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Section 1: 10-Q (FORM 10-Q)

cabo20160818_10q.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549  

 

FORM 10-Q 

 

(Mark One)

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2016 

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: 1-36863

 


Cable One, Inc. 

(Exact name of registrant as specified in its charter)


 

Delaware

 

13-3060083

(State or Other Jurisdiction of Incorporation or Organization)

 

(I.R.S. Employer Identification No.)

  

210 E. Earll Drive, Phoenix, Arizona

 

85012

(Address of Principal Executive Offices)

 

(Zip Code)

(602) 364-6000

(Registrant’s telephone number, including area code)

 

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 ☑ No ☐

  

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, 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 registrant was required to submit and post such files). Yes ☑ No ☐

  

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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer

 

Accelerated filer

 

 

 

 

 

Non-accelerated filer

 

Smaller reporting company

(Do not check if a smaller reporting company)

 

 

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☑

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date:

   

Description of Class

Shares Outstanding as of October 31, 2016

Common Stock, par value $0.01

5,712,573

 

 

 
 

 

     

CABLE ONE, INC.

FORM 10-Q

 TABLE OF CONTENTS

 

 

 

Page

PART I.

FINANCIAL INFORMATION

 

 

 

 

Item 1.

Condensed Consolidated Financial Statements

1

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

16

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

30

Item 4.

Controls and Procedures

30

 

 

  

PART II.

OTHER INFORMATION

31

 

 

  

Item 1.

Legal Proceedings

31

Item 1A.

Risk Factors

31

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

31

Item 3.

Defaults Upon Senior Securities

31

Item 4.

Mine Safety Disclosures

31

Item 5.

Other Information

31

Item 6.

Exhibits

32

Signatures

33

 

 

 
 i

 

 

PART I:  FINANCIAL INFORMATION

 

Item 1.     Financial Statements

  

CABLE ONE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

 

(in thousands, except par value and share data)

 

September 30,

2016

   

December 31,

2015

 
   

(unaudited)

         

Assets

               

Current Assets:

               

Cash and cash equivalents

  $ 123,701     $ 119,199  

Accounts receivable, net

    30,968       34,705  

Prepaid assets

    15,101       10,824  

Total Current Assets

    169,770       164,728  

Property, plant and equipment, net

    623,297       640,567  

Intangibles, net

    496,250       496,770  

Goodwill

    85,488       85,488  

Other assets

    9,703       11,252  

Total Assets

  $ 1,384,508     $ 1,398,805  
                 

Liabilities and Stockholders' Equity

               

Current Liabilities:

               

Accounts payable and accrued liabilities

  $ 82,429     $ 95,288  

Deferred revenue

    21,903       22,363  

Income taxes payable

    2,493       5,431  

Long-term debt - current portion

    5,625       3,750  

Total Current Liabilities

    112,450       126,832  

Long-term debt

    532,356       535,511  

Accrued compensation and related benefits

    24,668       24,399  

Other liabilities

    225       90  

Deferred income taxes

    277,190       276,627  

Total Liabilities

    946,889       963,459  
                 

Commitments and contingencies (see Note 15)

               
                 

Stockholders' Equity

               

Common stock ($0.01 par value; 40,000,000 shares authorized; 5,886,889 and 5,879,925 shares issued, and 5,712,573 and 5,833,442 shares outstanding as of September 30, 2016 and December 31, 2015, respectively)

    59       59  

Additional paid-in capital

    14,202       4,929  

Retained earnings

    495,960       447,282  

Accumulated other comprehensive loss

    (474

)

    (557

)

Treasury stock, at cost (174,316 and 46,483 shares held as of September 30, 2016 and December 31, 2015, respectively)

    (72,128

)

    (16,367

)

Total Stockholders' Equity

    437,619       435,346  

Total Liabilities and Stockholders' Equity

  $ 1,384,508     $ 1,398,805  

   

See accompanying notes to unaudited condensed consolidated financial statements.

 

 

 
1

 

       

CABLE ONE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

(Unaudited)

 

   

Three Months Ended

   

Nine Months Ended

 
   

September 30,

   

September 30,

 

(in thousands, except per share and share data)

 

2016

   

2015

   

2016

   

2015

 

Revenues

  $ 205,536     $ 198,215     $ 612,898     $ 603,822  

Costs and expenses

                               

Operating (excluding depreciation and amortization)

    76,691       75,291       229,356       235,674  

Selling, general and administrative

    48,807       47,820       136,182       149,508  

Depreciation and amortization

    36,218       36,108       105,600       107,922  

Total operating costs and expenses

    161,716       159,219       471,138       493,104  

Income from operations

    43,820       38,996       141,760       110,718  

Interest expense

    (7,529

)

    (7,804

)

    (22,633

)

    (8,801

)

Other income, net

    4,329       103       5,023       118  

Income before income taxes

    40,620       31,295       124,150       102,035  

Provision for income taxes

    19,746       11,883       49,598       39,079  

Net income

  $ 20,874     $ 19,412     $ 74,552     $ 62,956  
                                 

Other comprehensive gain, net of tax

    28       -       83       -  

Comprehensive income

  $ 20,902     $ 19,412     $ 74,635     $ 62,956  
                                 

Net income per common share:

                               

Basic

  $ 3.65     $ 3.31     $ 12.96     $ 10.76  

Diluted

  $ 3.63     $ 3.30     $ 12.91     $ 10.75  

Weighted average common shares outstanding:

                               

Basic

    5,720,257       5,871,928       5,753,204       5,852,956  

Diluted

    5,755,161       5,875,588       5,776,504       5,854,176  

    

See accompanying notes to unaudited condensed consolidated financial statements.

  

 

 
2

 

     

CABLE ONE, INC.

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

(Unaudited)

  

                   

Additional

           

Treasury

   

Accumulated Other

   

Total

 
   

Common Stock

   

Paid-In

   

Retained

   

Stock,

   

Comprehensive

   

Stockholders’

 

(in thousands, except share data)

 

Shares

   

Amount

   

Capital

   

Earnings

   

at cost

   

Loss

   

Equity

 

Balance at December 31, 2015

    5,833,442     $ 59     $ 4,929     $ 447,282     $ (16,367

)

  $ (557

)

  $ 435,346  

Net income

    -       -       -       74,552       -       -       74,552  

Changes in pension (net of tax)

    -       -       -       -       -       83       83  

Equity-based compensation

    6,964       -       9,653       -       -       -       9,653  

Issuance of common stock under restricted stock unit awards

    947       -       (380

)

    -       380       -       -  

Forfeiture of restricted stock

    (2,384

)

    -       -       -       -       -       -  

Repurchase of common stock

    (126,396

)

    -       -       -       (56,141

)

    -       (56,141

)

Dividends paid to stockholders

    -       -       -       (25,874

)

    -       -       (25,874

)

Balance at September 30, 2016

    5,712,573     $ 59     $ 14,202     $ 495,960     $ (72,128

)

  $ (474

)

  $ 437,619  

    

See accompanying notes to unaudited condensed consolidated financial statements.

      

 

 
3

 

    

CABLE ONE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

                                          

   

Nine Months Ended September 30,

 

(in thousands)

 

2016

   

2015

 

Cash flows from operating activities:

               

Net income

  $ 74,552     $ 62,956  

Adjustments to reconcile net income to net cash provided by operating activities:

               

Depreciation and amortization

    105,600       107,922  

Amortization of deferred financing costs

    1,233       -  

Equity-based compensation

    9,653       6,338  

Gain on sale of cable system

    (4,165

)

    -  

Deferred income taxes

    563       (23,377

)

Net loss on sales of property, plant and equipment

    1,625       1,133  

Changes in operating assets and liabilities:

               

Accounts receivable, net

    3,737       (676

)

Prepaid assets

    (4,292

)

    (727

)

Accounts payable and accrued liabilities

    6,433       24,650  

Deferred revenue

    (460

)

    855  

Income taxes payable

    (2,938

)

    15,348  

Other assets and other liabilities, net

    2,031       305  

Net cash provided by operating activities

    193,572       194,727  
                 

Cash flows from investing activities:

               

Capital expenditures

    (91,343

)

    (99,242

)

Change in accrued expenses related to capital expenditures

    (17,706

)

    (4,160

)

Proceeds from sale of cable system

    6,752       -  

Acquisition of cable system

    (760

)

    -  

Proceeds from sales of property, plant and equipment

    377       300  

Net cash used in investing activities

    (102,680

)

    (103,102

)

                 

Cash flows from financing activities:

               

Net transfers to GHC

    -       (32,795 )

Proceeds from issuance of long-term debt, net of issuance costs

    -       541,114  

Payments of debt issuance costs

    -       (1,768

)

Payments on long-term debt

    (2,512

)

    (625

)

Repurchase of common stock

    (56,141

)

    (5,932

)

Dividends paid to stockholders

    (25,874

)

    -  

Dividends paid to GHC

    -       (450,000 )

Cash overdraft

    (1,863

)

    (4,141

)

Other

    -       618  

Net cash (used in) provided by financing activities

    (86,390

)

    46,471  
                 

Change in cash and cash equivalents

    4,502       138,096  

Cash and cash equivalents, beginning of period

    119,199       6,410  

Cash and cash equivalents, end of period

  $ 123,701     $ 144,506  
                 

Supplemental cash flow disclosures:

               

Cash paid for interest expense

  $ 14,781     $ 584  

Cash paid for income taxes

  $ 51,372     $ 4,413  

Non-cash investing and financing activity:

               

Equipment financed with capital lease

  $ -     $ 301  

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

 
4

 

     

CABLE ONE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1.

SEPARATION FROM GRAHAM HOLDINGS COMPANY AND DESCRIPTION OF BUSINESS

 

On July 1, 2015, Cable One, Inc. (“Cable One”) became an independent company traded under the ticker symbol “CABO” on the New York Stock Exchange after completion of its spin-off from Graham Holdings Company (“GHC”). The spin-off was effected through the distribution by GHC of 100% of the outstanding shares of common stock of Cable One to GHC stockholders as of the record date for the distribution (the “spin-off”) in a pro rata dividend. In connection with the spin-off, approximately 5.84 million shares of Cable One’s common stock were issued and outstanding on July 1, 2015 at 12:01 a.m., based on approximately 0.96 million shares of GHC Class A Common Stock and 4.88 million shares of GHC Class B Common Stock outstanding as of June 30, 2015. No preferred stock was issued or outstanding.

 

The financial statements included herein have been retroactively restated, including share and per share amounts, to reflect the effects of the spin-off.

 

Cable One owns and operates cable systems that provide data, video and voice services to residential and commercial subscribers in 19 Western, Midwestern and Southern states of the United States of America. As of September 30, 2016, Cable One provided service to 510,573 data customers, 329,386 video customers and 118,205 voice customers.

 

Unless otherwise stated or the context otherwise indicates, all references in this Quarterly Report on Form 10-Q to “Cable One,” “us,” “our,” “we” or the “Company” means Cable One, Inc. and its wholly owned subsidiary, Cable One VoIP LLC (the “Subsidiary”). References in this Quarterly Report on Form 10-Q to “GHC” refer to Graham Holdings Company.

  

2.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Basis of Presentation. The accompanying Condensed Consolidated Financial Statements have been prepared in accordance with: (i) generally accepted accounting principles in the United States (“GAAP”) for interim financial information; and (ii) the guidance of Rule 10-01 of Regulation S-X under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), for financial statements required to be filed with the Securities and Exchange Commission (the “SEC”). They reflect the historical Condensed Consolidated Statements of Operations and Comprehensive Income, Condensed Consolidated Balance Sheets, Condensed Consolidated Statement of Stockholders’ Equity and Condensed Consolidated Statements of Cash Flows of the Company for the periods presented. As permitted under such rules, certain notes and other financial information normally required by GAAP have been condensed or omitted. Management believes the accompanying Condensed Consolidated Financial Statements reflect all normal and recurring adjustments necessary for a fair statement of the Company’s financial position, results of operations and cash flows as of and for the periods presented herein. These Condensed Consolidated Financial Statements are unaudited and should be read in conjunction with the Company’s audited financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2015.

 

Prior to the spin-off, the Company’s financial statements were derived from the consolidated financial statements and accounting records of GHC. The impact of transactions between the Company and GHC was included in these Condensed Consolidated Financial Statements and was considered to be effectively settled for cash in the Condensed Consolidated Financial Statements at the time the transaction was recorded. The total net effect of the settlement of these intercompany transactions was reflected in the Condensed Consolidated Statements of Cash Flows as a financing activity.

 

The Company functioned as part of the larger group of subsidiary companies controlled by GHC prior to the spin-off, and accordingly, GHC provided certain support and overhead functions to the Company. These functions included finance, human resources, legal, information technology, general insurance, risk management and other corporate functions. The costs of such services were allocated to the Company based on the most relevant allocation methods to the service provided. Management believed such allocations were reasonable and were consistently applied; however, they may not have been indicative of the actual expense that would have been incurred had the Company been operating on a stand-alone basis. See Notes 10 and 14 for details on these allocations.

 

 

 
5

 

 

Additionally, prior to the spin-off, the Company participated in a centralized approach to cash management and in financing its operations managed by GHC. Cash was transferred to GHC and GHC funded the Company’s operating and investing activities as needed. Accordingly, cash and cash equivalents at GHC were not allocated to the Company in the Condensed Consolidated Financial Statements. GHC’s third-party debt, and the related interest expense, were not allocated to the Company for any of the periods presented as the Company was not the legal obligor on the debt and GHC borrowings were not directly attributable to the Company’s business.

 

During the pre-spin periods presented, the Company’s income taxes have been prepared on a separate return basis as if the Company was a stand-alone entity. Prior to the spin-off, the Company’s operations were historically included in GHC’s consolidated U.S. Federal and certain state tax returns. The Company did not maintain taxes payable to/from GHC and was deemed to settle the annual current tax balances immediately with the legal tax-paying entities in the respective jurisdictions.

  

The Company’s results of operations for the three and nine months ended September 30, 2016 and 2015 may not be indicative of the Company’s future results. In addition, as the Company did not operate as a stand-alone entity prior to July 1, 2015, the Condensed Consolidated Financial Statements included herein may not necessarily be indicative of the Company’s future performance and may not necessarily reflect what its financial position, results of operations or cash flows would have been had it operated as a stand-alone entity during all of the periods presented.

 

Certain reclassifications have been made to prior period amounts to conform to the current year presentation. See the “Recently Adopted and Issued Accounting Pronouncements” section below for information regarding a balance sheet reclassification of deferred financing costs that resulted from the adoption of new accounting guidance. The Company also reclassified amounts in its Condensed Consolidated Statement of Cash Flows for the nine months ended September 30, 2015 from Capital expenditures to Change in accrued expenses related to capital expenditures to conform to the current year presentation. This reclassification had no impact on the previously reported cash flows from investing activities.

  

Principles of Consolidation. The accompanying Condensed Consolidated Financial Statements include the accounts of the Company and the Subsidiary. All significant intercompany accounts and transactions have been eliminated in consolidation.

 

Use of Estimates in the Preparation of the Condensed Consolidated Financial Statements. The preparation of the Condensed Consolidated Financial Statements in conformity with GAAP requires management to make estimates and judgments that affect the amounts reported herein. Management bases its estimates and assumptions on historical experience and on various other factors that are believed to be reasonable under the circumstances. Due to the inherent uncertainty involved in making estimates, actual results reported in future periods may be affected by changes in those estimates.

 

Recently Adopted and Issued Accounting Pronouncements. In May 2014, the Financial Accounting Standards Board (the “FASB”) issued comprehensive new guidance that supersedes all existing revenue recognition guidance. The new guidance requires revenue to be recognized when the Company transfers promised goods or services to customers in an amount that reflects the consideration to which the Company expects to be entitled in exchange for those goods or services. The new guidance also significantly expands the disclosure requirements for revenue recognition. This guidance, as amended, is effective for interim and fiscal years beginning after December 15, 2017. Early adoption is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. The standard permits two implementation approaches, one requiring retrospective application of the new guidance with a restatement of prior years and one requiring prospective application of the new guidance with disclosure of results under the old guidance. The Company is in the process of evaluating the impact of this new guidance on its financial statements and believes such evaluation will extend over several future periods due to the significance of the changes to the Company’s policies and business processes.

 

In August 2014, the FASB issued new guidance that requires management to assess the Company’s ability to continue as a going concern and to provide related disclosures in certain circumstances. This guidance is effective for interim and fiscal years ending after December 15, 2016, with early adoption permitted. The Company does not expect this guidance to have an impact on its financial statements.

 

In April 2015, the FASB issued new guidance to simplify the presentation of debt issuance costs. This guidance requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by this guidance. The new guidance should be applied on a full retrospective basis to all periods presented. This guidance is effective for interim and fiscal years beginning after December 15, 2015. In accordance with the provisions of the new guidance, the Company has recorded unamortized debt issuance costs net of the long-term debt liability in the accompanying Condensed Consolidated Balance Sheets as of September 30, 2016 and December 31, 2015. This resulted in a reclassification of deferred financing costs, which caused a reduction of $9.8 million to Long-term debt, $1.6 million to Current Assets and $8.2 million to Other assets in the accompanying Condensed Consolidated Balance Sheet as of December 31, 2015.

 

 

 
6

 

 

In September 2015, the FASB issued new guidance that requires that an acquirer in a business combination reflect adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amount is determined. The acquirer is required to also record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the adjustment had been completed at the acquisition date. In addition, an entity is required to present separately on the face of the income statement or disclose in the notes to the financial statements the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. This guidance is effective for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years. The amendments in this guidance should be applied prospectively to adjustments to provisional amounts that occur after the effective date of this guidance, with early adoption permitted. The Company does not expect this guidance to have a significant impact on its financial statements unless an acquisition is made.

 

In February 2016, the FASB issued new guidance that requires a lessee to record a right-of-use asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. This guidance is effective for interim and fiscal years beginning after December 15, 2018. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The Company is in the process of evaluating the impact of its pending adoption of this new guidance on its financial statements.

 

In March 2016, the FASB issued new guidance affecting several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. This guidance is effective for fiscal years beginning after December 15, 2016 and interim periods within those fiscal years, with early adoption permitted. If an entity early adopts this guidance in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. An entity that elects early adoption must adopt all of the guidance in the same period. The Company is in the process of evaluating the impact of its pending adoption of this new guidance on its financial statements.

 

In August 2016, the FASB issued new guidance affecting the classification of certain cash receipts and cash payments, including debt prepayments or debt extinguishments costs, settlement of zero-coupon debt instruments, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims and corporate-owned life insurance policies, distributions received from equity method investees, beneficial interests in securitization transactions, and separately identifiable cash flows and application of the predominance principle. This guidance is effective for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years, with early adoption permitted. If an entity early adopts this guidance in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. The Company does not expect this guidance to have a significant impact on its financial statements. 

 

 

 
7

 

  

3.

REVENUES

 

The Company’s revenues by product line were as follows (in thousands):

  

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 
   

2016

   

2015

   

2016

   

2015

 

Residential

                               

Data

  $ 86,797     $ 73,074     $ 256,267     $ 216,610  

Video

    73,841       81,209       222,710       254,764  

Voice

    10,475       11,950       32,733       37,469  

Business services

    25,406       22,436       73,724       65,466  

Advertising sales

    6,460       7,271       20,079       22,164  

Other

    2,557       2,275       7,385       7,349  

Total revenues

  $ 205,536     $ 198,215     $ 612,898     $ 603,822  

 

The amount of franchise fees recorded on a gross basis and included in residential video revenues above was $3.6 million and $3.7 million for the three months ended September 30, 2016 and 2015, respectively, and $10.7 million and $11.9 million for the nine months ended September 30, 2016 and 2015, respectively.  

 

4.

PROPERTY, PLANT AND EQUIPMENT

 

Property, plant and equipment consisted of the following (in thousands):

 

   

September 30, 2016

   

December 31, 2015

 

Cable distribution systems

  $ 1,080,105     $ 1,017,250  

Customer premise equipment

    253,488       259,678  

Other equipment and fixtures

    352,121       317,696  

Buildings and leasehold improvements

    86,925       84,503  

Capitalized software

    80,875       75,027  

Construction in progress

    57,981       89,742  

Land

    9,476       9,482  

Total property, plant and equipment

    1,920,971       1,853,378  

Less accumulated depreciation

    (1,297,674

)

    (1,212,811

)

Property, plant and equipment, net

  $ 623,297     $ 640,567  

 

Depreciation and amortization expense was $36.2 million and $36.1 million for the three months ended September 30, 2016 and 2015, respectively, and $105.6 million and $107.9 million for the nine months ended September 30, 2016 and 2015, respectively.

 

5.

GOODWILL AND INTANGIBLE ASSETS

 

The carrying amount of goodwill at September 30, 2016 and December 31, 2015 was $85.5 million. Historically, the Company has not recorded any impairment of goodwill.  

 

Intangible assets consisted of the following (dollars in thousands):  

 

             

September 30, 2016

 
   

Useful

   

Gross

           

Net

 
   

Life

   

Carrying

   

Accumulated

   

Carrying

 
   

Range (years)

   

Amount

   

Amortization

   

Amount

 

Amortized Intangible Assets

                                 

Cable franchise renewals and access rights

  1 - 25     $ 4,132     $ 3,758     $ 374  

Indefinite-Lived Intangible Assets

                                 

Franchise agreements

            $ 495,876                  

 

 

 
8

 

  

             

December 31, 2015

 
   

Useful

   

Gross

           

Net

 
   

Life

   

Carrying

   

Accumulated

   

Carrying

 
   

Range (years)

   

Amount

   

Amortization

   

Amount

 

Amortized Intangible Assets

                                 

Cable franchise renewals and access rights

   1 - 25     $ 4,127     $ 3,678     $ 449  

Indefinite-Lived Intangible Assets

                                 

Franchise agreements

            $ 496,321                  

  

6.

LONG-TERM DEBT

 

Long-term debt as of September 30, 2016 and December 31, 2015 consisted of the following (in thousands):

 

   

September 30, 2016

   

December 31, 2015

 

Senior Unsecured Notes

  $ 450,000     $ 450,000  

Senior Credit Facilities

    96,250       98,750  

Capital lease obligation

    288       301  

Total debt

    546,538       549,051  

Less unamortized debt issuance costs

    (8,557

)

    (9,790

)

Less current portion long-term debt

    (5,625

)

    (3,750

)

Total long-term debt

  $ 532,356     $ 535,511  

  

5.750% Senior Unsecured Notes Due 2022. On June 17, 2015, the Company issued $450 million aggregate principal amount of 5.750% senior unsecured notes due 2022 (the “Notes”). The Notes mature on June 15, 2022 and interest is payable on June 15 and December 15 of each year.

 

The Notes have not been, and will not be, registered under the Securities Act of 1933, as amended (the “Securities Act”), or the securities laws of any state or other jurisdiction and may not be offered or sold in the United States absent registration or an applicable exemption from the registration requirements of the Securities Act and any other applicable securities laws. The Notes were offered in the United States only to persons reasonably believed to be qualified institutional buyers in reliance on the exemption from registration set forth in Rule 144A under the Securities Act and outside the United States to non-U.S. persons in reliance on the exemption from registration set forth in Regulation S under the Securities Act.

 

The Notes were issued pursuant to an indenture (the “Indenture”) dated as of June 17, 2015. The Indenture provides for early redemption of the Notes, at the option of the Company, at the prices and subject to the terms specified in the Indenture. The Indenture includes certain covenants relating to debt incurrence, liens, restricted payments, assets sales and transactions with affiliates, changes in control and mergers or sales of all or substantially all of the Company’s assets. The Indenture also provides for customary events of default (subject, in certain cases, to customary grace periods).

 

Senior Credit Facilities Due 2020. On June 30, 2015, the Company entered into a Credit Agreement (the “Credit Agreement”) among the Company, as borrower, the lenders party thereto, JPMorgan Chase Bank, N.A., as administrative agent, and the other agents party thereto.  The Credit Agreement provides for a five-year revolving credit facility in an aggregate amount of $200 million (the “Revolving Credit Facility”) and a five-year term loan facility in an aggregate amount of $100 million (the “Term Loan Facility” and, together with the Revolving Credit Facility, the “Senior Credit Facilities”). Concurrently with its entry into the Credit Agreement, the Company borrowed the full amount of the Term Loan Facility (the “Term Loan”).

 

Borrowings under the Senior Credit Facilities bear interest, at the Company’s option, at a rate per annum determined by reference to either the London Interbank Offered Rate (“LIBOR”) or an adjusted base rate, in each case plus an applicable interest rate margin. The applicable interest rate margin with respect to LIBOR borrowings is a rate per annum between 1.50% and 2.25% and the applicable interest rate margin with respect to adjusted base rate borrowings is a rate per annum between 0.50% and 1.25%, in each case determined on a quarterly basis by reference to a pricing grid based upon the Company’s total net leverage ratio. As of September 30, 2016, borrowings under the Senior Credit Facilities bore interest at a rate of 2.14% per annum. In addition, the Company is required to pay commitment fees on any unused portion of the Revolving Credit Facility at a rate between 0.25% per annum and 0.40% per annum, determined by reference to the pricing grid. As of September 30, 2016, the commitment fee accrues at a rate of 0.25% per annum.

 

 

 
9

 

  

The Revolving Credit Facility also gives the Company the ability to issue letters of credit, which reduce the amount available for borrowing under the Revolving Credit Facility. Letter of credit issuances under the Revolving Credit Facility of $2.8 million at September 30, 2016 were held for the benefit of certain general and liability insurance matters and bore interest at a rate of 1.625% per annum.

 

The Senior Credit Facilities may be prepaid at any time without premium, and periodic principal repayments are due in certain quarterly installments as set forth in the Credit Agreement, with the outstanding balance of the Term Loan Facility to be paid on the fifth anniversary of funding.

 

The Company may, subject to the terms and conditions of the Credit Agreement, obtain additional credit facilities of up to $300 million under the Credit Agreement pursuant to an uncommitted incremental facility.

 

The Credit Agreement contains customary representations, warranties and affirmative and negative covenants, including limitations on indebtedness, liens, restricted payments, prepayments of certain indebtedness, investments, dispositions of assets, restrictions on subsidiary distributions and negative pledge clauses, fundamental changes, transactions with affiliates and amendments to organizational documents. The Credit Agreement also contains customary events of default. The Credit Agreement also requires the Company to maintain specified ratios of total net leverage and first lien net leverage to consolidated operating cash flow.

 

The Company was in compliance with all debt covenants as of September 30, 2016. 

 

As of September 30, 2016, the future maturities of long-term debt were as follows (in thousands): 

 

Years Ending December 31:

 

Amount

 

2016

  $ 1,250  

2017

    6,250  

2018

    8,750  

2019

    12,500  

2020

    67,500  

Thereafter

    450,288  

Total

  $ 546,538  

  

7.

FAIR VALUE MEASUREMENTS

 

The Company’s deferred compensation liabilities were $18.2 million and $18.3 million at September 30, 2016 and December 31, 2015, respectively. These liabilities are included in Accrued compensation and related benefits in the Condensed Consolidated Balance Sheets. These liabilities represent the market value of a participant’s balance in a notional investment account that is comprised primarily of mutual funds, which is based on observable market prices. However, since the deferred compensation obligations are not exchanged in an active market, they are classified as Level 2 in the fair value hierarchy. Realized and unrealized gains (losses) on deferred compensation are included in operating income.

 

The carrying amounts and fair values of the Company’s money market investments, commercial paper and long-term debt, including current portion, as of September 30, 2016, were as follows (in thousands):

 

   

September 30, 2016

 
   

Carrying

   

Fair

 
   

Amount

   

Value

 

Assets:

               

Money market investments

  $ 33,083     $ 33,083  

Commercial paper

  $ 74,922     $ 74,904  

Long-term debt, including current portion

               

Notes

  $ 450,000     $ 471,375  

Term Loan

  $ 96,250     $ 96,250  

 

 

 
10

 

 

Money market investments are included in Cash and cash equivalents in the Condensed Consolidated Balance Sheets. Commercial paper investments with original maturities of 90 days or less are also included in Cash and cash equivalents. These investments are primarily held in U.S. Treasury securities and registered money market funds. These investments were valued using a market approach based on the quoted market prices of the commercial paper (Level 1) or inputs that include quoted market prices for investments similar to the money market investments (Level 2). The fair value of the Notes was estimated based on quoted market prices in less active markets (Level 2). The fair value of the Term Loan was estimated based on discounting the remaining principal and interest payments using current market rates for similar debt (Level 2). 

  

8.

TREASURY STOCK

 

On July 1, 2015, the Company’s board of directors (the “Board”) authorized up to $250 million of share repurchases (subject to a total cap of 600,000 shares of Company common stock). Purchases under the stock repurchase program may be made from time to time on the open market and in privately negotiated transactions. The size and timing of these purchases will be based on a number of factors, including price and business and market conditions. As of September 30, 2016, the Company has repurchased 164,532 shares at an aggregate cost of $72.5 million.

 

9.

EQUITY-BASED COMPENSATION

 

Through June 30, 2015, certain of the Company’s employees participated in an equity-based incentive compensation plan maintained by GHC for the benefit of certain officers, directors and employees. Equity-based awards issued to employees included non-qualified stock options and restricted stock awards. These compensation costs are recognized within Selling, general and administrative expenses in the Condensed Consolidated Statements of Operations and Comprehensive Income.

 

Certain Compensation and Benefit Plans. The Cable One, Inc. 2015 Omnibus Incentive Compensation Plan (the “2015 Plan”) is designed to promote the interests of the Company and its stockholders by providing the employees and directors of the Company with incentives and rewards to encourage them to continue in the service of the Company and with a proprietary interest in pursuing the long-term growth, profitability and financial success of the Company. Any of the directors, officers and employees of the Company and its affiliates are eligible to be granted one or more types of awards permitted under the 2015 Plan. The 2015 Plan includes the authority to grant awards that are intended to qualify as “qualified performance-based compensation” under Section 162(m) of the Internal Revenue Code of 1986, as amended. Unless the 2015 Plan is sooner terminated by the Board, no awards may be granted under the 2015 Plan after the tenth anniversary of its effective date.

 

The 2015 Plan provides that, subject to certain adjustments for certain corporate events, the maximum number of shares of Company common stock that may be issued under the 2015 Plan is equal to 600,000, and no more than 400,000 shares may be issued pursuant to incentive stock options.

 

Restricted Stock Awards. The Company has granted restricted shares of Company common stock subject to service-based vesting conditions under the 2015 Plan to employees of the Company (the “Restricted Shares”). The Restricted Shares generally cliff-vest on the three-year anniversary of the grant date, except in the case of awards made to individuals (i) whose equity awards issued by GHC were forfeited in connection with the spin-off (the “Replacement Shares”), which Replacement Shares are generally scheduled to cliff-vest on December 12, 2016 (with certain exceptions as provided in the applicable award agreement), or (ii) who did not receive an equity award from GHC in 2015 in anticipation of the spin-off (the “Staking Shares”), which Staking Shares are scheduled to cliff-vest on January 2, 2018.  The Restricted Shares are also generally subject to the achievement of certain performance goals as defined in the 2015 Plan. For awards granted in 2015, the performance goals, which have been met, related primarily to year over year growth in Adjusted EBITDA less capital expenditures.  For performance-based awards granted in 2016, the performance goals relate primarily to year over year growth in Adjusted EBITDA and to capital expenditures as a percentage of total revenues. The Restricted Shares are subject to the terms and conditions of the 2015 Plan and will otherwise be subject to the terms and conditions of the applicable award agreement.

 

The compensation arrangements for the Company’s non-employee directors under the 2015 Plan provide that each non-employee director is entitled to an annual retainer of $150,000, plus an additional annual retainer of $15,000 for each non-employee director who serves as a committee chair or as lead independent director.  Each such retainer will be provided in the form of restricted stock units (“RSUs”).  Such RSUs will generally be granted on the date of the Company’s annual stockholders’ meeting and will vest on the first anniversary of the grant date, subject to the director’s continued service through such vesting date.  Settlement of such RSUs will be in the form of one share of the Company’s common stock and will follow vesting, unless the director has previously elected to defer such settlement until his or her separation from service from the Board. As of September 30, 2016, 2,197 RSUs were vested and deferred.

 

 

 
11

 

 

During the three months ended September 30, 2016, the Company granted five RSUs to non-employee directors.

 

The Restricted Shares and RSUs are collectively referred to as “restricted stock.” During the nine months ended September 30, 2016, the Company granted 9,355 shares of restricted stock, with a total value at the grant date of $4.1 million, to employees and non-employee directors, and a summary of the restricted stock is as follows: 

 

           

Weighted Average

 
           

Grant Date

 
   

Restricted

   

Fair Value

 
   

Stock

   

Per Share

 

Unvested as of January 1, 2016

    39,744     $ 383.18  

Granted

    9,355     $ 441.45  

Vested

    (3,149 )   $ 415.12  

Unvested as of September 30, 2016

    45,950     $ 392.87  

 

Compensation expense associated with unvested restricted stock is recognized on a straight-line basis over the vesting period. The expense recognized each period is dependent upon the Company’s estimate of the number of shares that will ultimately vest. Equity-based compensation expense for restricted stock was $2.4 million and $7.4 million for the three and nine months ended September 30, 2016, respectively.  At September 30, 2016, there was $10.4 million of unrecognized compensation expense related to restricted stock, which is expected to be recognized over a weighted average period of 1.1 years.

 

Stock Appreciation Rights. The Company has granted stock appreciation rights (“SARs”) under the 2015 Plan to certain executives and other employees of the Company. The SARs are scheduled to vest in four equal ratable installments beginning on the first anniversary of the grant date (generally subject to the holder’s continued employment with the Company through the applicable vesting date). The SARs are subject to the terms and conditions of the 2015 Plan and will otherwise be subject to the terms and conditions of the applicable award agreement.

  

A summary of SAR activity is as follows: 

 

   

Stock Appreciation Rights

   

Weighted Average Exercise Price

   

Weighted Average Fair
Value

   

Aggregate Intrinsic Value

(in millions)

   

Weighted Average Remaining Contractual Term

(in years)

 

Outstanding as of December 31, 2015

    135,600     $ 422.31     $ 87.22     $ 1.5       9.7  

Granted

    2,500     $ 441.51     $ 91.48     $ -       9.5  

Outstanding as of September 30, 2016

    138,100     $ 422.66     $ 87.30     $ 22.3       8.9  
                                         

Vested and exercisable as of September 30, 2016

    33,900     $ 422.31     $ 87.22     $ 5.5       8.9  

 

The fair value of the SARs was measured based on the Black-Scholes model. The inputs used in the fair value measurement for 2016 were as follows: 

 

   

2016

 

Expected volatility

    22.67

%

Risk-free interest rate

    1.45

%

Expected term (in years)

    6.25  

Expected dividend yield

    1.35

%

 

Compensation expense associated with unvested SARs is recognized on a straight-line basis over the vesting period. The expense recognized each period is dependent upon our estimate of the number of shares that will ultimately vest. Equity-based compensation expense for these SARs was $0.8 million and $2.2 million for the three and nine months ended September 30, 2016, respectively. At September 30, 2016, there was $8.8 million of unrecognized compensation expense related to the SARs, which is expected to be recognized over a weighted average period of 1.9 years.

 

 

 
12

 

  

Compensation Expense. Total equity-based compensation expense recognized was $3.2 million and $2.1 million for the three months ended September 30, 2016 and 2015, respectively, and $9.7 million and $6.3 million for the nine months ended September 30, 2016 and 2015, respectively. The Company recorded an additional income tax benefit of $1.2 million related to the equity-based awards granted through the third quarter of 2016. As of September 30, 2016, the total deferred tax asset related to all outstanding equity-based awards was $5.4 million.  Prior to the spin-off, a portion of these charges related to costs allocated to the Company for GHC corporate employees not solely dedicated to the Company.

 

Also, in connection with the spin-off, GHC modified the terms of 10,830 restricted stock awards in the second quarter of 2015 affecting 21 Cable One employees.  The modification resulted in the acceleration of the vesting period of 6,324 restricted stock awards and the forfeiture of 4,506 restricted stock awards.  The Company recorded $3.7 million of incremental stock compensation expense, net of forfeitures, related to such awards during the first half of 2015, which is included in Selling, general and administrative expenses in the Condensed Consolidated Statements of Operations and Comprehensive Income.

 

10.

POSTEMPLOYMENT BENEFIT PLANS, PRE-SPIN

 

Multiemployer Benefit Plans. Through June 30, 2015, certain of the Company’s employees participated in The Retirement Plan for Graham Holdings Company (the “GHC Retirement Plan”) and GHC’s Supplemental Executive Retirement Plan (collectively with the GHC Retirement Plan, the “GHC Plans”). The total cost of the GHC Plans was actuarially determined and the Company received an allocation of the service cost associated with the GHC Plans based upon actual benefits earned by the Company’s employees. The amount of pension expense allocated to the Company related to these multiemployer plans was $2.1 million for the first half of 2015, and is reflected within Operating and Selling, general and administrative expenses in the Condensed Consolidated Statements of Operations and Comprehensive Income.  

 

As of June 30, 2015, the GHC Retirement Plan was fully funded and is not in critical or endangered status as currently defined by the Pension Protection Act of 2006. The GHC Supplemental Executive Retirement Plan is unfunded.

 

Multiemployer Savings Plans. Also, through June 30, 2015, the Company’s employees participated in defined contribution plans (primarily 401(k) plans) sponsored by GHC. The defined contribution plans allowed eligible employees to contribute a portion of their salary to the plans, and, in some cases, a matching contribution to the funds was provided. The Company recorded expense associated with these GHC-sponsored defined contribution plans of approximately $0.3 million for the first half of 2015.

 

11.

POSTEMPLOYMENT BENEFIT PLANS, POST-SPIN

 

As a condition of the spin-off, the Company assumed full financial and reporting responsibility for the postemployment benefit plans offered to eligible employees, other than the GHC Retirement Plan. The accumulated benefits of Company employees participating in GHC sponsored multiemployer benefit and/or savings plans other than the GHC Retirement Plan were transferred into corresponding Cable One sponsored plans. After the spin-off, GHC will continue to administer the GHC Retirement Plan, including making payments under the plan, with respect to current and former Company employees with vested rights thereunder.

 

On June 5, 2015, the Board adopted the Cable One, Inc. Supplemental Executive Retirement Plan (the “SERP”), which became effective as of July 1, 2015. The SERP includes a defined benefit portion, or the “DB SERP,” and a defined contribution portion, or the “DC SERP.”

 

Upon the spin-off, under the SERP, a $5.4 million long-term liability was transferred from GHC to Cable One representing the accumulated DB SERP and DC SERP liabilities of $4.1 million and $1.3 million, respectively. As the DB SERP is unfunded, the Company makes contributions to the DB SERP based on actual benefit payments, which were not material for each of the three and nine months ended September 30, 2016 and 2015. Participant contributions into the DC SERP continued through December 31, 2015. No Company contributions were earned by DC SERP participants on or after July 1, 2015.

 

 

 
13

 

 

The Company uses a measurement date of December 31 for the DB SERP. An unamortized actuarial loss related to the DB SERP was recorded as of December 31, 2015, which is amortized through other comprehensive income over the estimated remaining service periods of the participants and is recognized in Other comprehensive gain, net of tax in the Condensed Consolidated Statements of Operations and Comprehensive Income.

 

On June 5, 2015, the Board also adopted the Cable One Inc. 401(k) Savings Plan (the “401(k) Plan”). The 401(k) Plan allows for eligible employees to contribute a portion of their salary to the 401(k) Plan, and in some cases, a matching contribution to the 401(k) Plan is made by the Company. The Company recorded matching contributions to the 401(k) Plan of $0.8 million and $2.1 million for the three and nine months ended September 30, 2016, respectively.

 

In addition to the advent of the post-spin postemployment plans described above, the Company has (prior to the spin-off) and may continue to enter into arrangements with certain current and former executives and officers of the Company who desire to defer all or a portion of their annual cash-based incentives under the Cable One, Inc. Deferred Compensation Plan. Upon execution of the agreements the Company transfers the deferred incentive to a long-term liability. Market-based gains and losses are applied to the respective outstanding balances at each reporting period such that market-based period gains represent additional compensation expense to the Company and market-based losses represent a reduction of compensation expense. The Company recorded compensation expense of $0.4 million and income of $0.5 million for the three months ended September 30, 2016 and 2015, respectively, and compensation expense of $0.2 million and income of $1.1 million for the nine months ended September 30, 2016 and 2015, respectively. The total deferred compensation balance as of September 30, 2016 and December 31, 2015 was $18.2 million and $18.3 million, respectively.

 

In 1999, the Company’s CEO was granted a special deferred compensation award in recognition of his efforts in growing Cable One. Annual payouts under this arrangement will commence when he separates service with Cable One. The base amounts began accruing interest on May 1, 2016 at an annual rate corresponding to the applicable rate for 12-month U.S. treasury bills (set at each anniversary and carried forward), credited and compounded on an annual basis. The award may be payable in installments upon mutual agreement of Cable One and the CEO, not to extend beyond a ten-year period, however, in the event of his death, all amounts due will be payable in a lump sum within 60 days. No amounts have been paid to the CEO in 2016 in respect of this arrangement. As of September 30, 2016, the Company had an accrued liability of $2.0 million for this special deferred compensation, which is included within the Accrued compensation and related benefits line item on the Condensed Consolidated Balance Sheets.

 

12.

INCOME TAXES

 

The Company’s effective tax rate was 48.6% and 38.0% for the three months ended September 30, 2016 and 2015, respectively, and 40.0% and 38.3% for the nine months ended September 30, 2016 and 2015, respectively. The effective tax rates for the 2016 periods were higher than in the same periods in the prior year primarily due to $4.1 million in adjustments to correct misstatements related to deferred taxes recorded prior to the spin-off, a state tax audit covering a period prior to the spin-off and other tax calculations from prior years. These amounts are not material to the originating periods or for the Company’s projected annual results. The Company also recorded a $0.7 million adjustment primarily related to a change in estimate in a state apportionment calculation.

 

13.

NET INCOME PER SHARE

 

Basic net income per common share is computed by dividing the net income allocable to the common stockholders by the weighted average number of common shares outstanding during the period. Diluted income per share further includes any common shares available to be issued upon exercise of outstanding equity awards if such inclusion would be dilutive. 

 

The following table sets forth the computation of basic and diluted net income per common share (in thousands, except share and per share amounts):

 

   

Three Months Ended

   

Nine Months Ended

 
   

September 30,

   

September 30,

 
   

2016

   

2015

   

2016

   

2015

 

Numerator:

                               

Net income

  $ 20,874     $ 19,412     $ 74,552     $ 62,956  

Denominator:

                               

Weighted average common shares outstanding - Basic

    5,720,257       5,871,928       5,753,204       5,852,956  

Effect of dilutive equity awards (1)

    34,904       3,660       23,300       1,220  

Weighted average common shares outstanding - Diluted

    5,755,161       5,875,588       5,776,504       5,854,176  
                                 

Net income per share:

                               

Basic

  $ 3.65     $ 3.31     $ 12.96     $ 10.76  

Diluted

  $ 3.63     $ 3.30     $ 12.91     $ 10.75  

__________

(1) SARs outstanding that were not included in the diluted net income per share calculation because the effect would have been anti-dilutive were 0 and 12,787 for the three and nine months ended September 30, 2016, respectively, and 44,217 for the three and nine months ended September 30, 2015, respectively.

 

 

 
14

 

 

14.

RELATED PARTY TRANSACTIONS

 

Allocation of expenses. Prior to the spin-off, the Condensed Consolidated Financial Statements included allocations of expenses from GHC for certain overhead functions, including, but not limited to, finance, human resources, legal, information technology, general insurance, risk management and other corporate functions. These expenses were allocated to the Company on the basis of direct usage when identifiable, with the remainder generally allocated on a proportional basis using revenue or headcount. The Company was allocated $5.8 million of corporate overhead costs incurred by GHC for the first half of 2015, which are included in Selling, general and administrative expenses in the Condensed Consolidated Statements of Operations and Comprehensive Income.

 

These expense allocations were determined on the basis that both the Company and GHC considered to be a reasonable reflection of the utilization of services provided or the benefit received by the Company. The allocations may not, however, have reflected the expense the Company would have incurred as an independent company for the periods prior to the spin-off. Actual costs that may have been incurred if the Company had been a stand-alone company would depend on a number of factors, including the chosen organizational structure and certain strategic decisions. 

 

15.

COMMITMENTS AND CONTINGENCIES

 

Litigation and Legal Matters. The Company is subject to complaints and administrative proceedings and is a defendant in various civil lawsuits that have arisen in the ordinary course of its businesses. Such matters include: contract disputes; actions alleging negligence; invasion of privacy; trademark, copyright and patent infringement; violations of applicable wage and hour laws; statutory or common law claims involving current and former employees; and other matters. Although the outcomes of the legal claims and proceedings against the Company cannot be predicted with certainty, based on currently available information, management believes that there are no existing claims or proceedings that are likely to have a material effect on the Company’s business, financial condition, results of operations or cash flows. Also, based on currently available information, management is of the opinion that the exposure to future material losses from existing legal proceedings is not reasonably possible or that future material losses in excess of the amounts accrued are not reasonably possible.

 

Regulation in the Cable Industry. The operation of a cable system is extensively regulated by the Federal Communications Commission (the “FCC”), some state governments and most local governments. The FCC has the authority to enforce its regulations through the imposition of substantial fines, the issuance of cease and desist orders and/or the imposition of other administrative sanctions, such as the revocation of FCC licenses needed to operate certain transmission facilities used in connection with cable operations. The Telecommunications Act of 1996 altered the regulatory structure governing the nation’s communications providers. It removed barriers to competition in both the cable television market and the telephone market. Among other things, it reduced the scope of cable rate regulation and encouraged additional competition in the video programming industry by allowing telephone companies to provide video programming in their own telephone service areas. Future legislative and regulatory changes could adversely affect the Company’s operations.

 

GHC Agreements. On June 16, 2015, Cable One entered into several agreements with GHC that set forth the principal actions taken in connection with the spin-off and that govern the relationship of the parties following the spin-off, including a Separation and Distribution Agreement, a Tax Matters Agreement and an Employee Matters Agreement.

 

 

 
15

 

  

Item 2.     Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited Condensed Consolidated Financial Statements and related notes included in this Quarterly Report on Form 10-Q and the audited financial statements and notes thereto as of and for the year ended December 31, 2015 and the related Management’s Discussion and Analysis of Financial Condition and Results of Operations, both of which are contained in our Annual Report on Form 10-K filed with the SEC on March 7, 2016.

 

Introduction 

 

Management’s discussion and analysis of financial condition and results of operations (“MD&A”) is a supplement to the accompanying Condensed Consolidated Financial Statements and provides additional information about our operations, current developments, financial condition, cash flows and results of operations. MD&A is organized as follows:

 

 

Overview. This section provides a general description of our business, as well as recent developments we believe are important in understanding our results of operations and financial condition or in understanding anticipated future trends.

 

 

• 

Results of Operations. This section provides an analysis of our results of operations for the three months ended September 30, 2016 and 2015 and for the nine months ended September 30, 2016 and 2015. 

 

 

• 

Financial Condition: Liquidity and Capital Resources. This section provides a discussion of our current financial condition and an analysis of our cash flows for the nine months ended September 30, 2016 and 2015. This section also provides a discussion of our financing activity, contractual obligations and commitments and off-balance sheet arrangements that existed at September 30, 2016. Included in this section is a discussion of the amount of financial capacity available to fund our future commitments and ongoing operating activities.

 

 

• 

Critical Accounting Policies and Estimates. This section identifies and summarizes those accounting policies that we consider important to our results of operations and financial condition, require significant judgment and require significant estimates on the part of management in application.

 

Overview

 

Spin-Off

 

On July 1, 2015, Cable One became an independent company traded under the ticker symbol “CABO” on the New York Stock Exchange. The spin-off was effected through the distribution by GHC of 100% of the outstanding shares of common stock of Cable One to GHC stockholders as of the record date for the distribution in a pro rata dividend. In connection with the spin-off, approximately 5.84 million shares of Cable One’s common stock were issued and outstanding on July 1, 2015 at 12:01 a.m., based on approximately 0.96 million shares of GHC Class A Common Stock and 4.88 million shares of GHC Class B Common Stock outstanding as of June 30, 2015. No preferred stock was issued or outstanding.

 

Our Business

 

          We are a fully integrated provider of data, video and voice services in 19 Western, Midwestern and Southern states. We provide these broadband services to residential and business customers in more than 35 cable systems covering over 400 cities and towns. The markets we serve are primarily non-metropolitan, secondary markets, with 76% of our customers located in five states: Arizona, Idaho, Mississippi, Oklahoma and Texas. Our biggest customer concentrations are in the Mississippi Gulf Coast region and in the greater Boise, Idaho region. We are the seventh-largest cable system operator in the United States based on customers and revenues for the first half of 2016, making services available to approximately 1,657,000 homes in the United States as of September 30, 2016.

 

As of September 30, 2016, we provided service to 658,088 residential and business customers out of approximately 1,657,000 homes passed. Of these customers, 510,573 subscribed to data services, 329,386 subscribed to video services and 118,205 subscribed to voice services.   

 

 
16

 

 

We generate revenues through five primary products. Ranked by share of our total revenues through the first nine months of 2016, they are residential data (41.8%) residential video (36.3%), business services (data, voice and video – 12.0%), residential voice (5.4%) and advertising sales (3.3%). The profit margins, growth rates and capital intensity of our five primary products vary significantly due to competition and product maturity.

 

Prior to 2012, we were focused on growing revenues through subscriber retention and growth in overall primary service units (“PSUs”). To that end, our strategies consisted of, among others, offering promotional discounts to new and existing subscribers adding new services and to subscribers purchasing more than one service offering.

 

Since 2012, we have adapted our strategy to face the relatively recent trend, affecting the entire cable industry, of declining profitability of residential video services and declining revenues from residential voice services. We believe the declining profitability of residential video services is primarily due to competition from other content providers and increasing programming costs and the declining revenues from residential voice services is primarily due to the increasing use of wireless voice services in addition to, or instead of, wireline voice. From 2013 through the third quarter of 2016, we shifted our focus away from maximizing customer PSUs and towards growing and maintaining our higher margin businesses, namely residential data and business services. Separately, we have also focused on retaining customers with a relatively high expected life-time value (“LTV”), who are less attracted by discounting, require less support and churn less. This strategy focuses on increasing cash flow, Adjusted EBITDA less capital expenditures and margins.

 

The trends described above have impacted our four largest product lines in the following ways:

 

 

Residential data. We experienced growth in the number of our residential data customers and revenues from sales to residential data customers in 2013, 2014, 2015 and the first nine months of 2016. We expect this growth to continue due to projected increases in the number of potential customers for us to serve, as there are still a number of households in our markets that do not subscribe to data services from any provider. We expect to capture a portion of these customers and anticipate capturing additional market share from existing data subscribers due to our recent upgrades in broadband capacity and our ability to offer higher access speeds than many of our competitors.

 

 

 

Residential video. Residential video service is a competitive and highly-penetrated business. As we focus on the higher-margin businesses of residential data and business services, we are de-emphasizing our residential video business and, as a result, expect residential video revenues to decline in the future.

 

 

Residential voice. We have experienced declines in residential voice customers as a result of homes in the United States deciding to terminate their landline voice service and exclusively use wireless voice service. We believe this trend will continue because of competition from wireless voice service. Revenues from residential voice customers have declined since 2012, and we expect this decline will continue.

 

 

• 

Business services. We have experienced significant growth in business data, voice and video customers and revenues and expect this to continue. We attribute this growth to our strategic focus, beginning in 2013 and expected to continue in the future, on increasing sales to business customers. Margins in products sold to business customers have remained attractive, and we expect this trend to continue.

 

We continue to experience increased competition, particularly from telephone companies, cable overbuilders, over-the-top (“OTT”) video providers and satellite television providers. Because of the levels of competition we face, we believe it is important to make investments in our infrastructure. We are investing at an aggressive pace by increasing cable plant capacities and reliability, launching all-digital video services, which can free up approximately three-fourths of average plant bandwidth for data services, and increasing data capacity by moving from four-channel bonding to 32-channel bonding, an 800% increase. We believe these investments are necessary to remain competitive. However, we anticipate that a significant amount of these capital projects will be completed by the end of 2016, freeing up sources of cash that would otherwise have been used on such investments.

  

The spin-off provided us the opportunity to further tailor our strategies to achieve greater operational focus and drive our return on investment. Our goals are to continue to grow residential data and business services and to maintain profit margins to deliver strong cash flow. To achieve these goals, we intend to continue our focus-driven cost management, remain focused on customers with high LTV and follow through with planned investments in broadband plant upgrades.

  

 

 
17

 

 

Our business is subject to extensive governmental regulation. Such regulation has led to increases in our operational and administrative expenses. In addition, we could be significantly impacted by changes to the existing regulatory framework, whether triggered by legislative, administrative or judicial rulings. On February 26, 2015, the FCC voted to use its Title II authority to regulate broadband Internet access services, and on March 12, 2015, the FCC released the text of the Open Internet Order (the “Order”). According to the Order, under this regime, the FCC will forbear from systematic rate regulation of Internet access service at the subscriber level, which we believe will permit us to continue to manage data usage efficiently by establishing appropriate rates. However, the Order also imposes on all providers of broadband Internet access service, including us, obligations that limit the ways we can manage certain types of traffic. In June 2016, the U.S. Court of Appeals for the D.C. Circuit upheld the Order in its entirety. A petition for an en banc rehearing of the June 2016 decision upholding the Order is currently pending in the U.S. Court of Appeals for the D.C. Circuit. We cannot predict whether or not future changes to the regulatory framework that are inconsistent with the Order will occur, whether the petition for an en banc rehearing will be granted, or whether the decision of the U.S. Court of Appeals for the D.C. Circuit will be appealed, and if any such rehearing or appeal would be successful.

  

 Results of Operations

 

Basis of Presentation

 

Prior to the spin-off, we functioned as part of the larger group of companies controlled by GHC, and, accordingly, GHC provided certain support and overhead functions to us. These functions included finance, human resources, legal, information technology, general insurance, risk management and other corporate functions. The costs of such services were allocated to us based on the most relevant allocation methods to the service provided. Management believed such allocations were reasonable and were consistently applied; however, they may not be indicative of the actual expense that would have been incurred had we been operating on a stand-alone basis. See Notes 10 and 14 of the Notes to our Condensed Consolidated Financial Statements for details on these allocations.

 

Prior to the spin-off, we participated in a centralized approach to cash management and in financing our operations managed by GHC. Cash was transferred to GHC and GHC funded our operating and investing activities as needed. Accordingly, cash and cash equivalents at the GHC level were not allocated to us in the Condensed Consolidated Financial Statements included elsewhere in this Quarterly Report on Form 10-Q. GHC third-party debt and the related interest expense were not allocated to us for any of the periods presented as we were not the legal obligor on the debt and GHC borrowings were not directly attributable to our business.

 

The obligation for U.S. Federal and certain state income taxes attributable to the tax period prior to the spin-off were retained by us, along with related deferred tax assets and liabilities. With respect to general insurance and workers’ compensation liabilities, we assumed financial responsibility.

 

Also, in connection with the spin-off, on June 29, 2015, we distributed $450 million to GHC, which was funded by the Notes. See “Financial Condition: Liquidity and Capital Resources—Financing Activity” for more information on our capitalization activities.

 

Our results of operations for the three and nine months ended September 30, 2016 may not be indicative of our future results. In addition, as we did not operate as a stand-alone entity prior to July 1, 2015, the financial information included in this Quarterly Report on Form 10-Q may not necessarily be indicative of our future performance and may not necessarily reflect what our financial position, results of operations or cash flows would have been had we operated as a stand-alone entity during all of the periods presented.

 

Customer Counts and PSUs by Primary Products

 

Between October 1, 2015 and September 30, 2016, we had a reduction of 56,764 residential PSUs, representing a decline of 6.0%. Including business customers, we had a reduction of 50,283 PSUs, representing a decline of 5.0%, and a reduction of 9,297 total customer relationships, representing a decline of 1.4% for the 12 months ended September 30, 2016. The declines in residential PSUs and total customer relationships were primarily the result of residential video and residential voice customer losses due to our shift in focus, as described above.

  

           For the nine months ended September 30, 2016, we had a reduction of 39,117 residential PSUs, representing a 4.2% decline from December 31, 2015. Including business customers, we had a reduction of 34,321 PSUs during the nine months ended September 30, 2016, representing a 3.5% decline from December 31, 2015, and we had a reduction of 6,516 total customer relationships, representing a 1.0% decrease from December 31, 2015.

 

 

 
18

 

 

           The following table provides an overview of selected customer data for our cable systems for the time periods specified:

 

   

As of September 30,

   

Annual Net Gain/(Loss)

 

Customer Counts and PSUs

 

2016

   

2015

   

Change

   

% Change

 

Residential data customers (1)

    466,668       457,973       8,695       1.9  

Residential video customers (2)

    315,589       366,294       (50,705

)

    (13.8

)

Residential voice customers (3)

    100,510       115,264       (14,754

)

    (12.8

)

Total residential (4)

    882,767       939,531       (56,764

)

    (6.0

)

Business data customers (5)

    43,905       38,892       5,013       12.9  

Business video customers (6)

    13,797       14,513       (716

)

    (4.9

)

Business voice customers (7)

    17,695       15,511       2,184       14.1  

Total business (8)

    75,397       68,916       6,481       9.4  

Total PSUs

    958,164       1,008,447       (50,283

)

    (5.0

)

Total residential customer relationships

    607,399       621,152       (13,753

)

    (2.2

)

Total business customer relationships

    50,689       46,233       4,456       9.6  

Total customer relationships

    658,088       667,385       (9,297 )     (1.4

)

 


(1)

Residential data customers include all residential customers who subscribe to our data service.

(2)

Residential video customers include all basic residential customers who receive video services and may have one or more digital set-top boxes or cable cards deployed. Residential bulk multi-dwelling accounts are included in our video customers.

(3)

Residential voice customers include all residential customers who subscribe to our voice service. Residential customers who take multiple voice lines are only counted once in the total.

(4)

Total residential PSUs represents the sum of residential data, residential video and residential voice customers, not counting additional outlets within one household.

(5)

Business data customers include commercial accounts that receive data service via a cable modem and commercial accounts that receive broadband service optically, via fiber connections.

(6)

Business video customers include commercial accounts.

(7)

Business voice customers include commercial accounts that subscribe to our voice service.

(8)

Total business PSUs represent the sum of business data, business video and business voice customers.

 

In recent years, our customer mix has shifted, causing subscribers to move from triple-play packages to single and double-play. This is because some residential video customers have defected to direct broadcast satellite services and OTT offerings in lieu of video and more households have discontinued landline voice service. In addition, we have focused on selling data-only packages to new customers rather than on cross-selling video to these customers.

 

Comparison of Three Months Ended September 30, 2016 to Three Months Ended September 30, 2015

 

Revenues

 

Revenues increased $7.3 million, or 3.7%, due primarily to increases in residential data and business services revenues of $13.7 million and $3.0 million, respectively, as a result of the customer mix shift described above, partially offset by decreases in residential video and residential voice revenues of $7.4 million and $1.5 million, respectively. The declines in residential video and residential voice revenues were primarily attributable to residential video customer losses of 13.8% and residential voice customer losses of 12.8% for the 12 months ended September 30, 2016.

 

 

 
19

 

 

Revenues by service offering were as follows for the three months ended September 30, 2016 and 2015, together with the percentages of revenues that each item represented for the periods presented (dollars in thousands):

 

   

Three Months Ended September 30,

 
   

2016

   

2015

   

2016 vs. 2015

 
           

% of

           

% of

       

%

 
   

Revenues

   

Revenues

   

Revenues

   

Revenues

   

Change

   

Change

 

Residential data

  $ 86,797       42.2     $ 73,074       36.9     $ 13,723       18.8  

Residential video

    73,841       35.9       81,209       41.0       (7,368

)

    (9.1

)

Residential voice

    10,475       5.1       11,950       6.0       (1,475

)

    (12.3

)

Business services

    25,406       12.4       22,436       11.3       2,970       13.2  

Advertising sales

    6,460       3.2       7,271       3.7       (811

)

    (11.2

)

Other

    2,557       1.2       2,275       1.1       282       12.4  

Total revenues

  $ 205,536       100.0     $ 198,215       100.0     $ 7,321       3.7  

     

    Average monthly revenue per unit for the indicated service offerings were as follows for the three months ended September 30, 2016 and 2015: 

 

   

Three Months Ended September 30,

   

2016 vs. 2015

 
                    $    

%

 
   

2016

   

2015

   

Change

   

Change

 

Residential data (1)

  $ 62.07     $ 53.22     $ 8.85       16.6  

Residential video (1)

    76.85       72.05       4.80       6.7  

Residential voice (1)

    34.18       33.77       0.41       1.2  

Business services (2)

    168.80       164.40       4.40       2.7  

Total customers (2)

    103.96       98.66       5.30       5.4  

(1)

Average monthly per unit values represent the applicable residential service revenues divided by the corresponding average number of customers at the beginning and end of each period.

(2)

Average monthly per unit values represent the applicable business services or total revenues divided by the corresponding average number of customer relationships at the beginning and end of each period.

 

Residential data service revenues increased $13.7 million, or 18.8%, due primarily to a rate increase taken in the fourth quarter of 2015, an increase in residential data customers of 1.9% for the 12 months ended September 30, 2016, a reduction in package discounting and increased subscriptions to premium tiers by residential customers.

 

Residential video service revenues declined $7.4 million, or 9.1%, due primarily to residential video customer losses of 13.8%, partially offset by a broadcast television surcharge imposed in the second quarter of 2016.

 

Residential voice service revenues decreased $1.5 million, or 12.3%, due primarily to a decline in residential voice customers of 12.8% for the 12 months ended September 30, 2016 as more residential customers have discontinued landline voice service.

 

Business services revenues increased $3.0 million, or 13.2%, due primarily to growth in our business data and voice services to both small and medium-sized businesses and enterprise customers. Total business customer relationships increased 9.6% for the 12 months ended September 30, 2016. Overall, business services comprised 12.4% of our total revenues for the third quarter of 2016 compared to 11.3% of our total revenues for the third quarter of 2015.

 

Advertising sales revenues declined $0.8 million, or 11.2%, due primarily to the negative impact of decreased video customers on the number of viewers available to be reached by advertising spots.

 

Other revenues increased $0.3 million, or 12.4%, due primarily to an increase in reconnect fees and other miscellaneous revenue of $0.4 million, partially offset by a decrease in late charges revenue of $0.1 million.

 

 Operating Costs and Expenses

 

Operating expenses (excluding depreciation and amortization) increased $1.4 million, or 1.9%, due primarily to a $2.9 million increase in non-programming operating expenses, partially offset by a $1.5 million decrease in programming costs, which primarily resulted from a 13.8% reduction in residential video customers. The increase in non-programming operating expenses was primarily attributable to increases in the net impact of changes in capitalized and contract labor of $1.3 million as the mix of plant-related labor shifted to repair and maintenance activities, fixed asset disposals of $0.8 million, backbone and Internet connectivity fees of $0.6 million, and software maintenance of $0.2 million. Operating expenses (excluding depreciation and amortization) as a percentage of revenues were 37.3% and 38.0% for the three months ended September 30, 2016 and 2015, respectively.

  

 

 
20

 

 

Selling, general and administrative expenses increased $1.0 million, or 2.1%, due primarily to increases in equity and cash-based incentive compensation of $3.2 million; acquisition-related costs of $2.5 million; and advertising and marketing costs of $1.3 million; partially offset by decreases in salaries, wages and benefits costs of $2.4 million due to decreased headcount and lower group insurance costs; processing costs for customer billing following the completion of our billing system conversion of $2.1 million; and general insurance costs of $1.2 million. Selling, general and administrative expenses as a percentage of revenues were 23.7% and 24.1% for the three months ended September 30, 2016 and 2015, respectively.

 

           Depreciation and amortization increased $0.1 million, or 0.3%.

 

Interest Expense

 

Interest expense decreased $0.3 million, or 3.5%.

 

Other Income

 

Other income increased $4.2 million, due to a $4.2 million net gain on the sale of a cable system.

 

Provision for Income Taxes  

 

            Provision for income taxes increased $7.9 million, or 66.2%, due primarily to certain pre-spin period discrete tax items recorded during the third quarter of 2016 and an increase in taxable income of $9.3 million, or 29.8%. Our effective tax rate was 48.6% and 38.0% for the three months ended September 30, 2016 and 2015, respectively. The effective tax rate for the 2016 period was higher than in the same period in the prior year primarily due to $4.1 million in adjustments to correct misstatements related to deferred taxes recorded prior to the spin-off, a state tax audit covering a period prior to the spin-off and other tax calculations from prior years. We also recorded a $0.7 million adjustment primarily related to a change in estimate in a state apportionment calculation. 

 

Net Income  

 

           Net income increased $1.5 million, or 7.5%, due primarily to higher revenues from the increases in residential data and business services customers and the residential data rate increase taken in the fourth quarter of 2015 as well as the net gain on the sale of a cable system, partially offset by increased operating; selling, general and administrative; and income tax expenses incurred during the current quarter.

 

Comparison of Nine Months Ended September 30, 2016 to Nine Months Ended September 30, 2015

 

Revenues

 

Revenues increased $9.1 million, or 1.5%, due primarily to increases in residential data and business services revenues of $39.7 million and $8.3 million, respectively, as a result of the customer mix shift described above, partially offset by decreases in residential video and residential voice revenues of $32.1 million and $4.7 million, respectively. The declines in residential video and residential voice revenues were primarily attributable to residential video customer losses of 13.8% and residential voice customer losses of 12.8% for the 12 months ended September 30, 2016.

 

 

 
21

 

 

Revenues by service offering were as follows for the nine months ended September 30, 2016 and 2015, together with the percentages of revenues that each item represented for the periods presented (dollars in thousands):

 

   

Nine Months Ended September 30,

 
   

2016

   

2015

   

2016 vs. 2015

 
           

% of

           

% of

    $    

%

 
   

Revenues

   

Revenues

   

Revenues

   

Revenues

   

Change

   

Change

 

Residential data

  $ 256,267       41.8     $ 216,610       35.9     $ 39,657       18.3  

Residential video

    222,710       36.3       254,764       42.2       (32,054

)

    (12.6

)

Residential voice

    32,733       5.4       37,469       6.2       (4,736

)

    (12.6

)

Business services

    73,724       12.0       65,466       10.8       8,258       12.6  

Advertising sales

    20,079       3.3       22,164       3.7       (2,085

)

    (9.4

)

Other

    7,385       1.2       7,349       1.2       36       0.5  

Total revenues

  $ 612,898       100.0     $ 603,822       100.0     $ 9,076       1.5  

      

    Average monthly revenue per unit for the indicated service offerings were as follows for the nine months ended

September 30, 2016 and 2015: 

   

Nine Months Ended September 30,

   

2016 vs. 2015

 
                    $    

%

 
   

2016

   

2015

   

Change

   

Change

 

Residential data (1)

  $ 61.39     $ 53.02     $ 8.37       15.8  

Residential video (1)

    74.37       70.53       3.84       5.4  

Residential voice (1)

    34.39       33.82       0.57       1.7  

Business services (2)

    167.05       163.52       3.53       2.2  

Total customers (2)

    102.97       99.10       3.87       3.9  


(1)

Average monthly per unit values represent the applicable residential service revenues divided by the corresponding average number of customers at the beginning and end of each period.

(2)

Average monthly per unit values represent the applicable business services or total revenues divided by the corresponding average number of customer relationships at the beginning and end of each period.

 

Residential data service revenues increased $39.7 million, or 18.3%, due primarily to a rate increase taken in the fourth quarter of 2015, an increase in residential data customers of 1.9% for the 12 months ended September 30, 2016, a reduction in package discounting and increased subscriptions to premium tiers by residential customers.

 

Residential video service revenues declined $32.1 million, or 12.6%, due primarily to residential video customer losses of 13.8% for the 12 months ended September 30, 2016, partially offset by a broadcast television surcharge imposed in the second quarter of 2016.

 

Residential voice service revenues decreased $4.7 million, or 12.6%, due primarily to a decline in residential voice customers of 12.8% for the 12 months ended September 30, 2016 as more residential customers have discontinued landline voice service.

 

Business services revenues increased $8.3 million, or 12.6%, due primarily to growth in our business data and voice services to both small and medium-sized businesses and enterprise customers. Total business customer relationships increased 9.6% for the 12 months ended September 30, 2016. Overall, business services comprised 12.0% of our total revenues for the nine months ended September 30, 2016, compared to 10.8% of our total revenues for the nine months ended September 30, 2015.

 

Advertising sales revenues declined $2.1 million, or 9.4%, due primarily to the negative impact of decreased video customers on the number of viewers available to be reached by advertising spots.

 

Other revenues remained flat at approximately $7.3 million, due primarily to an increase in reconnect fees, offset by a similar-sized decrease in late fees.

 

 

 
22

 

  

Operating Costs and Expenses  

 

Operating expenses (excluding depreciation and amortization) declined $6.3 million, or 2.7%, due primarily to a 13.8% reduction in residential video customers, which significantly reduced programming costs. In total, programming costs declined $8.5 million and non-programming operating expenses increased $2.2 million. The increase in non-programming operating expenses was primarily attributable to increases in backbone and Internet connectivity fees of $1.7 million, repair and maintenance costs of $1.0 million, and employee and contract labor costs of $0.7 million, partially offset by a decrease in franchise fees of $1.2 million due to the decrease in video revenues subject to franchise fees. Operating expenses (excluding depreciation and amortization) as a percentage of revenues were 37.4% and 39.0% for the nine months ended September 30, 2016 and 2015, respectively.

  

 Selling, general and administrative expenses declined $13.3 million, or 8.9%, due primarily to decreases in processing costs for customer billing following the completion of our billing system conversion of $10.1 million; salaries, wages and benefits costs of $7.1 million due to decreased headcount and lower group insurance and 401(k) matching contributions; property taxes and rent expense of $2.0 million; the net impact of changes in capitalized and contract labor of $0.9 million; and bad debt expense of $0.8 million; partially offset by increases in equity and cash-based compensation expense of $5.3 million and acquisition-related costs of $3.1 million. Selling, general and administrative expenses as a percentage of revenues were 22.2% and 24.8% for the nine months ended September 30, 2016 and 2015, respectively.

 

           Depreciation and amortization decreased $2.3 million, or 2.2%, due primarily to decreases in depreciation related to assets reaching the end of their depreciable lives, partially offset by depreciation of assets added during the nine months ended September 30, 2016.

 

Interest Expense

 

Interest expense was $22.6 million for the nine months ended September 30, 2016, attributable to our long-term debt incurred in connection with the spin-off. Interest expense was $8.8 million for the nine months ended September 30, 2015. The increase was due to the issuance of our long-term debt in June 2015, for which we incurred nine months of interest expense in 2016, compared with approximately four months of interest expense in 2015.

 

Other Income

 

Other income increased $4.9 million due primarily to a $4.2 million net gain on the sale of a cable system and higher interest income and the impact of certain state income tax credits totaling $0.4 million.

 

Provision for Income Taxes  

 

           Provision for income taxes increased $10.5 million, or 26.9%, due primarily to an increase in taxable income of $22.1 million, or 21.7%. Our effective tax rate was 40.0% and 38.3% for the nine months ended September 30, 2016 and 2015, respectively. The effective tax rate for the 2016 period was higher than in the same period in the prior year primarily due to $4.1 million in adjustments to correct misstatements related to deferred taxes recorded prior to the spin-off, a state tax audit covering a period prior to the spin-off and other tax calculations from prior years. We also recorded a $0.7 million adjustment primarily related to a change in estimate in a state apportionment calculation. 

 

Net Income  

 

Net income increased $11.6 million, or 18.4%, due primarily to decreased operating and selling, general and administrative expenses; higher revenues from the increases in residential data and business services customers and the residential data rate increase taken in the fourth quarter of 2015; and the net gain on the sale of a cable system; partially offset by increased interest and income tax expenses incurred during the current period.

 

Use of Adjusted EBITDA

 

We use certain measures that are not defined by GAAP to evaluate various aspects of our business. Adjusted EBITDA is a non-GAAP financial measure and should be considered in addition to, not as a substitute for, net income reported in accordance with GAAP. This term, as defined by us, may not be comparable to similarly titled measures used by other companies. Adjusted EBITDA is reconciled to net income below.

 

 

 
23

 

 

Adjusted EBITDA is defined as net income plus net interest expense, provision for income taxes, depreciation and amortization, equity- and pre-spin cash-based incentive compensation expense, loss (gain) on deferred compensation, other income, net, acquisition-related costs, loss on disposal of fixed assets and other unusual operating expenses, as defined in the table below. As such, it eliminates the significant non-cash depreciation and amortization expense that results from the capital-intensive nature of our business as well as other non-cash or special items and is unaffected by our capital structure or investment activities. 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.

  

           We use Adjusted EBITDA to assess our performance. In addition, Adjusted EBITDA generally correlates to the leverage ratio calculation under our Senior Credit Facilities and outstanding Notes to determine compliance with the covenants contained in the Senior Credit Facilities and Notes. For the purpose of calculating compliance with leverage covenants, we use a measure similar to Adjusted EBITDA, as presented. Adjusted EBITDA is also a significant performance measure used by us in our annual incentive compensation program. Adjusted EBITDA does not take into account cash used for mandatory debt service requirements or other non-discretionary expenditures, and thus does not represent residual funds available for discretionary uses.

  

   

Three Months Ended September 30,

 

(dollars in thousands)

 

2016

   

2015

   

$ Change

   

% Change

 

Net income

  $ 20,874     $ 19,412     $ 1,462       7.5  
                                 

Plus:   Interest expense, net

    7,529       7,804       (275

)

    (3.5

)

Provision for income taxes

    19,746       11,883       7,863       66.2  

Depreciation and amortization

    36,218       36,108       110       0.3  

Equity-based incentive compensation expense

    3,187       2,054       1,133       55.2  

Loss (gain) on deferred compensation

    358       (490

)

    848       (173.1

Other income, net

    (4,329

)

    (103

)

    (4,226

)

    NM  

Acquisition-related costs

    2,512       -       2,512       NM  

Loss on disposal of fixed assets

    1,060       216       844       NM  

Billing system implementation costs

    -       540       (540

)

    (100.0

)

                                 

Adjusted EBITDA

  $ 87,155     $ 77,424     $ 9,731       12.6  

 

   

Nine Months Ended September 30,

 

(dollars in thousands)

 

2016

   

2015

   

$ Change

   

% Change

 

Net income

  $ 74,552     $ 62,956     $ 11,596       18.4  
                                 

Plus:   Interest expense, net

    22,633       8,801       13,832       157.2  

Provision for income taxes

    49,598       39,079       10,519       26.9  

Depreciation and amortization

    105,600       107,922       (2,322

)

    (2.2

)

Equity- and pre-spin cash-based incentive compensation expense