dwelling unit complexes and control our inside wiring; |
• | equal employment opportunity; |
• | emergency alert systems, disability access, pole attachments, and technical standards; |
• | marketing practices, customer service, and consumer protection; and |
• | approval for mergers and acquisitions often accompanied by the imposition of restrictions and requirements on an applicant’s business in order to secure approval of the proposed transaction. |
Legislators and regulators at all levels of government frequently consider changing, and sometimes do change, existing statutes, rules, regulations, or interpretations thereof, or prescribe new ones. Any future legislative, judicial, regulatory or administrative actions may increase our costs or impose additional restrictions on our businesses.
As a result of the closing of the 2016 merger with TWC and acquisition of Bright House, our businesses are subject to the conditions set forth in the FCC Order and the DOJ Consent Decree and those imposed by state utility commissions and local franchise authorities, and there can be no assurance that these conditions will not have an adverse effect on our businesses and results of operations.
In connection with the Transactions, the FCC Order, the DOJ Consent Decree, and the approvals from state utility commissions and local franchise authorities incorporated numerous commitments and voluntary conditions made by the parties and imposed numerous conditions on our businesses relating to the operation of our business and other matters. Under federal approvals, among other things, (i) we are not permitted to charge usage-based prices or impose data caps and are prohibited from charging interconnection fees for qualifying parties; (ii) we are prohibited from entering into or enforcing any agreement with a programmer that forbids, limits or creates incentives to limit the programmer’s provision of content to OVD and cannot retaliate against programmers for licensing to OVDs; (iii) we are not able to avail ourself of other distributors’ MFN provisions if they are inconsistent with this prohibition; (iv) we appointed an independent compliance monitor and comply with a broad array of reporting requirements; and (v) we must satisfy various other conditions relating to our Internet services, including building out an additional two million locations with access to a high-speed connection of at least 60 megabits per second, and implementing a reduced price high-speed Internet program for low income families. These and other conditions and commitments relating to the transactions are of varying duration, ranging from three to seven years. In light of the breadth and duration of the conditions and potential changes in market conditions during the time the conditions and commitments are in effect, there can be no assurance that our compliance, and ability to comply, with the conditions will not have a material adverse effect on our business or results of operations.
Changes to existing statutes, rules, regulations, or interpretations thereof, or adoption of new ones, could have an adverse effect on our business.
There are ongoing efforts to amend or expand the federal, state, and local regulation of some of the services offered over our cable systems, which may compound the regulatory risks we already face. For example, with respect to our retail broadband Internet access service, the FCC has reclassified the service twice in the last few years, with the first change adding federal regulatory obligations and the second change largely removing those new regulatory obligations. These changes reflect a lack of regulatory certainty in this business area, which may continue as a result of litigation, as well as future legislative or administrative changes.
Other potential legislative and regulatory changes could adversely impact our business by increasing our costs and competition and limiting our ability to offer services in a manner that that would maximize our revenue potential. These changes could include,
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for example, the adoption of new privacy restrictions on our collection, use and disclosure of certain customer information, new data security and cybersecurity mandates that could result in additional network and information security requirements for our business, new restraints on our discretion over programming decisions, including commercial leased access programming, new restrictions on the rates we charge for video programming and the marketing and packaging of that video programming and other services to consumers, changes to the cable industry’s compulsory copyright license to carry broadcast signals, new requirements to assure the availability of navigation devices (such as set-top boxes) from third-party providers, new Universal Service Fund obligations on our provision of Internet service that would add to the cost of that service; increases in government-administered broadband subsidies to rural areas that could result in subsidized overbuilding of our more rural facilities, changes to the FCC's administration of spectrum, and changes in the regulatory framework for VoIP phone service, including the scope of regulatory obligations associated with our VoIP service and our ability to interconnect our VoIP service with incumbent providers of traditional telecommunications service.
If any of these such laws or regulations are enacted, they could affect our operations and require significant expenditures. We cannot predict future developments in these areas, and we are already subject to Charter-specific conditions regarding certain Internet practices as a result of the FCC’s approval in 2016 of the merger with TWC and acquisition of Bright House, but any changes to the regulatory framework for our video, Internet or VoIP services could have a negative impact on our business and results of operations.
It remains uncertain what rule changes, if any, will ultimately be adopted by Congress and the FCC and what operating or financial impact any such rules might have on us, including on our programming agreements, customer privacy and the user experience. In addition, the FCC, the FTC, and various state agencies and attorney generals actively investigate industry practices and could impose substantial forfeitures for alleged regulatory violations.
Our cable system franchises are subject to non-renewal or termination and are non-exclusive. The failure to renew a franchise or the grant of additional franchises in one or more service areas could adversely affect our business.
Our cable systems generally operate pursuant to franchises, permits, and similar authorizations issued by a state or local governmental authority controlling the public rights-of-way. Many franchises establish comprehensive facilities and service requirements, as well as specific customer service standards and monetary penalties for non-compliance. In many cases, franchises are terminable if the franchisee fails to comply with significant provisions set forth in the franchise agreement governing system operations. Franchises are generally granted for fixed terms and must be periodically renewed. Franchising authorities may resist granting a renewal if either past performance or the prospective operating proposal is considered inadequate. Franchise authorities often demand concessions or other commitments as a condition to renewal. In some instances, local franchises have not been renewed at expiration, and we have operated and are operating under either temporary operating agreements or without a franchise while negotiating renewal terms with the local franchising authorities.
We cannot assure you that we will be able to comply with all significant provisions of our franchise agreements and certain of our franchisers have from time to time alleged that we have not complied with these agreements. Additionally, although historically we have renewed our franchises without incurring significant costs, we cannot assure you that we will be able to renew, or to renew as favorably, our franchises in the future. A termination of or a sustained failure to renew a franchise in one or more service areas could adversely affect our business in the affected geographic area.
Our cable system franchises are non-exclusive. Consequently, local and state franchising authorities can grant additional franchises to competitors in the same geographic area or operate their own cable systems. In some cases, local government entities and municipal utilities may legally compete with us on more favorable terms.
Tax legislation and administrative initiatives or challenges to our tax and fee positions could adversely affect our results of operations and financial condition.
We operate cable systems in locations throughout the United States and, as a result, we are subject to the tax laws and regulations of federal, state and local governments. From time to time, various legislative and/or administrative initiatives may be proposed that could adversely affect our tax positions. There can be no assurance that our effective tax rate or tax payments will not be adversely affected by these initiatives. Certain states and localities have imposed or are considering imposing new or additional taxes or fees on our services or changing the methodologies or base on which certain fees and taxes are computed. Potential changes include additional taxes or fees on our services which could impact our customers, changes to income tax sourcing rules and other changes to general business taxes, central/unit-level assessment of property taxes and other matters that could increase our income, franchise, sales, use and/or property tax liabilities. For example, some local franchising authorities are seeking to impose franchise fee assessments on our broadband Internet access service (in addition to our video service), and more may do so in the future. If they do so, and challenges to such assessments are unsuccessful, it could adversely impact our costs. Although the FCC recently
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issued a decision precluding the imposition of such duplicative fees, that favorable decision is currently subject to judicial review. In addition, federal, state and local tax laws and regulations are extremely complex and subject to varying interpretations. There can be no assurance that our tax positions will not be challenged by relevant tax authorities or that we would be successful in any such challenge.
Item 1B. Unresolved Staff Comments.
None.
Item 2. Properties.
Our principal physical assets consist of cable distribution plant and equipment, including signal receiving, encoding and decoding devices, headend reception facilities, distribution systems, and customer premise equipment for each of our cable systems.
Our cable plant and related equipment are generally attached to utility poles under pole rental agreements with local public utilities and telephone companies, and in certain locations are buried in underground ducts or trenches. We own or lease real property for signal reception sites, and own our service vehicles.
We generally lease space for business offices. Our headend and tower locations are located on owned or leased parcels of land, and we generally own the towers on which our equipment is located.
The physical components of our cable systems require maintenance as well as periodic upgrades to support the new services and products we introduce. See “Item 1. Business – Our Network Technology and Customer Premise Equipment.” We believe that our properties are generally in good operating condition and are suitable for our business operations.
Item 3. Legal Proceedings.
The legal proceedings information set forth in Note 21 to the accompanying consolidated financial statements contained in “Part II. Item 8. Financial Statements and Supplementary Data” in this Annual Report on Form 10-K is incorporated herein by reference.
Item 4. Mine Safety Disclosures.
Not applicable.
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PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Charter’s Class A common stock is listed on the NASDAQ Global Select Market under the symbol “CHTR.” As of December 31, 2019, there were approximately 12,300 holders of record of Charter’s Class A common stock and one holder of Charter's Class B common stock. Charter has not paid cash dividends on its common stock and does not intend to do so in the foreseeable future. During 2019, there were no unregistered sales of securities of the registrant.
Securities Authorized for Issuance Under Equity Compensation Plans
The following information is provided as of December 31, 2019 with respect to equity compensation plans:
Plan Category | Number of Securities to be Issued Upon Exercise of Outstanding Options, Warrants and Rights | Weighted Average Exercise Price of Outstanding Warrants and Rights | Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans | |||||||||
Equity compensation plans approved by security holders | 12,608,020 | (1) | $ | 242.50 | 15,882,887 | (1) | ||||||
Equity compensation plans not approved by security holders | — | $ | — | — | ||||||||
TOTAL | 12,608,020 | (1) | 15,882,887 | (1) | ||||||||
(1) | This total does not include 8,284 shares issued pursuant to restricted stock grants made under our 2019 Stock Incentive Plan, which are subject to vesting based on continued service. |
For information regarding securities issued under our equity compensation plans, see Note 16 to our accompanying consolidated financial statements contained in “Part II. Item 8. Financial Statements and Supplementary Data.”
Performance Graph
The performance graph required by Item 5 will be included in Charter’s 2019 Proxy Statement (the “Proxy Statement”) under the headings “Compensation Discussion and Analysis,” or in amendment to this Annual Report on Form 10-K and is incorporated herein by reference.
Purchases of Equity Securities by the Issuer
The following table presents Charter’s purchases of equity securities completed during the fourth quarter of 2019 (dollars in millions, except per share data).
Period | Total Number of Shares Purchased (1) | Average Price Paid per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (2) | Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs (2) | |||
October 1 - 31, 2019 | 1,186,853 | $ | 428.17 | 1,157,618 | $803 | ||
November 1 - 30, 2019 | 1,586,050 | $ | 472.21 | 1,538,480 | $2,254 | ||
December 1 - 31, 2019 | 2,270,062 | $ | 471.62 | 2,243,602 | $1,361 | ||
(1) | Includes 29,235, 47,570 and 26,460 shares withheld from employees for the payment of taxes and exercise costs upon the exercise of stock options or vesting of other equity awards for the months of October, November and December 2019, respectively. |
(2) | During the three months ended December 31, 2019, Charter purchased approximately 4.9 million shares of its Class A common stock for approximately $2.3 billion. Charter Holdings purchased 0.7 million Charter Holdings common units from A/N at an average price per unit of $442.38, or $292 million during the three months ended December 31, 2019. As of December 31, 2019, Charter had remaining board authority to purchase an additional $1.4 billion of Charter’s Class A common stock and/ |
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or Charter Holdings common units. In addition to open market purchases including pursuant to Rule 10b5-1 plans adopted from time to time, Charter may also buy shares of Charter Class A common stock, from time to time, pursuant to private transactions outside of its Rule 10b5-1 plan and any such repurchases may also trigger the repurchases from A/N pursuant to and to the extent provided in the Letter Agreement. See "Part II. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources."
Item 6. Selected Financial Data.
The following table presents selected consolidated financial data for the periods indicated (dollars in millions, except per share data):
Years Ended December 31, | |||||||||||||||||||
2019 | 2018 | 2017 | 2016 | 2015 | |||||||||||||||
Statement of Operations Data: | |||||||||||||||||||
Revenues | $ | 45,764 | $ | 43,634 | $ | 41,581 | $ | 29,003 | $ | 9,754 | |||||||||
Income from operations | $ | 6,511 | $ | 5,221 | $ | 4,106 | $ | 2,456 | $ | 1,114 | |||||||||
Interest expense, net | $ | 3,797 | $ | 3,540 | $ | 3,090 | $ | 2,499 | $ | 1,306 | |||||||||
Income (loss) before income taxes | $ | 2,431 | $ | 1,686 | $ | 1,028 | $ | 820 | $ | (331 | ) | ||||||||
Net income (loss) attributable to Charter shareholders | $ | 1,668 | $ | 1,230 | $ | 9,895 | $ | 3,522 | $ | (271 | ) | ||||||||
Income (loss) per common share, basic | $ | 7.60 | $ | 5.29 | $ | 38.55 | $ | 17.05 | $ | (2.68 | ) | ||||||||
Income (loss) per common share, diluted | $ | 7.45 | $ | 5.22 | $ | 34.09 | $ | 15.94 | $ | (2.68 | ) | ||||||||
Weighted average shares outstanding, basic (a) | 219,506,735 | 232,356,665 | 256,720,715 | 206,539,100 | 101,152,647 | ||||||||||||||
Weighted average shares outstanding, diluted (a) | 223,786,380 | 235,525,226 | 296,703,956 | 234,791,439 | 101,152,647 | ||||||||||||||
Balance Sheet Data (end of period): | |||||||||||||||||||
Investment in cable properties | $ | 138,920 | $ | 141,564 | $ | 142,712 | $ | 144,396 | $ | 16,375 | |||||||||
Total assets | $ | 148,188 | $ | 146,130 | $ | 146,623 | $ | 149,067 | $ | 39,316 | |||||||||
Total debt | $ | 79,078 | $ | 72,827 | $ | 70,231 | $ | 61,747 | $ | 35,723 | |||||||||
Total shareholders’ equity (deficit) | $ | 38,811 | $ | 44,272 | $ | 47,531 | $ | 50,366 | $ | (46 | ) | ||||||||
(a) | Weighted average number of shares outstanding for the year ended December 31, 2015 have been recast to reflect the application of the Parent Merger Exchange Ratio (as defined in the Merger Agreement related to the merger with TWC and acquisition of Bright House in 2016). |
Comparability of the above information from year to year is affected by acquisitions and dispositions completed by us, including the merger with TWC and acquisition of Bright House in 2016.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Reference is made to “Part I. Item 1A. Risk Factors” and “Cautionary Statement Regarding Forward-Looking Statements,” which describe important factors that could cause actual results to differ from expectations and non-historical information contained herein. In addition, the following discussion should be read in conjunction with the audited consolidated financial statements and accompanying notes thereto of Charter included in “Part II. Item 8. Financial Statements and Supplementary Data.”
Overview
We are the second largest cable operator in the United States and a leading broadband communications services company providing video, Internet and voice services to approximately 29.2 million residential and small and medium business customers at December 31, 2019. We also offer mobile service to residential customers and recently launched mobile service to small and medium business customers. In addition, we sell video and online advertising inventory to local, regional and national advertising customers and tailored communications and managed solutions to larger enterprise customers. We also own and operate regional sports networks and local sports, news and community channels. See “Part I. Item 1. Business — Products and Services” for further description of these services, including customer statistics for different services.
In 2019, with the integration of TWC and Bright House substantially behind us, we are realizing the benefits of operating as one company, with a unified product, marketing and service infrastructure. We remain focused on driving customer relationship growth
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by deploying superior products and services packaged with attractive pricing. We expect our insourced, high quality workforce will continue to drive an improved customer experience which will result in lower customer churn, longer customer lifetimes and, combined with our continued ramping of our self-installation program, improved productivity with fewer customer calls and truck rolls per customer relationship. With approximately 85% of our residential customer base now in SPP packages, we expect additional benefits from lower legacy package migration activity, combined with SPP customers rolling off introductory pricing and price increases. Further, we expect to continue to drive customer relationship growth through sales of bundled services and improving customer retention despite the expectation for continued losses of video and wireline voice customers. With the completion of our all-digital conversion, roll-out of DOCSIS 3.1 technology across our footprint, and the integration of TWC and Bright House substantially complete, we have experienced a meaningful reduction in cable capital expenditures as a percent of revenue in 2019 and expect continued lower cable capital intensity in 2020.
We launched our mobile product, Spectrum Mobile, in the second half of 2018 under our MVNO reseller agreement with Verizon. Our Spectrum Mobile service is offered to customers subscribing to our Internet service and runs on Verizon's mobile network combined with Spectrum WiFi. In the second quarter of 2019, we expanded our Spectrum Mobile bring-your-own-device program across all sales channels to include a broader set of devices which we believe lowers the cost for consumers of switching mobile carriers, and reduces the short-term working capital impact of selling new mobile devices on installment plans. We expect these developments, along with the launch of 5G service offerings in 2020, to contribute to the growth of our mobile business. We also continue to explore ways to drive even more mobile traffic to our network. We plan to use our WiFi network in conjunction with additional unlicensed, and potentially licensed, spectrum to improve network performance and expand capacity to offer consumers a superior mobile service at a lower total cost to us. Further, we have experimental wireless licenses from the FCC that we are utilizing to test next generation mobile services in several service areas around the country.
We believe Spectrum-branded mobile services will drive higher sales of our core products, create longer customer lives and increase profitability and cash flow over time. As a result of growth costs associated with our new mobile product line, we cannot be certain that we will be able to grow revenues or maintain our margins at recent historical rates. During the years ended December 31, 2019 and 2018, our mobile product line increased revenues by $726 million and $106 million, respectively, reduced Adjusted EBITDA by approximately $520 million and $240 million, respectively, and reduced free cash flow by approximately $1.2 billion and $594 million, respectively. As we continue to grow our mobile service and scale the business, we expect continued negative impacts to Adjusted EBITDA, as well as negative working capital impacts from the timing of device-related cash flows when we sell the handset or tablet to customers pursuant to equipment installment plans.
The Company realized revenue, Adjusted EBITDA and income from operations during the periods presented as follows (in millions; all percentages are calculated using whole numbers. Minor differences may exist due to rounding).
Years ended December 31, | ||||||||||
2019 | 2018 | 2019 vs. 2018 Growth | ||||||||
Revenues | $ | 45,764 | $ | 43,634 | 4.9 | % | ||||
Adjusted EBITDA | $ | 16,855 | $ | 16,059 | 5.0 | % | ||||
Income from operations | $ | 6,511 | $ | 5,221 | 24.7 | % | ||||
Adjusted EBITDA is defined as net income attributable to Charter shareholders plus net income attributable to noncontrolling interest, net interest expense, income taxes, depreciation and amortization, stock compensation expense, loss on extinguishment of debt, (gain) loss on financial instruments, net, other pension (benefits) costs, net, other (income) expense, net and other operating (income) expenses, net, such as merger and restructuring costs, special charges and (gain) loss on sale or retirement of assets. See “—Use of Adjusted EBITDA and Free Cash Flow” for further information on Adjusted EBITDA and free cash flow.
Growth in total revenue was primarily due to growth in our residential Internet, mobile and commercial business customers. Adjusted EBITDA and income from operations growth was impacted by growth in revenue and increases in operating costs and expenses, primarily mobile, programming and regulatory, connectivity and produced content. Income from operations was also affected by a decrease in depreciation and amortization expense.
Approximately 91% of our revenues for each of the years ended December 31, 2019 and 2018 are attributable to monthly subscription fees charged to customers for our video, Internet, voice, mobile and commercial services. Generally, these customer subscriptions may be discontinued by the customer at any time subject to a fee for certain commercial customers. The remaining 9% of revenue is derived primarily from advertising revenues, franchise and other regulatory fee revenues (which are collected
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by us but then paid to local authorities), VOD and pay-per-view programming, installation, processing fees or reconnection fees charged to customers to commence or reinstate service, revenue from regional sports and news channels and commissions related to the sale of merchandise by home shopping services.
Critical Accounting Policies and Estimates
Certain of our accounting policies require our management to make difficult, subjective and/or complex judgments. Management has discussed these policies with the Audit Committee of Charter’s board of directors, and the Audit Committee has reviewed the following disclosure. We consider the following policies to be the most critical in understanding the estimates, assumptions and judgments that are involved in preparing our financial statements, and the uncertainties that could affect our results of operations, financial condition and cash flows:
• | Capitalization of labor and overhead costs |
• | Valuation and impairment of franchises and goodwill |
• | Income taxes |
• | Defined benefit pension plans |
Capitalization of labor and overhead costs
Costs associated with network construction or upgrades, placement of the customer drop to the dwelling and the placement of outlets within a dwelling along with the costs associated with the deployment of new customer premise equipment necessary to provide video, Internet or voice services, are capitalized. Costs capitalized include materials, direct labor and certain indirect costs. These indirect costs are associated with the activities of personnel who assist in installation activities, and consist of compensation and overhead costs associated with these support functions. While our capitalization is based on specific activities, once capitalized, we track these costs on a composite basis by fixed asset category at the cable system level, and not on a specific asset basis. For assets that are sold or retired, we remove the estimated applicable cost and accumulated depreciation. The costs of disconnecting service and removing customer premise equipment from a dwelling and the costs to reconnect a customer drop or to redeploy previously installed customer premise equipment are charged to operating expense as incurred. Costs for repairs and maintenance are charged to operating expense as incurred, while plant and equipment replacement, including replacement of certain components, betterments, and replacement of cable drops and outlets, are capitalized.
We make judgments regarding the installation and construction activities to be capitalized. We capitalized direct labor and overhead of $1.6 billion and $1.8 billion, respectively, for the years ended December 31, 2019 and 2018. We capitalize direct labor and overhead using standards developed from actual costs and applicable operational data. We calculate standards annually (or more frequently if circumstances dictate) for items such as the labor rates, overhead rates, and the actual amount of time required to perform a capitalizable activity. For example, the standard amounts of time required to perform capitalizable activities are based on studies of the time required to perform such activities. Overhead rates are established based on an analysis of the nature of costs incurred in support of capitalizable activities, and a determination of the portion of costs that is directly attributable to capitalizable activities. The impact of changes that resulted from these studies were not material in the periods presented.
Labor costs directly associated with capital projects are capitalized. Capitalizable activities performed in connection with installations include such activities as:
• | dispatching a “truck roll” to the customer’s dwelling or business for service connection or placement of new equipment; |
• | verification of serviceability to the customer’s dwelling or business (i.e., determining whether the customer’s dwelling is capable of receiving service by our cable network); |
• | customer premise activities performed by in-house field technicians and third-party contractors in connection with the installation, replacement and betterment of equipment and materials to enable video, Internet or voice services; and |
• | verifying the integrity of the customer’s network connection by initiating test signals downstream from the headend to the customer premise equipment, as well as testing signal levels at the utility pole or pedestal. |
Judgment is required to determine the extent to which overhead costs incurred result from specific capital activities, and therefore should be capitalized. The primary costs that are included in the determination of the overhead rate are (i) employee benefits and payroll taxes associated with capitalized direct labor, (ii) direct variable costs associated with capitalizable activities, (iii) the cost of support personnel, such as care personnel and dispatchers, who assist with capitalizable installation activities, and (iv) indirect costs directly attributable to capitalizable activities.
While we believe our existing capitalization policies are appropriate, a significant change in the nature or extent of our operating practices could affect management’s judgment about the extent to which we should capitalize direct labor or overhead in the future.
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We monitor the appropriateness of our capitalization policies, and perform updates to our internal studies on an ongoing basis to determine whether facts or circumstances warrant a change to our capitalization policies.
Valuation and impairment of franchises
The net carrying value of franchises as of both December 31, 2019 and 2018 was approximately $67.3 billion (representing 45% and 46% of total assets, respectively). For more information and a complete discussion of how we value and test franchise assets for impairment, see Note 5 to the accompanying consolidated financial statements contained in “Part II. Item 8. Financial Statements and Supplementary Data.”
We perform an impairment assessment of franchise assets annually or more frequently as warranted by events or changes in circumstances. We performed a qualitative assessment in 2019. Our assessment included consideration of a fair value appraisal performed for tax purposes in the beginning of 2019 as of a December 31, 2018 valuation date (the "Appraisal") along with a multitude of factors that affect the fair value of our franchise assets. Examples of such factors include environmental and competitive changes within our operating footprint, actual and projected operating performance, the consistency of our operating margins, equity and debt market trends, including changes in our market capitalization, and changes in our regulatory and political landscape, among other factors. Based on our assessment, we concluded that it was more likely than not that the estimated fair values of our franchise assets equals or exceeds their carrying values and that a quantitative impairment test is not required.
Valuation and impairment of goodwill
The net carrying value of goodwill as of both December 31, 2019 and 2018 was approximately $29.6 billion (representing 20% of total assets). We have determined that we have one reporting unit for purposes of the assessment of goodwill impairment. For more information and a complete discussion on how we test goodwill for impairment, see Note 5 to the accompanying consolidated financial statements contained in “Part II. Item 8. Financial Statements and Supplementary Data.” We perform our impairment assessment of goodwill annually as of November 30. As with our franchise impairment testing, we elected to perform a qualitative assessment of goodwill in 2019 which included the Appraisal and other factors described above. Based on the Appraisal, we determined that the fair value of the reporting unit significantly exceeded the net asset carrying value of the reporting unit. Given the completion of the assessment and absence of significant adverse changes in factors impacting our fair value estimates, we concluded that it is more likely than not that our goodwill is not impaired.
Income taxes
As of December 31, 2019, Charter had approximately $7.5 billion of federal tax net operating loss carryforwards resulting in a gross deferred tax asset of approximately $1.6 billion. These losses resulted from the operations of Charter Holdco and its subsidiaries and from loss carryforwards received as a result of the merger with TWC in 2016. Federal tax net operating loss carryforwards expire in the years 2020 through 2035. In addition, as of December 31, 2019, Charter had state tax net operating loss carryforwards, resulting in a gross deferred tax asset (net of federal tax benefit) of approximately $257 million. State tax net operating loss carryforwards generally expire in the years 2020 through 2039. Such tax loss carryforwards can accumulate and be used to offset Charter’s future taxable income. After December 31, 2019, $905 million of Charter's federal tax loss carryforwards are subject to Section 382 and other restrictions. Pursuant to these restrictions, Charter estimates that approximately $226 million annually over each of the next four years of federal tax loss carryforwards, should become unrestricted and available for Charter’s use. Charter’s state tax loss carryforwards are subject to similar but varying restrictions.
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. In evaluating the need for a valuation allowance, management takes into account various factors, including the expected level of future taxable income, available tax planning strategies and reversals of existing taxable temporary differences. Approximately $9 million of valuation allowance associated with federal capital loss carryforwards and approximately $37 million of valuation allowance associated with state tax loss carryforwards and other miscellaneous deferred tax assets remains on the December 31, 2019 consolidated balance sheet.
In determining our tax provision for financial reporting purposes, we establish a reserve for uncertain tax positions unless such positions are determined to be “more likely than not” of being sustained upon examination, based on their technical merits. In evaluating whether a tax position has met the more-likely-than-not recognition threshold, we presume the position will be examined by the appropriate taxing authority that has full knowledge of all relevant information. A tax position that meets the more-likely-than-not recognition threshold is measured to determine the amount of benefit to be recognized in our financial statements. The tax position is measured as the largest amount of benefit that has a greater than 50% likelihood of being realized when the position is ultimately resolved. There is considerable judgment involved in determining whether positions taken on the tax return are “more
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likely than not” of being sustained. We adjust our uncertain tax reserve estimates periodically because of ongoing examinations by, and settlements with, the various taxing authorities, as well as changes in tax laws, regulations and interpretations.
No tax years for Charter are currently under examination by the IRS for income tax purposes. Charter's 2016 through 2019 tax years remain open for examination and assessment. Charter’s short period return dated May 17, 2016 (prior to the merger with TWC and acquisition of Bright House) remain subject to examination and assessment. Years prior to 2016 remain open solely for purposes of examination of Charter’s loss and credit carryforwards. The IRS is currently examining Charter Holdings' income tax return for 2016. Charter Holdings’ 2017 through 2019 tax years remain open for examination and assessment. The IRS is currently examining TWC’s income tax returns for 2011 through 2014. TWC’s tax year 2015 remains subject to examination and assessment. Prior to TWC’s separation from Time Warner Inc. (“Time Warner”) in March 2009, TWC was included in the consolidated U.S. federal and certain state income tax returns of Time Warner. The IRS has examined Time Warner’s 2008 through 2010 income tax returns and the results are under appeal. We do not anticipate that these examinations will have a material impact on our consolidated financial position or results of operations. In addition, we are also subject to ongoing examinations of our tax returns by state and local tax authorities for various periods. Activity related to these state and local examinations did not have a material impact on our consolidated financial position or results of operations during the year ended December 31, 2019, nor do we anticipate a material impact in the future.
Defined benefit pension plans
We sponsor three qualified defined benefit pension plans and one nonqualified defined benefit pension plan that provide pension benefits to a majority of employees who were employed by TWC before the merger with TWC. As of December 31, 2019, the accumulated benefit obligation and fair value of plan assets was $3.4 billion and $3.2 billion, respectively, and the net underfunded liability was recorded as a $1 million noncurrent asset, $4 million current liability and $160 million long-term liability. As of December 31, 2018, the accumulated benefit obligation and fair value of plan assets was $3.0 billion and $2.9 billion, respectively, and the net underfunded liability was recorded as a $1 million noncurrent asset, $4 million current liability and $95 million long-term liability.
Pension benefits are based on formulas that reflect the employees’ years of service and compensation during their employment period. Actuarial gains or losses are changes in the amount of either the benefit obligation or the fair value of plan assets resulting from experience different from that assumed or from changes in assumptions. We have elected to follow a mark-to-market pension accounting policy for recording the actuarial gains or losses annually during the fourth quarter, or earlier if a remeasurement event occurs during an interim period. We use a December 31 measurement date for our pension plans.
We recognized net periodic pension costs of $69 million and net periodic pension benefits of $192 million in 2019 and 2018, respectively. Net periodic pension benefit or expense is determined using certain assumptions, including the expected long-term rate of return on plan assets, discount rate and mortality assumptions. We determined the discount rate used to compute pension expense based on the yield of a large population of high-quality corporate bonds with cash flows sufficient in timing and amount to settle projected future defined benefit payments. In developing the expected long-term rate of return on assets, we considered the current pension portfolio’s composition, past average rate of earnings, and our asset allocation targets. We used a discount rate of 3.48% to determine the December 31, 2019 pension plan benefit obligation. A decrease in the discount rate of 25 basis points would result in a $157 million increase in our pension plan benefit obligation as of December 31, 2019 and net periodic pension expense recognized in 2019 under our mark-to-market accounting policy. The expected long-term rate of return on plan assets used to determine net periodic pension benefit for the year ended December 31, 2020 is expected to be 5.00%. A decrease in the expected long-term rate of return of 25 basis points to 4.75%, while holding all other assumptions constant, would result in an increase in our 2020 net periodic pension expense of approximately $7 million. See Note 22 to the accompanying consolidated financial statements contained in “Part II. Item 8. Financial Statements and Supplementary Data” for additional discussion on these assumptions.
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Results of Operations
A discussion of changes in our results of operations during the year ended December 31, 2018 compared to the year ended December 31, 2017 has been omitted from this Annual Report on Form 10-K, but may be found in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2018, filed with the SEC on January 31, 2019, which is available free of charge on the SECs website at www.sec.gov and on our investor relations website at ir.charter.com.
The following table sets forth the consolidated statements of operations for the periods presented (dollars in millions, except per share data):
Year Ended December 31, | |||||||
2019 | 2018 | ||||||
Revenues | $ | 45,764 | $ | 43,634 | |||
Costs and Expenses: | |||||||
Operating costs and expenses (exclusive of items shown separately below) | 29,224 | 27,860 | |||||
Depreciation and amortization | 9,926 | 10,318 | |||||
Other operating expenses, net | 103 | 235 | |||||
39,253 | 38,413 | ||||||
Income from operations | 6,511 | 5,221 | |||||
Other Expenses: | |||||||
Interest expense, net | (3,797 | ) | (3,540 | ) | |||
Loss on extinguishment of debt | (25 | ) | — | ||||
Loss on financial instruments, net | (54 | ) | (110 | ) | |||
Other pension benefits (costs), net | (69 | ) | 192 | ||||
Other expense, net | (135 | ) | (77 | ) | |||
(4,080 | ) | (3,535 | ) | ||||
Income before income taxes | 2,431 | 1,686 | |||||
Income tax expense | (439 | ) | (180 | ) | |||
Consolidated net income | 1,992 | 1,506 | |||||
Less: Net income attributable to noncontrolling interests | (324 | ) | (276 | ) | |||
Net income attributable to Charter shareholders | $ | 1,668 | $ | 1,230 | |||
EARNINGS PER COMMON SHARE ATTRIBUTABLE TO CHARTER SHAREHOLDERS: | |||||||
Basic | $ | 7.60 | $ | 5.29 | |||
Diluted | $ | 7.45 | $ | 5.22 | |||
Weighted average common shares outstanding, basic | 219,506,735 | 232,356,665 | |||||
Weighted average common shares outstanding, diluted | 223,786,380 | 235,525,226 | |||||
Revenues. Total revenues grew $2.1 billion or 4.9% during the year ended December 31, 2019 as compared to 2018 primarily due to increases in the number of residential Internet and commercial business customers, price adjustments as well as the launch of our mobile service in the second half of 2018 offset by a decrease in video customers.
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Revenues by service offering were as follows (dollars in millions; all percentages are calculated using whole numbers. Minor differences may exist due to rounding):
Years ended December 31, | ||||||||||
2019 | 2018 | % Growth | ||||||||
Video | $ | 17,607 | $ | 17,348 | 1.5 | % | ||||
Internet | 16,667 | 15,181 | 9.8 | % | ||||||
Voice | 1,920 | 2,114 | (9.1 | )% | ||||||
Residential revenue | 36,194 | 34,643 | 4.5 | % | ||||||
Small and medium business | 3,868 | 3,665 | 5.6 | % | ||||||
Enterprise | 2,556 | 2,528 | 1.1 | % | ||||||
Commercial revenue | 6,424 | 6,193 | 3.7 | % | ||||||
Advertising sales | 1,568 | 1,785 | (12.1 | )% | ||||||
Mobile | 726 | 106 | NM | |||||||
Other | 852 | 907 | (6.2 | )% | ||||||
$ | 45,764 | $ | 43,634 | 4.9 | % | |||||
Video revenues consist primarily of revenues from basic and digital video services provided to our residential customers, as well as franchise fees, equipment service fees and video installation revenue. The increase in video revenues was attributable to the following (dollars in millions):
2019 compared to 2018 | |||
Increase related to rate changes | $ | 758 | |
Decrease in average residential video customers | (412 | ) | |
Decrease in VOD and pay-per-view | (87 | ) | |
$ | 259 | ||
The increase related to rate changes was primarily due to price adjustments including annual increases and promotional roll-off. Residential video customers decreased by 484,000 in 2019 compared to 2018.
The increase in Internet revenues from our residential customers was attributable to the following (dollars in millions):
2019 compared to 2018 | |||
Increase in average residential Internet customers | $ | 790 | |
Increase related to rate changes | 696 | ||
$ | 1,486 | ||
Residential Internet customers grew by 1,283,000 in 2019 compared to 2018. The increase related to rate changes was primarily due to price adjustments including promotional roll-off.
The decrease in voice revenues from our residential customers was attributable to the following (dollars in millions):
2019 compared to 2018 | |||
Decrease in average residential voice customers | $ | (102 | ) |
Decrease related to rate changes | (92 | ) | |
$ | (194 | ) | |
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The decrease related to rate changes was primarily due to value-based pricing. Residential wireline voice customers decreased by 692,000 in 2019 compared to 2018.
The increase in small and medium business commercial revenues was attributable to the following (dollars in millions):
2019 compared to 2018 | |||
Increase in small and medium business customers | $ | 317 | |
Decrease related to rate changes | (114 | ) | |
$ | 203 | ||
Small and medium business PSUs increased by 237,000 in 2019 compared to 2018. The decrease related to rate changes was primarily due to value-based pricing related to SPP, net of promotional roll-off and price adjustments.
Enterprise revenues increased $28 million during the year ended December 31, 2019 as compared to the corresponding period in 2018 primarily due to growth in customers offset by the sale of non-strategic assets. Enterprise PSUs increased by 19,000 in 2019 compared to 2018.
Advertising sales revenues consist primarily of revenues from commercial advertising customers, programmers and other vendors, as well as local cable and advertising on regional sports and news channels. Advertising sales revenues decreased $217 million during the year ended December 31, 2019 as compared to the corresponding period in 2018 primarily due to a decrease in political revenue.
During the year ended December 31, 2019, mobile revenues included approximately $488 million of device revenues and approximately $238 million of service revenues. During the year ended December 31, 2018, mobile revenues included approximately $97 million of device revenues and approximately $9 million of service revenues. As of December 31, 2019, we had 1,082,000 mobile lines compared to 134,000 mobile as of December 31, 2108.
Other revenues consist of revenue from regional sports and news channels (excluding intercompany charges or advertising sales on those channels), home shopping, late payment fees, wire maintenance fees and other miscellaneous revenues. The decrease during the year ended December 31, 2019 as compared to the corresponding period in 2018 was primarily due to a decrease in late payment fees and home shopping revenue offset by the sale of video devices.
Operating costs and expenses. The increase in our operating costs and expenses, exclusive of items shown separately in the consolidated statements of operations, was attributable to the following (dollars in millions):
2019 compared to 2018 | |||
Programming | $ | 166 | |
Regulatory, connectivity and produced content | 156 | ||
Costs to service customers | (50 | ) | |
Marketing | 2 | ||
Mobile | 900 | ||
Other | 190 | ||
$ | 1,364 | ||
Programming costs were approximately $11.3 billion and $11.1 billion, representing 39% and 40% of operating costs and expenses for the years ended December 31, 2019 and 2018, respectively. Programming costs consist primarily of costs paid to programmers for basic, digital, premium, VOD, and pay-per-view programming. The increase in programming costs is primarily a result of contractual rate adjustments, including renewals and increases in amounts paid for retransmission consents partly offset by lower video customers and pay-per-view. We expect programming rates will continue to increase due to a variety of factors, including annual increases imposed by programmers with additional selling power as a result of media consolidation, increased demands by owners of broadcast stations for payment for retransmission consent or linking carriage of other services to retransmission consent, and additional programming, particularly new services. We have been unable to fully pass these increases on to our customers and do not expect to be able to do so in the future without a potential loss of customers.
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Regulatory, connectivity and produced content increased $156 million during the year ended December 31, 2019 compared to the corresponding period in 2018 primarily due to higher costs of video devices sold to customers, regulatory pass-through fees and original programming costs.
Costs to service customers decreased $50 million during the year ended December 31, 2019 compared to the corresponding period in 2018 primarily due to lower maintenance and labor costs driven by fewer customer calls and truck rolls with improved productivity and a higher number of self-installations.
Mobile costs of $1.2 billion and $346 million for the years ended December 31, 2019 and 2018, respectively, were comprised of mobile device costs and mobile service and operating costs.
The increase in other expense was attributable to the following (dollars in millions):
2019 compared to 2018 | |||
Corporate costs | $ | 80 | |
Property tax and insurance | 54 | ||
Stock compensation expense | 30 | ||
Sports and news | 26 | ||
Advertising sales expense | (32 | ) | |
Other | 32 | ||
$ | 190 | ||
Depreciation and amortization. Depreciation and amortization expense decreased by $392 million during the year ended December 31, 2019 compared to the corresponding period in 2018 primarily due to certain assets acquired from TWC and Bright House becoming fully depreciated offset by an increase in depreciation as a result of more recent capital expenditures.
Other operating expenses, net. The decrease in other operating expenses, net was attributable to the following (dollars in millions):
2019 compared to 2018 | |||
Merger and restructuring costs | $ | (87 | ) |
Loss on sale of assets, net | (43 | ) | |
Special charges, net | (2 | ) | |
$ | (132 | ) | |
The decrease in merger and restructuring costs is primarily due to lower employee retention and employee termination costs incurred during 2019 as compared to 2018.
The decrease in loss on sale of assets, net for the year ended December 31, 2019 as compared to the year ended December 31, 2018 is primarily due to a $42 million impairment of non-strategic assets incurred during 2019 compared to a $75 million impairment of non-strategic assets incurred during 2018. For more information, see Note 15 to the accompanying consolidated financial statements contained in “Part II. Item 8. Financial Statements and Supplementary Data.”
Interest expense, net. Net interest expense increased by $257 million in 2019 from 2018 primarily due to an increase in weighted average debt outstanding of approximately $3.0 billion primarily as a result of the issuance of notes in 2019 and 2018 for general corporate purposes including stock buybacks and debt repayments offset by a decrease in weighted average interest rates.
Loss on extinguishment of debt. Loss on extinguishment of debt of $25 million for the year ended December 31, 2019 primarily represents losses recognized as a result of the repurchase of CCO Holdings notes and amendments to Charter Operating's credit facilities. For more information, see Note 9 to the accompanying consolidated financial statements contained in “Part II. Item 8. Financial Statements and Supplementary Data.”
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Loss on financial instruments, net. Gains and losses on financial instruments are recognized due to changes in the fair value of our interest rate and our cross currency derivative instruments, and the foreign currency remeasurement of the fixed-rate British pound sterling denominated notes (the “Sterling Notes”) into U.S. dollars. For more information, see Note 12 to the accompanying consolidated financial statements contained in “Part II. Item 8. Financial Statements and Supplementary Data.”
Other pension benefits (costs), net. Other pension benefits (costs), net increased by $261 million during the year ended December 31, 2019 compared to the corresponding period in 2018 primarily due to a remeasurement loss recorded in 2019 versus a remeasurement gain in 2018. For more information, see Note 22 to the accompanying consolidated financial statements contained in “Part II. Item 8. Financial Statements and Supplementary Data.”
Other expense, net. Other expense, net includes impairments on equity investments of approximately $121 million and $58 million for the years ended December 31, 2019 and 2018, respectively. For more information, see Note 6 to the accompanying consolidated financial statements contained in “Part II. Item 8. Financial Statements and Supplementary Data.”
Income tax expense. We recognized income tax expense of $439 million and $180 million for the years ended December 31, 2019 and 2018, respectively. Income tax expense increased during the year ended December 31, 2019 compared to the corresponding period in 2018 primarily as a result of higher pretax income and lower benefit from state tax rate changes. For more information, see Note 17 to the accompanying consolidated financial statements contained in “Part II. Item 8. Financial Statements and Supplementary Data.”
Net income attributable to noncontrolling interest. Net income attributable to noncontrolling interest for financial reporting purposes represents A/N’s portion of Charter Holdings’ net income based on its effective common unit ownership interest and the preferred dividend of $150 million for each of the years ended December 31, 2019 and 2018. For more information, see Note 11 to the accompanying consolidated financial statements contained in “Part II. Item 8. Financial Statements and Supplementary Data.”
Net income attributable to Charter shareholders. Net income attributable to Charter shareholders was $1.7 billion and $1.2 billion for the years ended December 31, 2019 and 2018, respectively, primarily as a result of the factors described above.
Use of Adjusted EBITDA and Free Cash Flow
We use certain measures that are not defined by U.S. generally accepted accounting principles (“GAAP”) to evaluate various aspects of our business. Adjusted EBITDA and free cash flow are non-GAAP financial measures and should be considered in addition to, not as a substitute for, net income attributable to Charter shareholders and net cash flows from operating activities reported in accordance with GAAP. These terms, as defined by us, may not be comparable to similarly titled measures used by other companies. Adjusted EBITDA and free cash flow are reconciled to net income attributable to Charter shareholders and net cash flows from operating activities, respectively, below.
Adjusted EBITDA eliminates the significant non-cash depreciation and amortization expense that results from the capital-intensive nature of our businesses as well as other non-cash or special items, and is unaffected by our capital structure or investment activities. However, this measure is limited in that it does not reflect the periodic costs of certain capitalized tangible and intangible assets used in generating revenues and our cash cost of financing. These costs are evaluated through other financial measures.
Free cash flow is defined as net cash flows from operating activities, less capital expenditures and changes in accrued expenses related to capital expenditures.
Management and Charter’s board of directors use Adjusted EBITDA and free cash flow to assess our performance and our ability to service our debt, fund operations and make additional investments with internally generated funds. In addition, Adjusted EBITDA generally correlates to the leverage ratio calculation under our credit facilities or outstanding notes to determine compliance with the covenants contained in the facilities and notes (all such documents have been previously filed with the SEC). For the purpose of calculating compliance with leverage covenants, we use Adjusted EBITDA, as presented, excluding certain expenses paid by our operating subsidiaries to other Charter entities. Our debt covenants refer to these expenses as management fees, which fees were in the amount of $1.2 billion and $1.1 billion for the years ended December 31, 2019 and 2018, respectively.
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Years ended December 31, | |||||||
2019 | 2018 | ||||||
Net income attributable to Charter shareholders | $ | 1,668 | $ | 1,230 | |||
Plus: Net income attributable to noncontrolling interest | 324 | 276 | |||||
Interest expense, net | 3,797 | 3,540 | |||||
Income tax expense | 439 | 180 | |||||
Depreciation and amortization | 9,926 | 10,318 | |||||
Stock compensation expense | 315 | 285 | |||||
Loss on extinguishment of debt | 25 | — | |||||
Loss on financial instruments, net | 54 | 110 | |||||
Other pension (benefits) costs, net | 69 | (192 | ) | ||||
Other, net | 238 | 312 | |||||
Adjusted EBITDA | $ | 16,855 | $ | 16,059 | |||
Net cash flows from operating activities | $ | 11,748 | $ | 11,767 | |||
Less: Purchases of property, plant and equipment | (7,195 | ) | (9,125 | ) | |||
Change in accrued expenses related to capital expenditures | 55 | (470 | ) | ||||
Free cash flow | $ | 4,608 | $ | 2,172 | |||
Liquidity and Capital Resources
Overview
We have significant amounts of debt. The principal amount of our debt as of December 31, 2019 was $78.4 billion, consisting of $10.4 billion of credit facility debt, $45.9 billion of investment grade senior secured notes and $22.1 billion of high-yield senior unsecured notes. Our business requires significant cash to fund principal and interest payments on our debt.
Our projected cash needs and projected sources of liquidity depend upon, among other things, our actual results, and the timing and amount of our expenditures. As we continue to grow our new mobile services, we expect an initial funding period to grow a new product as well as negative working capital impacts from the timing of device-related cash flows when we provide the handset or tablet to customers pursuant to equipment installment plans. Free cash flow was $4.6 billion and $2.2 billion for the years ended December 31, 2019 and 2018, respectively. See table below for factors impacting free cash flow during the year ended December 31, 2019 compared to 2018. As of December 31, 2019, the amount available under our credit facilities was approximately $4.7 billion and cash on hand was approximately $3.5 billion. We expect to utilize free cash flow, cash on hand and availability under our credit facilities as well as future refinancing transactions to further extend the maturities of our obligations. The timing and terms of any refinancing transactions will be subject to market conditions among other considerations. Additionally, we may, from time to time, and depending on market conditions and other factors, use cash on hand and the proceeds from securities offerings or other borrowings to retire our debt through open market purchases, privately negotiated purchases, tender offers or redemption provisions. We believe we have sufficient liquidity from cash on hand, free cash flow and Charter Operating’s revolving credit facility as well as access to the capital markets to fund our projected cash needs.
We continue to evaluate the deployment of our cash on hand and anticipated future free cash flow including to invest in our business growth and other strategic opportunities, including mergers and acquisitions as well as stock repurchases and dividends. Charter's target leverage of net debt to the last twelve months Adjusted EBITDA remains at 4 to 4.5 times Adjusted EBITDA, and up to 3.5 times Adjusted EBITDA at the Charter Operating level. Our leverage ratio was 4.5 times Adjusted EBITDA as of December 31, 2019. As Adjusted EBITDA grows, we expect to increase the total amount of our indebtedness to maintain leverage within Charter's target leverage range. During the years ended December 31, 2019 and 2018, Charter purchased approximately 16.7 million and 14.1 million shares, respectively, of Charter Class A common stock for approximately $6.7 billion and $4.3 billion, respectively.
In December 2017, Charter and A/N entered into an amendment to the letter agreement (the "Letter Agreement") that requires A/N to sell to Charter or to Charter Holdings, on a monthly basis, a number of shares of Charter Class A common stock or Charter Holdings common units that represents a pro rata participation by A/N and its affiliates in any repurchases of shares of Charter Class A common stock from persons other than A/N effected by Charter during the immediately preceding calendar month, at a purchase price equal to the average price paid by Charter for the shares repurchased from persons other than A/N during such immediately preceding calendar month. A/N and Charter both have the right to terminate or suspend the pro rata repurchase arrangement on a prospective basis. Charter Holdings purchased from A/N 2.3 million and 2.1 million Charter Holdings common
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units at an average price per unit of $388.72 and $308.90, or $885 million and $656 million, during the years ended December 31, 2019 and 2018, respectively.
As of December 31, 2019, Charter had remaining board authority to purchase an additional $1.4 billion of Charter’s Class A common stock and/or Charter Holdings common units. Although Charter expects to continue to buy back its common stock consistent with its leverage target range, Charter is not obligated to acquire any particular amount of common stock, and the timing of any purchases that may occur cannot be predicted and will largely depend on market conditions and other potential uses of capital. Purchases may include open market purchases, tender offers or negotiated transactions.
As possible acquisitions, swaps or dispositions arise, we actively review them against our objectives including, among other considerations, improving the operational efficiency, geographic clustering of assets, product development or technology capabilities of our business and achieving appropriate return targets, and we may participate to the extent we believe these possibilities present attractive opportunities. However, there can be no assurance that we will actually complete any acquisitions, dispositions or system swaps, or that any such transactions will be material to our operations or results.
Recent Events
In December 2019, CCO Holdings and CCO Holdings Capital Corp. jointly issued an additional $1.2 billion aggregate principal amount of 4.750% senior unsecured notes due 2030 at a price of 101.125% of the aggregate principal amount. The net proceeds were or will be used to pay related fees and expenses and for general corporate purposes, including to fund buybacks of Charter Class A common stock and Charter Holdings common units as well as repaying certain indebtedness.
In December 2019, Charter Operating and Charter Communications Operating Capital Corp. jointly issued an additional $1.3 billion aggregate principal amount of 4.800% senior secured notes due 2050 at a price of 101.964% of the aggregate principal amount. The net proceeds were or will be used to pay related fees and expenses and for general corporate purposes, including to fund buybacks of Charter Class A common stock and Charter Holdings common units as well as repaying certain indebtedness.
In addition to the debt issued in December 2019 as described above, CCO Holdings and CCO Holdings Capital Corp. jointly issued $3.35 billion aggregate principal amount of senior unsecured notes at varying rates, prices and maturity dates in 2019, and Charter Operating and Charter Communications Operating Capital Corp. jointly issued $4.75 billion aggregate principal amount of senior secured notes at varying rates, prices and maturity dates in 2019. The net proceeds were used to pay related fees and expenses and for general corporate purposes, including funding buybacks of Charter Class A common stock and Charter Holdings common units as well as repaying certain indebtedness.
In 2019, Charter Operating also entered into an amendment to its Credit Agreement repricing $4.5 billion of its revolving loan and $4.0 billion of term loan A to LIBOR plus 1.25% and its existing term loan B to LIBOR plus 1.75%. In addition, $4.5 billion of the revolving loan and $4.0 billion of term loan A maturities were extended to 2025 and $3.8 billion of term loan B maturities were extended to 2027.
Free Cash Flow
Free cash flow increased $2.4 billion during the year ended December 31, 2019 compared to the corresponding prior period due to the following.
2019 compared to 2018 | |||
Decrease in capital expenditures | $ | 1,930 | |
Increase in Adjusted EBITDA | 796 | ||
Change in working capital, excluding change in accrued interest | (255 | ) | |
Increase in cash paid for interest, net | (75 | ) | |
Other, net | 40 | ||
$ | 2,436 | ||
Free cash flow was reduced by $567 million during the year ended December 31, 2019 compared to the corresponding prior period due to mobile with impacts negatively affecting working capital, capital expenditures and Adjusted EBITDA.
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Contractual Obligations
The following table summarizes our payment obligations as of December 31, 2019 under our long-term debt and certain other contractual obligations and commitments (dollars in millions.)
Payments by Period | |||||||||||||||||||||
Total | Less than 1 year | 1-3 years | 3-5 years | More than 5 years | |||||||||||||||||
Long-Term Debt Principal Payments (a) | $ | 78,416 | $ | 3,777 | $ | 6,504 | $ | 8,701 | $ | 59,434 | |||||||||||
Long-Term Debt Interest Payments (b) | 50,577 | 3,924 | 7,551 | 6,635 | 32,467 | ||||||||||||||||
Finance and Operating Lease Obligations (c) | 1,594 | 272 | 492 | 360 | 470 | ||||||||||||||||
Programming Minimum Commitments (d) | 276 | 216 | 49 | 11 | — | ||||||||||||||||
Other (e) | 12,658 | 2,536 | 3,034 | 892 | 6,196 | ||||||||||||||||
$ | 143,521 | $ | 10,725 | $ | 17,630 | $ | 16,599 | $ | 98,567 | ||||||||||||
(a) | The table presents maturities of long-term debt outstanding as of December 31, 2019. Refer to Notes 9 and 21 to our accompanying consolidated financial statements contained in “Part II. Item 8. Financial Statements and Supplementary Data” for a description of our long-term debt and other contractual obligations and commitments. |
(b) | Interest payments on variable debt are estimated using amounts outstanding at December 31, 2019 and the average implied forward LIBOR rates applicable for the quarter during the interest rate reset based on the yield curve in effect at December 31, 2019. Actual interest payments will differ based on actual LIBOR rates and actual amounts outstanding for applicable periods. |
(c) | We lease certain facilities and equipment under noncancelable finance and operating leases. Finance lease obligations represented $95 million of total finance and operating lease obligations as of December 31, 2019. Lease and rental costs charged to expense for the years ended December 31, 2019 and 2018 were $445 million and $382 million, respectively. |
(d) | We pay programming fees under multi-year contracts typically based on a flat fee per customer, which may be fixed for the term, or may in some cases escalate over the term. Programming costs included in the accompanying statement of operations were approximately $11.3 billion and $11.1 billion for the years ended December 31, 2019 and 2018, respectively. Certain of our programming agreements are based on a flat fee per month or have guaranteed minimum payments. The table sets forth the aggregate guaranteed minimum commitments under our programming contracts. |
(e) | “Other” represents other guaranteed minimum commitments, including rights negotiated directly with content owners for distribution on company-owned channels or networks, commitments related to our role as an advertising and distribution sales agent for third party-owned channels or networks, commitments to our customer premise equipment and device vendors and contractual obligations related to third-party network augmentation. |
The following items are not included in the contractual obligations table because the obligations are not fixed and/or determinable due to various factors discussed below. However, we incur these costs as part of our operations:
• | We rent utility poles used in our operations. Generally, pole rentals are cancelable on short notice, but we anticipate that such rentals will recur. Rent expense incurred for pole rental attachments for the years ended December 31, 2019 and 2018 was $180 million and $171 million, respectively. |
• | We pay franchise fees under multi-year franchise agreements based on a percentage of revenues generated from video service per year. We also pay other franchise related costs, such as public education grants, under multi-year agreements. Franchise fees and other franchise-related costs included in the accompanying statement of operations were $750 million and $747 million for the years ended December 31, 2019 and 2018, respectively. |
• | We have $363 million in letters of credit, of which $36 million is secured under the Charter Operating credit facility, primarily to our various casualty carriers as collateral for reimbursement of workers' compensation, auto liability and general liability claims. |
• | Minimum pension funding requirements have not been presented in the table above as such amounts have not been determined beyond 2019. We made no cash contributions to the qualified pension plans in 2019; however, we are permitted to make discretionary cash contributions to the qualified pension plans in 2020. For the nonqualified pension plan, we contributed $4 million during 2019 and will continue to make contributions in 2020 to the extent benefits are paid. |
See "Part I. Item 1. Business — Commitments Related to the 2016 Merger with TWC and Acquisition of Bright House" for a listing of commitments as a result of the merger with TWC and acquisition of Bright House in 2016.
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Historical Operating, Investing, and Financing Activities
Cash and Cash Equivalents. We held $3.5 billion and $551 million in cash and cash equivalents as of December 31, 2019 and 2018, respectively. We also held $66 million and $214 million in restricted cash as of December 31, 2019 and 2018, respectively, representing escrowed funds of a consolidated variable interest entity. See Note 6 to the accompanying consolidated financial statements contained in “Item 1. Financial Statements.”
Operating Activities. Net cash provided by operating activities decreased $19 million during the year ended December 31, 2019 compared to the year ended December 31, 2018, primarily due to changes in working capital, excluding the change in accrued interest and accrued expenses related to capital expenditures, that used $780 million more cash and an increase in cash paid for interest, net of $75 million offset by an increase in Adjusted EBITDA of