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Edited Transcript of CHTR earnings conference call or presentation 26-Jul-19 12:30pm GMT

Q2 2019 Charter Communications Inc Earnings Call

ST. LOUIS Jul 30, 2019 (Thomson StreetEvents) -- Edited Transcript of Charter Communications Inc earnings conference call or presentation Friday, July 26, 2019 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Christopher L. Winfrey

Charter Communications, Inc. - CFO

* Stefan Anninger

Charter Communications, Inc. - VP of IR

* Thomas M. Rutledge

Charter Communications, Inc. - Chairman & CEO

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Conference Call Participants

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* Benjamin Daniel Swinburne

Morgan Stanley, Research Division - MD

* Brett Joseph Feldman

Goldman Sachs Group Inc., Research Division - Equity Analyst

* Bryan D. Kraft

Deutsche Bank AG, Research Division - Senior Analyst

* Craig Eder Moffett

MoffettNathanson LLC - Founding Partner

* Douglas David Mitchelson

Crédit Suisse AG, Research Division - MD

* Jessica Jean Reif Ehrlich

BofA Merrill Lynch, Research Division - MD in Equity Research

* John Christopher Hodulik

UBS Investment Bank, Research Division - MD, Sector Head of the United States Communications Group and Telco & Pay TV Analyst

* Jonathan Chaplin

New Street Research LLP - US Team Head of Communications Services

* Kannan Venkateshwar

Barclays Bank PLC, Research Division - Director & Senior Research Analyst

* Michael L. McCormack

Guggenheim Securities, LLC, Research Division - MD & Telecommunications Senior Analyst

* Philip A. Cusick

JP Morgan Chase & Co, Research Division - MD and Senior Analyst

* Vijay A. Jayant

Evercore ISI Institutional Equities, Research Division - Senior MD and Head of Media, Entertainment, Cable, Satellite & Telecommunication

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Presentation

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Operator [1]

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Good morning. My name is Jessa, and I will be your conference operator today. At this time, I would like to welcome everyone to Charter's Second Quarter Investor Call. (Operator Instructions) Thank you. You may begin your conference.

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Stefan Anninger, Charter Communications, Inc. - VP of IR [2]

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Good morning, and welcome to Charter's Second Quarter 2019 Investor Call.

The presentation that accompanies this call can be found on our website, ir.charter.com, under the Financial Information section.

Before we proceed, I would like to remind you that there are a number of risk factors and other cautionary statements contained in our SEC filings, including our most recent 10-K and also our 10-Q filed this morning. We will not review those risk factors and other cautionary statements on this call. However, we encourage you to read them carefully.

Various remarks that we make on this call concerning expectations, predictions, plans and prospects constitute forward-looking statements. These forward-looking statements are subject to risks and uncertainties that may cause actual results to differ from historical or anticipated results. Any forward-looking statements reflect management's current view only, and Charter undertakes no obligation to revise or update such statements or to make additional forward-looking statements in the future.

During the course of today's call, we will be referring to non-GAAP measures as defined and reconciled in our earnings materials. These non-GAAP measures, as defined by Charter, may not be comparable to measures with similar titles used by other companies.

Please also note that all growth rates noted on this call and in the presentation are calculated on a year-over-year basis, unless otherwise specified.

On today's call, we have Tom Rutledge, Chairman and CEO; and Chris Winfrey, our CFO. With that, let's turn the call over to Tom.

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Thomas M. Rutledge, Charter Communications, Inc. - Chairman & CEO [3]

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Good morning. Our core connectivity business is strong and continue to execute well, and we continue to benefit from consolidating cable operations under our centralized operating strategy in the ways we expected, including lower customer churn, fewer service transactions per customer and improving customer satisfaction, resulting in industry-leading growth of over 1 million customer relationships year-over-year and Internet customer growth of over 1.3 million year-over-year.

In the second quarter, we had a net gain of over 200,000 customer relationships with customer growth nearly 4% over the last 12 months. We added over 250,000 Internet customers, and we also added 208,000 mobile lines, accelerating as our high-quality, attractively priced mobile product is beginning to resonate with customers to penetrate the marketplace.

We grew cable adjusted EBITDA by 5.4%, which, combined with our lower cable capital expenditures, yielded strong year-over-year cable free cash flow growth of over 50%. That's nearly over 40% when including our investment in Spectrum Mobile.

We remain focused on a number of service-oriented initiatives, and we have a clear pathway to drive higher customer satisfaction and retention with positive growth and financial effects. Our in-sourced and high-quality workforce is driving an improved customer experience. In the second quarter, well over 90% of phone call volume was handled by our in-house agents with billing and service-related calls down by 10% year-over-year. And over 80% of truck rolls were handled by our in-house field techs with total trucks rolls down nearly 7% year-over-year.

Our call center virtualization plans remain on track. We've gone from 13 billing instances to one front-end service environment, meaning better quality service and lower costs. Our self-installation program is also ramping quickly with customer self-installations now representing over 40% of our sales volume. Our online selling and service platforms are also becoming increasingly successful.

All of these initiatives are having meaningful impact on our core business, including enhanced customer experience by allowing customers to interact with us on their terms, either through digital platforms or highly skilled employees; reducing selling friction and service transaction volumes, all of which reduce our cost service per customer relationship now and for many years to come.

We're using our transactional selling machine and improving brand recognition to generate sales of our Spectrum Mobile product with the ultimate goal of driving faster overall relationship growth. With over 0.5 million Spectrum Mobile lines at the end of the second quarter, we're pleased with the progress we've made since launching in September of last year. In late May, we expanded the availability of our Bring Your Own Device program to all of our sales channels with a positive impact on sales. Previously, our Bring Your Own Device program was only available by visiting select Spectrum Mobile stores. Now customers can purchase Spectrum Mobile while bringing their own device through all of our sales channels, including our inbound, retail, online and direct channels. Later this year, we'll expand the availability of Spectrum Mobile service to our small and medium business customers. Mobile remains a key focus of Charter, and we continue to work on broadening our mobile capabilities.

We also remain focused on opportunities to continue to develop our core asset, our hybrid fiber coax wireline network and its capacity. And we have a cost-efficient pathway to do that. Our infrastructure today delivers low-latency service and superior capacity and speed. And we have a scalable, relatively low-cost upgrade path that allows for further low-latency superiority, 10-gig symmetrical speeds with DOCSIS 4.0, also called Full Duplex, and expanded network throughput. Specifically, over time, we can expand our network from 750 megahertz to up to 3 gigahertz to meaningfully increase our total throughput and capacity, all of which positions us to continue to be the network of choice for a wide array of application such as gaming, 8K video, developing high-capacity, low-latency product, such as virtual reality, and medical and educational use cases. And we're doing that on a development path that is faster and more cost efficient than can be achieved by our competitors.

So now I'll turn the call over to Chris.

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Christopher L. Winfrey, Charter Communications, Inc. - CFO [4]

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Thanks, Tom. Turning to our results on Slide 5 of today's presentation. Total residential and SMB customer relationships grew by over 1 million in the last 12 months and by 203,000 in the second quarter. Including residential and SMB, Internet grew by 258,000 units in the quarter. Video declined by 141,000. Wireline voice declined by 182,000, and we added 208,000 higher ARPU mobile lines.

82% of our residential customers, including Legacy Charter, were in Spectrum pricing and packaging at the end of the second quarter. And residential customer growth relationship growth continued to increase to 3.4% year-over-year.

In residential Internet, we added a total of 221,000 customers in the highest seasonal disconnect order, just above last year's second quarter, resulting in residential Internet customer growth of 5.1% year-over-year. Both Legacy Charter and Legacy Bright House net additions were meaningfully better year-over-year in the second quarter with residential Internet relationship growth rates of 5.9% and 7.7%, respectively, despite higher penetrations than the Legacy TWC footprint.

So while Legacy TWC's residential Internet growth rate of 4.3% year-over-year is still good, the relative size of that footprint and the time it has taken for growth rates to mirror Charter impacts the consolidated results.

Key metrics, like calls per customer, truck rolls per customer and churn are all moving in the right direction across the company, and we remain confident in our ability to continue to accelerate residential customer relationship and Internet customer growth for the full year 2019.

Over the last year, our residential video customers declined by 2.5%. Similar to Internet and overall relationship churn, we benefited from the decline in total video churn year-over-year, but that was offset by lower video gross additions. Despite some video loss, we expect to continue to grow our EBITDA and cash flow at healthy rates. And as part of a bundle, video drives Internet sales and reduces churn for our connectivity services, it remains an integral part of our business strategy for connectivity services, even as it drives less standalone profit over time.

In wireline voice, we lost 207,000 residential customers in the quarter driven by lower sell-in following our transition to selling mobile into bundle and continued fixed to mobile substitution in the market generally.

Turning to mobile. We added 208,000 mobile lines in the quarter versus 176,000 in the first quarter of 2019, so a nice acceleration driven by growing brand awareness and expansion of our Bring Your Own Device capabilities across all sales channels, which occurred late in the quarter.

As of June 30, we had 518,000 lines with a healthy mix of both Unlimited and By the Gig lines, so mobile is ramping nicely. And the early results of this product launch remain promising. Over time, we not only expect Spectrum Mobile to become a meaningful driver of our connectivity sales and retention, we also expect it to be profitable on a standalone basis once it reaches scale. And beyond that, we believe there will be opportunities to further improve the economics of our mobile business and offer unique connectivity services.

Over the last year, we grew total residential customers by 884,000 or 3.4%. Residential revenue per customer relationship grew by 0.3% year-over-year given a lower rate of SPP migration and promotional campaign roll-off and rate adjustments. Those ARPU benefits were partly offset by a higher mix of nonvideo customers, a higher mix of Choice and Stream within our video base and $24 million lower pay-per-view revenue year-over-year in the second quarter.

As Slide 6 shows our cable customer growth, combined with our ARPU growth, resulted in year-over-year residential revenue growth of 3.7%. Keep in mind that our cable ARPU does not reflect any mobile revenue.

Turning to commercial. Total SMB and enterprise revenue combined grew by 4.7% in the second quarter. SMB revenue grew by 5.3%, faster than last quarter as the revenue effect from the repricing of our SMB products and Legacy TWC and Bright House continues to slow. Enterprise revenue was up by 4%. Excluding cell backhaul and NaviSite, enterprise grew by 6.7% with nearly 10% PSU growth year-over-year. Our enterprise group is at an earlier stage of its own pricing and packaging transition, similar to what we've done in our SMB and residential businesses over the last 2 years. And the process of moving customers to more competitive pricing pressures enterprise ARPU in the near term.

Second quarter advertising revenue declined by 7.5% year-over-year exclusively due to less political revenue in 2019. Other revenue declined by 11.3% year-over-year in the second quarter driven primarily from lower late fees with fewer delinquent accounts, which is also reflected in lower bad debt year-over-year.

Mobile revenue totaled $158 million with $111 million of that revenue being EIP device revenue.

In total, consolidated second quarter revenue was up 4.5% year-over-year with cable revenue growth of 3.1% or 3.8% when excluding advertising and pay-per-view.

Moving to operating expenses on Slide 7. In the second quarter, total operating expenses grew by $359 million or 5.3% year-over-year. Excluding mobile, operating expenses increased 1.7%. Programming increased 0.9% year-over-year due to higher rates. That was offset by a video subscriber decline of 2.2% year-over-year, a higher mix of lighter video packages such as Choice and Stream and lower pay-per-view expenses year-over-year, which is roughly 0.5% of programming growth rate impact. Despite the lower overall growth rate, our programming expense can vary, and we do have some renewals in the back half of this year.

Regulatory, connectivity and produced content grew by 6.7% driven by cost of video CPE sold to customers, franchise and regulatory fees and original programming cost in that order. Cost to service customers declined by 0.9% year-over-year compared to 3.8% customer relationship growth. Even excluding some bad debt improvement, cost to service customers were essentially flat year-over-year. As Tom mentioned, we're meaningfully lowering our per relationship service cost through a number of operating efficiency improvements, which is core to our strategy.

Cable marketing expenses were essentially flat year-over-year, and other cable expenses were up 8.4% driven by software cost, insurance, property taxes and enterprise cost.

Mobile expenses totaled $277 million and were comprised of mobile device costs tied to the EIP device revenue I mentioned, subscriber acquisition and usage cost and operating expenses to stand up and operate the business, including our own personnel and overhead cost and our portion of the JV with Comcast.

Cable adjusted EBITDA grew by 5.4% in the second quarter, including a roughly 1.5% negative growth rate impact from 2018 political advertising revenue, net of its associated expense. And when including the mobile EBITDA start-up loss of $119 million, the total company adjusted EBITDA grew by 3.3% in the quarter.

Turning to net income on Slide 8. We generated $314 million of net income attributable to Charter shareholders in the second quarter versus $273 million last year. The year-over-year increase was primarily driven by higher adjusted EBITDA and lower depreciation and amortization expense, partly offset by higher interest expense, a greater noncash loss on financial instruments and higher GAAP tax expense.

Turning to Slide 9. Capital expenditures totaled just under $1.6 billion in the second quarter with our cable CapEx declining by over $800 million year-over-year driven by lower scalable infrastructure primarily driven by the completion of DOCSIS 3.1 last year and the associated bandwidth benefit in 2019; lower CPE and installation CapEx due to fewer SPP migrations year-over-year; and the completion of all-digital in 2018. There's also the positive capital effect of increasing self-installation, lower video sales, a newer average life of boxes deployed and the higher mix of boxless video outlets. Support spending for cable was also lower driven by declining investments related to in-sourcing and integration, and that was partly offset by higher spend on line extensions as we continue to build out and fulfill our merger conditions.

We spent $93 million on mobile-related CapEx this quarter, which is mostly accounted for in support capital and was driven by retail footprint upgrades for mobile and software, some of which is related to our JV with Comcast. As a reminder, for the full year 2019, our internal plan reflects roughly $7 billion of total cable CapEx in 2019, and that's despite a lower run rate in the first half of this year.

As Slide 10 shows, we generated $1.1 billion of consolidated free cash flow this quarter, including just under $300 million of investment in the launch of mobile. Excluding mobile, we generated $1.4 billion of cable free cash flow, up nearly $500 million versus last year's second quarter. The year-over-year growth was driven by the higher adjusted EBITDA and the lower cable CapEx I mentioned, and that was partly offset by a negative cash contribution from cable working capital of $284 million during the second quarter, primarily due to continued lower payables from lower CapEx and a onetime receivables impact from standardizing our residential bill cycle timing. And that was to simplify our bill for customers and reduce related billing inquiries to push out collections of customer payments by a few days.

Although I expect our full year change in capital -- working capital to be negative driven by the reasons we've discussed on these calls, the second half of this year should have a more net neutral impact to free cash flow. And as we move beyond this 2019 calendar year, I would expect changes in our cable working capital to be neutral to beneficial to our full year free cash flow results.

On the mobile side, we continue to add mobile customers, which drives handset-related working capital needs as we accelerate growth rates. And we expect that trend to continue for the foreseeable future due to growth.

We finished the quarter with $72.6 billion in debt principal. Our current run rate annualized cash interest, including the impact of issuing investment-grade and high-yield notes earlier this month is $3.9 billion. As of the end of the second quarter, our net debt to last 12-month adjusted EBITDA was 4.4x. We intend to stay at or below the high end of our 4 to 4.5 leverage range, and we included the upfront investment in mobile to be more conservative than looking at cable-only leverage, which was 4.28x at the end of Q2 and it's declining.

During the quarter, we repurchased 2.7 million Charter shares and Charter Holdings common units totaling about $1 billion at an average price of $370 per share. In September of 2016, we've repurchased 21% of Charter's equity at an average price of $330 per share.

So our operating model, network capabilities now and in the future and our balance sheet strategy all work together over long periods of time. We expect our results to continue to reflect a growing infrastructure asset with a lot of ancillary products used for and sell on top of our core connectivity services with good value and service to our customers to grow cash flow with tax-advantaged levered equity returns.

Operator, we're now ready for Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Ben Swinburne from Morgan Stanley.

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Benjamin Daniel Swinburne, Morgan Stanley, Research Division - MD [2]

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Wanted to ask you guys, first, about mobile and a couple of questions. Are you now sort of in full sales mode across the footprint in terms of devices you're supporting, all your sales channels, full marketing push? I know you've introduced more BYOD in May, but just as we think about the second half of the year, should we expect that business to continue to accelerate? And are we going to see sort of the full push on that product? And I'm wondering also as you think about profitability and your ability to use WiFi offload to sort of manage your bandwidth costs, and if there are opportunities to get better at that as you move through the year. And then just as a question, Chris, on CapEx. I know you reiterated the $7 billion, but I just wanted to come back because as you mentioned, you're run rating below that. You've got a spend about $4 billion or accrue, $4 billion in the second half to get to $7 billion. So just curious if maybe there -- what's driving that second half step-up in CapEx given sort of we know what the sort of $7 billion trends are?

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Thomas M. Rutledge, Charter Communications, Inc. - Chairman & CEO [3]

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All right. Ben, so are we in full sales mode? Yes, I would say we're just getting to full sales mode at the end of the second quarter. And will that accelerate our ability to -- will our ability to grow accelerate? Yes, we think it will, and will continue to grow the mobile business at a more rapid rate with all of our sales channels available with a fully supported device inventory. We're not 100% there from devices, but we're nearly there in terms of the market share distribution of devices. And so we do expect the mobile business to accelerate. And we expect our ability to close sales and through our transaction volume at a higher and higher rate.

In terms of bandwidth cost on WiFi, I think on a relative basis, I don't expect that will improve this year on a per-unit basis, but a significant portion of the traffic is already on our WiFi network on a per-customer basis. There are opportunities that we're experimenting with using additional Spectrum, like CBRS, which is also free Spectrum-like, like WiFi is, and using that to offload traffic, but I don't expect that to be a meaningful contributor in 2019.

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Christopher L. Winfrey, Charter Communications, Inc. - CFO [4]

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Ben, on CapEx, if you take a look at traditional cable capital expenditure, it does tend to be back ended through the course of the year. At the end of 2018, we're coming off a pretty large investment cycle as it related to big integration projects, DOCSIS 3.1, all-digital. And so some of that has pushed out our planning and spend for this year a little bit later than, frankly, what we'd even budgeted for. It doesn't mean that I don't think that the business is capable of spending it and that they're not good ROI projects and they need to get done. So it is going to be a little bit of a challenge to get to the $7 billion. And -- but in a sort of perverse way, we're hopeful that, that can get done because it's good capital to spend and it benefits the business. So time will tell. But for now, that's still our goal is in spending at or just below $7 billion. And by the way, that's just for cable CapEx just be clear. And I know I said it before, but...

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Operator [5]

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

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Craig Eder Moffett, MoffettNathanson LLC - Founding Partner [6]

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Two questions, if I could. First, there were reports that you had been -- that you had submitted a bid for at least certain Sprint assets. I'm wondering if you can just share some insight into what assets you were interested in and if you could just add some color to that story. And then second, the -- obviously, the bulk case for your shares is, at this point, very focused on margin expansion. Your margins did expand in the quarter, perhaps not quite as quickly as some had hoped, but I wonder if you could just share some observations about the trajectory for your margins going forward, particularly given that your margins are still some 10 points lower than what our best-in-class margins in the sector now. Is there any reason why we shouldn't expect to see those kinds of numbers from you at some point down the road?

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Thomas M. Rutledge, Charter Communications, Inc. - Chairman & CEO [7]

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Well, I don't want to give you any color, but we've read a lot of reports about us over the last several months and weeks, and many of them weren't accurate.

In terms of margin expansion, we are seeing margin expansion. We expected to see margin expansion, and that's occurring because of the nature of the products that are more predominant in our selling machine today. We're getting significant impacts from our costs to serve. But you can get high margins a variety of ways. You could cut your cost dramatically, but inhibit your ability to grow, and we have industry-leading growth. And so that has an impact on our margins. But we think that the free cash flow generation by having a high-growth machine in the long run is a significantly greater asset valuation builder. So we're not trying to be the highest-margin company in the country by any means. That said, we expect our margins to continue to go to -- to improve because as you penetrate deeper into the market, your cost -- your network costs are allocated over bigger customer base and, therefore, your average cost per customer goes down. The change in videos means that there's less transaction activity associated with that service, which is relatively low margin from a gross margin perspective. And the cost to serve using digital buy flows and using self-service that's now capable in an all-digital environment takes cost out of the business. So we think the fundamental output of our business is lower-capital intensity, higher free cash flow and higher operating margins.

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Christopher L. Winfrey, Charter Communications, Inc. - CFO [8]

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Just to piggy back on what Tom said that what is our target is to be the highest free cash flow growth in the industry, not only on a gross basis, but also on a per-share basis. And we feel pretty good about that opportunity given the operating strategy.

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Operator [9]

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Your next question comes from the line of John Hodulik from UBS.

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John Christopher Hodulik, UBS Investment Bank, Research Division - MD, Sector Head of the United States Communications Group and Telco & Pay TV Analyst [10]

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Great. First maybe a couple of quick follow-ups on the longer-term wireless strategy for Tom. You obviously don't want to comment on those press reports, but have you guys looked at or are you looking at eventually providing wireless service outside your footprint? And then as relates to the Spectrum strategy, you guys have been active in terms of C-Band and I think it makes a lot of sense to talk about the -- and look at the CBRS, but would you also look at Spectrum opportunities from third parties? Or is it just sort of CBRS and upcoming auctions? And then one more question on video. It seems pretty clear that the pace of change in the video ecosystem is accelerating. And we've heard from sort of a change in strategy, I would say, at Comcast and certainly at AT&T to focus more on profitability. How would you characterize your own sort of video strategy? And should we expect the mix of Choice customers and Stream customers to continue to increase from here going forward?

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Thomas M. Rutledge, Charter Communications, Inc. - Chairman & CEO [11]

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Well, so in terms of wireless, we don't have plans today to serve outside of our footprint. As you know, we're a fundamentally regional operator, and wireless companies are national companies. We do have joint venture with Comcast, so that you have 2 regional companies providing on a similar platform wireless services nationwide. Customers who buy from us in our footprint and move out of our footprint can remain our customers. But our fundamental wireless objective today is to drive our overall customer relationships inside our physical assets using wireless and video and broadband and wireline and all new products to drive those customer relationships on the existing physical infrastructure.

Will we use third-party Spectrum? Of course. We are looking at CBRS. There are other opportunities to improve in specific locations in a cost-efficient way our ability to provide high-capacity mobile services to our customers. And we will, to the extent they develop for us, take advantage of them.

Our video strategy is really, today, to not look at video as a standalone business. There's still a lot of value in the bundle to a lot of consumers. The problem with the bundle of video today is that the content companies that supply it have essentially put their service for free, available everywhere through TV everywhere and excessive streams and password sharing and free over-the-air television, which can be received through antennas, all of which are unencrypted and essentially free. And it's hard to compete with free. We look at video as an attribute of our overall customer relationship. We want to have the best video services of all kinds available and make it easy for consumers to consume video on our product, but we don't look at it as a business -- as a standalone business. We look at it as an attribute of the connectivity relationship that we've established with the customer. And so we have gross margins in that business. And I don't think we want to go underwater from a gross margin perspective. But we look at that as a product enhancement to our connectivity, not as a standalone individual line of business.

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Operator [12]

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Your next question comes from the line of Jonathan Chaplin from New Street Research.

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Jonathan Chaplin, New Street Research LLP - US Team Head of Communications Services [13]

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Two quick ones for Chris. Generally, Chris, you guys generate more broadband ads in the second half of the year than the first half of the year. I'm just wondering if there's any reason why that trend wouldn't continue this year. And then just curious following up, Tom, on your comment on profitability in video. The cash flow contribution from a wireless sub when you get to scale, how different is that from the cash flow contribution you get from a video sub today?

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Christopher L. Winfrey, Charter Communications, Inc. - CFO [14]

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The second one's an interesting question. The -- I don't think I'll answer that without going too deep. So broadband, you're right. Trends tend to be better the second half of the year than the first half. There's nothing going on that would change that normal seasonality. And for all the reasons that Tom spoke about earlier, and I did as well, all the operating metrics are moving in the right direction. And we expect that -- our target and our goal is to be accelerating customer and Internet relationship growth rate for the full year. And I think that implies also even doing pretty well in the second half as well. We'll see where we end up, but that's the goal.

Cash flow contribution from a wireless customer once we've reached scale. Yes, I think you have 2 opposing trends. You have -- when you think about cash flow contribution going all the way down to EBITDA and including the effects of CapEx, you're comparing a video business where the contribution margin is declining over time, its utility to Internet is not, but its cash flow on a standalone basis, which Tom just went through why, it's not the right way to look at it. But those lines will cross. At what point in time, I'm not going to get into exactly what our models would say, but I think your premise is generally right.

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Thomas M. Rutledge, Charter Communications, Inc. - Chairman & CEO [15]

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I would add that the mobile contribution as the networks converge, the opportunity to move that to a higher contribution exists. And the other aspect of the mobile contribution is its pull-through to the overall relationship and how significant that is. And so it's -- you have to look -- you can look at it as a standalone business with a margin contribution, but you can also look at it, as I just described, video, which is the product that you carry on a network that is ultimately an attribute of the network and drives your overall customer relationships.

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Operator [16]

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Your next question comes from the line of Jessica Reif Ehrlich from Bank of America Merrill Lynch.

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Jessica Jean Reif Ehrlich, BofA Merrill Lynch, Research Division - MD in Equity Research [17]

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Tom, I just wanted to follow up on something you said in your prepared remarks. Can you elaborate on your plans to upgrade to 3 gigahertz? I know you said you could, but you also alluded to, like, a whole new suite of products and services. So I guess what's the plan, time frame, cost and what are you -- what services?

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Thomas M. Rutledge, Charter Communications, Inc. - Chairman & CEO [18]

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Yes. Well, I would say we just upgraded the network to 1 gig, and we did that for less than $10 per home passed. And so every home passed that we currently have, which is 51 million, has a 1 gig capable network sitting in front of it. And we think there's a significant amount of product development that can occur within that capacity that we're making available everywhere right now. And so we don't have any plans to immediately upgrade our network. And in fact, because we have the 1 gig everywhere, certain costs of network development have actually come out of the business because we have so much more capacity in the network, and what we call contention costs, the cost of continuously upgrading your network to make the volume of data go through it. And so capital intensity has come out of the business as a result of the last upgrade we did.

All I'm saying is that we have a relatively inexpensive pathway to future services, which are even hard to describe, but that can be very high capacity, very low latency, high compute -- distributed high compute. And we can make new products and services develop over time more efficiently than our competitors. And that is a great asset over the long term.

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Operator [19]

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Your next question comes from the line of Philip Cusick from JPMorgan.

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Philip A. Cusick, JP Morgan Chase & Co, Research Division - MD and Senior Analyst [20]

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Chris, you've expressed confidence in accelerating broadband growth in the back half and you've talked a lot about the sort of slow changes that are happening in the business. But I'm still having a hard time seeing what needs to change for that to happen versus the stable broadband adds from last year this quarter. And then second, as you -- and we've talked about this before, but as you think about pricing, can you get this business to double-digit broadband revenue growth without taking more price, especially as this -- as video trends weaken?

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Christopher L. Winfrey, Charter Communications, Inc. - CFO [21]

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Repeat the second question. Your question was double-digit broadband revenues.

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Philip A. Cusick, JP Morgan Chase & Co, Research Division - MD and Senior Analyst [22]

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Yes. So we get to a double-digit broadband revenue growth as video trends weaken. And is that sort of dragging broadband down with it?

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Christopher L. Winfrey, Charter Communications, Inc. - CFO [23]

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Yes. And let me start with the first question. I think pretty sure, whether it's at your conference or whether it was the last earnings call I mentioned, Q2 is a seasonal disconnect quarter. So trying to evaluate the success of a multiyear strategy based on a seasonal disconnect quarter, it's a little fraught. And we had a really good year-over-year in Q1. We expect accelerated customer relationship and Internet growth for the full year. I just commented, I think, the back half will be better. It's also true that during the first half of last year, even we were still working through a number of different integration issues, and it's also true that churn is coming down across every single type of churn, 3 major types of churn across 3 different companies or legacy platforms, so 9 different metrics of churn that are all going south in a good way. And so all you need to do is maintain or increase your sales to have -- to improve net adds. And given everything that we've been talking about in the business, while it's not guaranteed, we're pretty confident that, that's where we're heading. It's not -- it doesn't mean a single quarter. It means for a year, which I think is more important than a single quarter, that's where we're heading. And we're pretty confident.

As it relates to double-digit broadband revenue growth, keep in mind that GAAP forces us to reallocate revenue across all these products. So I wouldn't spend too much time on a single product line looking at the revenue growth of that. What makes more -- the bigger difference is customer relationship growth and on the bill to the extent that we have a change in rate, either because of higher amount of single play that's coming through or because of some additional speed upticks, which we are getting a fair amount of that going into the 400 megabit service more than we probably expected, I think the broadband business has the ability and the potential to grow at a really healthy rate for a long period of time. Whether or not with GAAP allocations that are moving across voice back into broadband and video or not, I think it's going to be healthy for a long time, and I think that's where I'd leave it.

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Philip A. Cusick, JP Morgan Chase & Co, Research Division - MD and Senior Analyst [24]

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Can I clarify that for a second? It sounds like if churn is down and units are flat year-over-year, then sales must be down as well.

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Christopher L. Winfrey, Charter Communications, Inc. - CFO [25]

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Yes. But if you go back to where...

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Philip A. Cusick, JP Morgan Chase & Co, Research Division - MD and Senior Analyst [26]

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With more efficient sales, I would think margins would be better than they're showing if sales are down.

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Christopher L. Winfrey, Charter Communications, Inc. - CFO [27]

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Margins are up, what, 0.8% year-over-year in cable, and that's not a small move. And then -- so I don't know. I don't -- I think it's pretty healthy and attractive. And the -- what I mentioned in the prepared remarks is if you think about the -- and I disclosed it because I think it matters, the growth rates, if you take a look at Legacy Charter growing in the high 5s and Bright House growing at even 7.7% and TWC growing at 4.3%, 4.3% is a great growth rate, but it's not where we'd like to get it. And so to your point, the -- in the second quarter of having slightly lower sales that was occurring in the TWC footprint, and I don't think there's anything systemic there. We're just now hitting our stride, and I think we'll look at it throughout the year.

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Operator [28]

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Your next question comes from the line of Brett Feldman from Goldman Sachs.

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Brett Joseph Feldman, Goldman Sachs Group Inc., Research Division - Equity Analyst [29]

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Yes, and just to follow up on that, I mean, is there an incremental color around the competitive backdrop within the Legacy Time Warner footprint that we need to be thinking more about? Or is it just normal ebbs and flows in the business because it would seem like with that being your biggest subsidiary, that's the biggest opportunity for a needle mover in terms of improved broadband trends? And then just a question on the billing cycle migration or standardization. You mentioned the working capital impact. Were there any other impacts, whether it was a subscriber trends or ARPUs or anything else we should adjust for as we work through our models?

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Thomas M. Rutledge, Charter Communications, Inc. - Chairman & CEO [30]

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So Brett, Tom. As -- I think that the performance of all of that assets, Bright House, Time Warner Cable and Charter should converge. And that's our expectation. And there's nothing that we see specific about the marketplace or the competitive environment that would prevent that. So we think that there are still execution issues that we can improve on as we consolidated the company and consolidated the call flow and workflow and sales flow, so that we get similar results across the platform. And that has taken us some time, but we're getting there. And we anticipate that we'll get to a kind of a converged output, which will be higher than what we have today.

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Christopher L. Winfrey, Charter Communications, Inc. - CFO [31]

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And on the billing standardization, Brett, really, it's a small change, but it just had a working capital impact. It actually has a meaningful impact on the number of billing calls that we expect to receive, so we expect a significant reduction. And then -- and as a result of having less service calls, improved churn over time. But there is no impact to ARPU. There's no impact to subs. And there's no financial impact other than the working capital and -- that I mentioned on the call. So net-net, a onetime change and should be for the long-term benefit of the company.

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Operator [32]

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Your next question comes from the line of Vijay Jayant from Evercore.

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Vijay A. Jayant, Evercore ISI Institutional Equities, Research Division - Senior MD and Head of Media, Entertainment, Cable, Satellite & Telecommunication [33]

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Mostly for probably Chris. So obviously, there's a lot of question about margins given the sub trends. So I just wanted to come back to a comment you made that in second quarter, there was a 1.5% negative growth impact from advertising to EBITDA. I didn't quite understand. So advertising had negative contribution. So I just want to understand that. And second, the other operating expenses, which normally grow by 5% was up more like 8% this quarter, and there are some property taxes and enterprise costs. Is that the new run rate? If you can help us with that.

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Christopher L. Winfrey, Charter Communications, Inc. - CFO [34]

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Sure. So the 1.5% EBITDA impact from advertising, that's net of the cost related to political advertising. So we're in a nonpolitical year. And where you had political advertising last year, you don't this year. And it's just to say if you didn't have political advertising impacting the EBITDA margin for cable, it would have been 1.5% higher. The reason I provided that is I didn't want people to just flow through the revenue effects without taking into account that there is some cost attached to political advertising as well. So I think for this quarter, if we wanted to provide it, we'll probably do the same in Q3 and Q4 just so people can take a look at it on an apples-to-apples basis.

And sorry, the second question was related to -- other expenses. Yes, oddly enough, some of that expense is actually being driven by our in-sourcing where property, casualty, I know this is in the weeds, but it's the truth. Property and casualty, insurance expense related to in-sourcing your labor force is flowing through us as opposed to contract labor. Now that we're towards the tail end of in-sourcing the labor force to the target levels, I think, over time, I'm not telling you Q3 or Q4, I'm telling you, looking out into next year beyond, my hope is that, that's not the new run rate.

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Operator [35]

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Your next question comes from the line of Doug Mitchelson from Crédit Suisse.

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Douglas David Mitchelson, Crédit Suisse AG, Research Division - MD [36]

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Tom, I guess, if you look at what AT&T is trying to do in terms of bending the cost curve on programming cost. And obviously, you got Disney next week and Fox in the not-too-distant future, sort of at the end of the year, do you sort of think there's an opportunity for pay TV companies to get tougher with the programmers and -- or is that something -- or do you sort of see the other side of it and say, "You know what? Let's just keep raising the price of our video services enough, so that our dollar gross margin stays unchanged on a per customer basis?" And so programmers want to pursue price increases and basically price the product out of the business. That's okay because your sort of baseline here is you're a connectivity company. And they're not going to get those video services any cheaper outside piracy anyway. So any thought on just your video strategy around programming cost and how to manage it would be helpful.

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Thomas M. Rutledge, Charter Communications, Inc. - Chairman & CEO [37]

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Well, I feel strongly both ways, and there -- and I'm not really trying to be funny. I don't like raising the prices to our customers. Customers don't know what the value -- where that price increase is coming from. And they attribute it to us, and that affects our overall satisfaction. It affects our overall relationship and our brand equity, so to speak, with the customer. And so I think hitting rates and asking people to disconnect is not a very attractive way to manage the video business.

On the other hand, if you don't fight with programmers to maintain some sort of price integrity for your customer, you'll pass through a lot of product. So it's a balancing act from my point of view. What I really wish is that the price value of programming wasn't being destroyed by the programmers. And the reason I say that is if you do a 10% programming price increase and you lose 10% of your customers, you don't really get anywhere. And yet, you've alienated a lot of people. And in fact, that's actually happening and has been happening. The reason is price increases aren't able to go through. And if you look at the difference between where prices have gone and where revenues have gone, the content companies, they're not able to realize their price increases in their revenue line. And the reason is the product is available for free everywhere: over the air, TV everywhere, all sorts of excess streams being sold through virtual multichannel video providers and through TV everywhere. And there's absolutely no security on the product whatsoever. That changes the price-value relationship to customers and makes it impossible to raise prices and generate revenue. So my wish would be that the content industry would manage their content and their copyright to their own benefit, instead of pushing through price. And we still think that we have a lot of video customers, and they don't want to have price increases. And so I expect continuous fighting for the foreseeable future.

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Douglas David Mitchelson, Crédit Suisse AG, Research Division - MD [38]

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This might not be something you have at your fingertips, Tom, but you can see what people are doing on broadband. Is there any sort of quantification you can give us relative to piracy? Or are you sort of seeing in the traffic sort of obvious increases in piracy over time?

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Thomas M. Rutledge, Charter Communications, Inc. - Chairman & CEO [39]

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Yes. It's massive. And essentially, all the customers that are lost to video are still watching TV.

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Operator [40]

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Your next question comes from the line of Bryan Kraft from Deutsche Bank.

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Bryan D. Kraft, Deutsche Bank AG, Research Division - Senior Analyst [41]

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I had 2. The first one is a free cash flow question. Chris, as we think about mobile CapEx next year, should we expect it to continue at this, call it, a little less than $100 million per quarter beyond this year? Or at some point, does it tail off as you complete your structure and retail footprint build-out? And then the other question I had is if you were to build out your own wireless network capacity over a licensed spectrum, would your existing MVNO agreement have to have been modified? In other words, does the MVNO agreement allow you to incorporate your own network capacity into the service model and have customers switching between Verizon's network and your own?

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Christopher L. Winfrey, Charter Communications, Inc. - CFO [42]

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So mobile CapEx, actually, is a function primarily of the retail footprint upgrade. We won't need 100% done by the end of this year. So I think some of that will continue, at least, through the first half of next year. But it has a finite life attached to it, so that CapEx is going to be largely nonrecurring. There is some software development CapEx, which is elevated as you get into the business, and that should also come down. It won't -- that piece won't 100% disappear.

And as it relates to the MVNO, what we talked about, particularly on the last call, was Tom went through is we are testing aggressively what's called dual SIM. And that under our current MVNO would give us the ability in a high quality way to offload traffic that comes from any small cell build that we did using the CBRS or other unlicensed or licensed spectrum. That all looks really promising at this point. It would be ROI based to the extent that we were doing any of that small cell build in the home, in the business or on strand. And that would have an implication, positive ROI, but it would have an implication on some CapEx associated with that tying to your first question.

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Thomas M. Rutledge, Charter Communications, Inc. - Chairman & CEO [43]

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And the other thing, Bryan, I would add to that is 80% of all the bits in the wireless mobile platform are currently being carried on our WiFi network. And that's true, all of this of all the carriers. And so our -- I said last time, our average customers using over 250 gigs a month and if you look at our average customer who's on broadband only and who's still watching TV, all of the last discussion we just had, but they're watching it for free or they're paying for Netflix or some other service, and watching it for free, they are using over 450 gigs a month. And so the average cellular customer is using between 6 and 8. So you have this tremendous offload already occurring on our network, and we expect that churn to continue and we go -- and take advantage of it from an investment and cost of service perspective.

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Operator [44]

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Your next question comes from the line of Mike McCormack from Guggenheim Partners.

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Michael L. McCormack, Guggenheim Securities, LLC, Research Division - MD & Telecommunications Senior Analyst [45]

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Maybe just a quick comment on the Stream product, what you're seeing there as far as the demographic just picking it up by presuming you might know the answer. And then maybe just frame how you think about that from a success-based standpoint. Like how successful is it so far? And then thinking about the plant. I know Tom, you've talked about the 1 gig ubiquitous product. When you get into the neighborhood, what's the real experience there if we need to think about the longer term and having all those subs guaranteed at 1 gig? What might be required from a CapEx standpoint to do that?

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Thomas M. Rutledge, Charter Communications, Inc. - Chairman & CEO [46]

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So the Stream issue, we are selling more Stream products proportionally to video products. That's cost driven for consumers. There are a lot of -- the price of the bundle is very expensive. And we talked about content companies trying to push rate buttons. And so there are a lot of customers who can't afford it, don't necessarily know how to go over-the-top and take it for free or wouldn't consider doing that. And so they're downgrading to Stream, both from existing packages and going there from -- on the increment. And it's really to save money. Most consumers would like to have it all. And so we are -- we're trying to smartly market Stream products to those consumers who are income constrained. And it's -- we're generally pretty good at targeting that, but it's not a perfect science. So there's a tension between our strategies and trying to sell full packages and to sell Stream at the same time to those who are income constrained. And we're just weighing the marketplace and trying to be responsive to consumers' video needs. So I don't know where it goes and I don't know where our contractual relationships will allow us to take it either.

With regard to upgrading throughput in the plant, we have a lot of capacity in the plant already. And we don't expect material changes in our capital trends as a result of the growth of data throughput in a sort of a foreseeable future. We do think there's a long run opportunity to create new products that can't work in today's environment -- for relatively small capital investments. But if you look at the concurrent operating model, the current marketplace, we don't anticipate, even with the rate of data consumption increasing, that we're going to have any sort of outsized trend in capital required.

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Operator [47]

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Your last question comes from the line of Kannan Venkateshwar from Barclays.

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Kannan Venkateshwar, Barclays Bank PLC, Research Division - Director & Senior Research Analyst [48]

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I guess one for Chris and one for Tom. So Chris, I guess, the programming expense on account of some of the new content that you're producing, some of the exclusives, I think they show up in the franchise fees line. And I think that number has been growing mid-single digits recently. So how long should we expect that line to be elevated in terms of content? And Tom, from your perspective, I think you've expressed an interest in potentially other cable assets if they do become available. So just wanted to get your updated thoughts on priorities relative to wireless. If there are opportunities that do come up, how you stack up those priorities?

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Christopher L. Winfrey, Charter Communications, Inc. - CFO [49]

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On a original content programming expense, if you take a look at, I think, what's in the Q as well as in the prepared remarks I had, it's the tiniest of all the drivers in that line. We're talking single-digit millions, and that's a function of the cost of production being amortized over the life of the asset, which is typical content industry accounting. So it's not a material driver inside of Q2 and it's not going to be significant in any way, particularly when you look at it as it relates to our programming. So very, very small. We just mentioned it because I think it's the third or fourth largest driver in that category.

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Thomas M. Rutledge, Charter Communications, Inc. - Chairman & CEO [50]

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And so to your second question about what's more important from an asset perspective if you're doing M&A, look, I think the cable business is a great business. And I think it's well positioned to be the connectivity infrastructure going forward. And it has cost opportunities that can't be easily replicated and, therefore, makes it a wonderful business that allows you to move massive capacity through it. And it's fully deployed. And I think there are scale advantages to having more cable. And so I would look at the cable asset as the most valuable asset. We don't have any need today to do any wireless M&A, and I don't know that I would do any if it were available. Obviously, it depends on what it cost. But the cable business is the predominant distribution vehicle for data, even in a mobile environment, because as you think about the future of mobile, the cells are very small. We already are a small cell provider through our WiFi platform. And as other small cell technologies become available, we have a fully distributed high-capacity, easy-to-upgrade, efficient to upgrade network pretty much everywhere on the streets and byways, and that gives -- makes the cable business a great business.

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Christopher L. Winfrey, Charter Communications, Inc. - CFO [51]

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Thank you. Thanks, everyone, for being on the call today.

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Operator [52]

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This will conclude today's conference call. Thank you for your participation. You may now disconnect.