Certain statements contained in this Quarterly Report that are not historical facts contain "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements represent our goals, beliefs, plans and expectations about our prospects for the future and other future events. Forward-looking statements include all statements that are not historical fact and can be identified by terms such as "may," "intend," "might," "will," "should," "could," "would," "anticipate," "expect," "believe," "estimate," "plan," "project," "predict," "potential," or the negative of these terms. Although these forward-looking statements reflect our good-faith belief and reasonable judgment based on current information, these statements are qualified by important factors, many of which are beyond our control, which could cause our actual results to differ materially from those in the forward-looking statements, including, but not limited to: º • º the wide range of competition we face in our business; º •
º conditions in the economy, including economic uncertainty or downturn,
high unemployment levels and the level of activity in the housing sector; º • º our ability to offset increased direct costs, particularly programming, with price increases; º • º plans to develop future networks and upgrade facilities; º • º the current and future markets for our services and products; º • º lower demand for our services; º • º competitive and technological developments; º • º our exposure to the credit risk of customers, vendors and other third parties; º • º possible acquisitions, alliances or dispositions; º • º the effects of regulatory changes on our business; º • º a depressed economy or natural disasters in the areas where we operate; º • º our substantial level of indebtedness; º • º certain covenants in our debt documents; º • º our failure to realize the anticipated benefits of acquisitions in the expected time frame or at all; º • º our expectations with respect to the continuing integration of
Knology, Inc.("Knology") and the ability to realize expected cost savings related thereto; º • º our ability to manage the risks involved in the foregoing; and other factors described from time to time in our reports filed or furnished with the U.S. Securities and Exchange Commission(the "SEC"), and in particular those factors set forth in the section entitled "Risk Factors" on our Form 10-K filed with the SECon March 17, 2014and other reports subsequently filed with the SEC. Given these uncertainties, you should not place undue reliance on any such forward-looking statements. The forward-looking statements included in this report are made as of the date hereof or the date specified herein, based on information available to us as of such date. Except as required by law, we assume no obligation to update these forward-looking statements, even if new information becomes available in the future. 17
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We are a fully integrated provider of high-speed data ("HSD"), cable television ("Video"), and digital telephony ("Telephony") services. We serve markets in twenty Midwestern and
Southeastern United States. The Company manages and operates its broadband cable Midwestern systems in Detroitand Lansing, Michigan; Chicago, Illinois; Clevelandand Columbus, Ohio; Evansville, Indiana; Rapid Cityand Sioux Falls, South Dakota(which systems are under a definitive agreement to be divested, see "Overview-Sale of South Dakota Systems" below); Baltimore, Maryland; and Lawrence, Kansas. The Southeastern systems are located in Augusta, Columbusand West Point, Georgia; Charleston, South Carolina; Dothan, Huntsvilleand Montgomery, Alabama; Knoxville, Tennessee; and Panama Cityand Pinellas County, Florida. Our primary business is the delivery of bundled communication services over our own network. In addition to our bundled package offerings, we sell these services on an unbundled basis. We have built our business through (i) acquisitions of cable systems, (ii) upgrades of acquired networks to introduce expanded broadband services including bundled high-speed data, video and telephony services, (iii) construction and expansion of our broadband network to offer integrated high-speed data, video and telephony services and (iv) organic growth of connections through increased penetration of services to new marketable homes and our existing customer base. At June 30, 2014, our networks passed 3,114 thousand homes and served 868 thousand total customers, reflecting a total customer penetration rate of approximately 28%. Our most significant competitors are other cable television operators, direct broadcast satellite providers and certain telephone companies that offer services which provide features and functions similar to our HSD Video, and Telephony services. We believe our strategy of operating primarily in secondary markets provides better operating and financial stability compared to the more competitive environments in large metropolitan markets. We have a history of successfully competing in chosen markets despite the presence of competing incumbent providers through attractive high value bundling of our services and investments in new service offerings. We believe the current economic conditions in the U. S., including the housing market and unemployment levels, may adversely affect consumer demand for our services. Additional capital and credit market disruptions could cause broader economic downturns, which could also lead to lower demand for our products and lower levels of advertising sales. A slowdown in growth of the housing market or an increase in unemployment levels can severely affect consumer confidence and may cause increased delinquencies or cancellations by our customers or lead to unfavorable changes in the mix of products purchased. In addition, we are susceptible to risks associated with the potential financial instability of our vendors and third parties on which we rely to provide products and services or to which we delegate certain functions. The same economic conditions that may affect our customers, as well as volatility and disruption in the capital and credit markets, also could adversely affect vendors and third parties and lead to significant increases in prices, reduction in output or the bankruptcy of our vendors or third parties upon which we rely. Furthermore, programming costs are a significant part of our operating expenses and are expected to continue to increase primarily as a result of contractual rate increases and additional service offerings.
Sale of South Dakota Systems
June 12, 2014, we and Clarity Telecom("Clarity") entered into a definitive agreement under which Clarity will acquire our Rapid Cityand Sioux Falls, South Dakotasystems for gross proceeds of approximately $262 millionin cash, subject to certain adjustments set forth in the agreement. The sale is expected to close in the late third or early fourth quarter of 2014, following the satisfactory of regulatory requirements and other customary closing conditions. We anticipate that the sale of the South Dakotasystems will enhance our operating efficiencies and enables us to continue focusing more 18
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aggressively on our long-term strategic initiatives. Since the sale is probable of closing within a year, the indefinite-lived intangibles in
South Dakotasystems are no longer considered to have indefinite lives and are considered to be a source of future taxable income that will be recognized upon the sale transaction. The consequences of the gain on the sale will not be recognized until the sale is complete.
Additional 10.25% Senior Notes
April 1, 2014, we issued $100.0 millionaggregate principal amount of additional 10.250% Senior Notes, due 2019, (the "Additional Notes") in a private offering conducted pursuant to Rule 144A and Regulation S under the Securities Act of 1933, as amended (the "Securities Act"). The Additional Notes were issued at 113.000% plus interest deemed to have accrued from January 15, 2014. We used the net proceeds of the offering to repay the borrowings outstanding under our revolving credit facility, for general corporate purposes, and to pay certain fees and expenses relating to the offering. The Additional Notes have been issued under the indenture governing our existing $725.0 millionSenior Notes, due 2019, issued on July 17, 2012("Senior Notes"). The Additional Notes will be treated as a single series with the existing Senior Notes and will have the same terms as those of the Senior Notes. We entered into a registration rights agreement, pursuant to which we file an exchange offer for the Additional Notes in a registration statement ("Exchange Offer") with the SECno later than 270 days from April 1, 2014. We filed the registration statement with the SECon June 18, 2014and the registration statement became effective on June 30, 2014. The Exchange Offer was completed on July 31, 2014.
Refinancing of Term B-1 Loans
November 27, 2013, we entered into a second amendment (the "Second Amendment") to the credit agreement, dated as of July 17, 2012, as amended on April 1, 2013(the "Credit Agreement") among us, the guarantors thereto, the lenders party thereto, and the other parties thereto. Capitalized terms used herein without definition shall have the same meanings as set forth in the Credit Agreement. The Second Amendment provided for the refinancing of the Credit Agreement, resulting in $425.0 millionin new Term B-1 Loans, which bear interest, at our option, at LIBOR plus 3.00% or adjusted base rate ("ABR") plus 2.00%. The new Term B-1 Loans includes a 0.75% LIBOR floor. The new Term B-1 Loans replaced $398.0 millionin outstanding Term B-1 Loans which were previously priced, at our option, at LIBOR plus 3.25% or ABR plus 2.25% and which previously included a 1.00% LIBOR floor. We utilized the excess proceeds from the new Term B-1 Loans to repay existing, outstanding borrowings on our revolving credit facility and to pay fees and expenses associated with the refinancing.
April 1, 2013, we entered into a first amendment (the "First Amendment") to our July 17, 2012credit agreement among us, the guarantors thereto, the lenders party thereto, and the other parties thereto (the "Prior Senior Secured Credit Facility"). The First Amendment provides for a new term loan and credit facility (the "Senior Secured Credit Facility") consisting of (i) a $200.0 millionsenior secured revolving facility ("Revolving Credit Facility") with a final maturity of July 17, 2017, (ii) $400.0 millionTerm B-1 loans ("Term B-1 Loans") with a final maturity date of July 17, 2017, and (iii) $1,560.4 millionin Term B loans ("Term B Loans") with a final maturity of April 1, 2019. The Term B and Term B-1 Loans require quarterly principal payments totaling $4.9 millionwhich commenced June 30, 2013. The Revolving Credit Facility, Term B-1 Loans 19
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and Term B Loans bore interest (prior to the Second Amendment discussed above), at our option, as follows: Debt Obligation Interest Rate Revolving Credit Facility LIBOR plus 3.50% or ABR plus 2.50%. Term B-1 Loans LIBOR plus 3.25% or ABR plus 2.25%. LIBOR floor of 1.00%. Term B Loans If the Senior Secured Leverage Ratio, as defined, is greater than 5.00 to 1.00, LIBOR plus 4.00% or ABR plus 3.00%. If the Senior Secured Leverage Ratio, as defined, is less than or equal to 5.00 to 1.00, LIBOR plus 3.75% or ABR plus 2.75%. LIBOR floor of 1.00%. We also pay a commitment fee of between 37.5 to 50.0 basis points, payable quarterly, on the average daily unused amount of the Revolving Credit Facility based on our leverage ratio. The First Amendment provided for the refinancing of our then outstanding borrowings under the Prior Senior Secured Credit Facility, which consisted of a
$1,920.0 million, six-year senior secured term loan facility (the "Prior Senior Secured Term Loans") and a $200.0 million, five-year senior secured revolving credit facility (the "Prior Revolving Credit Facility"). The First Amendment replaced $51.0 millionin then outstanding Prior Revolving Credit Facility loans and $1,905.6 millionin the then outstanding Prior Senior Secured Term Loans, both of which were previously priced, at our option, at LIBOR plus 5.00% or ABR plus 4.00%. The Prior Senior Secured Term Loans included a 1.25% Libor floor. We paid approximately $21.0 millionfor underwriting and other fees and expenses incurred in connection with the First Amendment, including a 1% soft call premium of $19.1 millionon the then Prior Senior Secured Term Loans. For accounting purposes, the First Amendment refinancing was treated as a debt modification, resulting in the majority of the fees and expenses being capitalized as debt issue costs. The obligations under the Credit Amendment are guaranteed by our Members and our subsidiaries and are secured on a first priority basis by substantially all of the tangible and intangible assets of us and the guarantors, subject to certain exceptions. The Credit Amendment contains affirmative and negative covenants that we believe are usual and customary for a senior secured credit agreement. The negative covenants include, among other things, limitations on indebtedness, liens, sale of assets, investments, dividends, subordinated debt payments and amendments, sale leasebacks and transactions with us and our affiliates. The Credit Amendment also requires us to comply with a maximum senior secured leverage ratio.
Bluemile Asset Acquisition
September 27, 2013, we entered into and closed an asset purchase agreement to acquire certain assets from Bluemile, Inc.("Bluemile"), an Ohio Corporation, for initial cash consideration of approximately $15.0 million, subject to closing and post-closing adjustments, plus up to $5.0 millionin consideration contingent upon achieving certain financial metrics during the twelve month period ended December 31, 2014(the "Bluemile Assets" acquisition). Bluemile owned and operated a national optical and IP network, data center and an enterprise cloud infrastructure. The data center, optical and IP network and cloud services will enable us to enhance our products and services to existing customers and potential customers in all of our regions. The Bluemile Assets acquisition has been accounted for using the acquisition method of accounting. The effects of the Bluemile Assets acquisition are included in our consolidated financial statements beginning September 27, 2013. Including closing adjustments we paid cash consideration of 20
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$15.4 millionat closing, before direct acquisition costs of $0.2 million. Additionally, pursuant to Accounting Standards Codification ("ASC") 805 "Business Combinations", we have recorded an estimate of the fair value of the contingent consideration liability based upon a discounted analysis of future financial estimates and weighted probability assumptions of outcomes. This analysis resulted in an initial contingent consideration liability of approximately $4.6 million, which will be adjusted periodically as a component of operating expenses based on changes in the fair value of the liability resulting from changes in the assumptions pertaining to the achievement of the defined financial milestone.
Critical Accounting Policies and Estimates
In the preparation of our condensed consolidated financial statements, we are required to make estimates, judgments and assumptions we believe are reasonable based upon the information available, in accordance with accounting principles generally accepted in
the United States of America("GAAP"). The estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. Critical accounting policies are defined as those policies that are reflective of significant judgments, estimates and uncertainties, which would potentially result in materially different results under different assumptions and conditions. We believe the following accounting policies are the most critical in the preparation of our condensed consolidated financial statements because of the judgment necessary to account for these matters and the significant estimates involved, which are susceptible to change.
Valuation of Plant, Property and Equipment and Intangible Assets
Carrying Value. The aggregate carrying value of our plant, property and equipment and intangible assets (including franchise operating rights and goodwill) comprised approximately 90% and 92% of our total assets at
June 30, 2014and December 31, 2013, respectively. Plant, property and equipment are recorded at cost and include costs associated with the construction of cable transmission and distribution facilities and new service installations at the customer location. Capitalized costs include materials, labor, and certain indirect costs attributable to the capitalization activity. Maintenance and repairs are expensed as incurred. Upon sale or retirement of an asset, the cost and related depreciation are removed from the related accounts and resulting gains or losses are reflected in operating results. We make judgments regarding the installation and construction activities to be capitalized. We capitalize direct labor associated with capitalizable activities and indirect cost using standards developed from operational data, including the proportionate time to perform a new installation relative to the total technical operations activities and an evaluation of the nature of the indirect costs incurred to support capitalizable activities. Judgment is required to determine the extent to which indirect costs incurred related to capitalizable activities, and as a result should be capitalized. Indirect costs include (i) employee benefits and payroll taxes associated with capitalized direct labor, (ii) direct variable cost of installation and construction vehicle costs, (iii) the direct variable costs of support personnel directly involved in assisting with installation activities, such as dispatchers and (iv) indirect costs directly attributable to capitalizable activities. Intangible assets consist primarily of acquired franchise operating rights, customer relationships and goodwill. Franchise operating rights represent the value attributable to agreements with local franchising authorities, which allows access to homes in the public right of way. Our franchise operating rights were acquired through business combinations. We do not amortize cable franchise operating rights as we have determined they have an indefinite life. Costs incurred in negotiating and renewing cable franchise agreements are expensed as incurred. Customer relationships represent the value of the benefit to us of acquiring the existing subscriber base and are amortized over the estimated life of the subscriber base, generally four years, on a straight-line basis. Goodwill represents the excess purchase price over the fair value of the identifiable net assets we acquired in business combinations. 21
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Asset Impairments. Long-lived assets, including plant, property and equipment and intangible assets subject to amortization are evaluated for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. If the total of the expected undiscounted cash flows is less than the carrying amount of the asset, a loss is recognized for the difference between the fair value and the carrying value of the asset. We evaluate the recoverability of our franchise operating rights at least annually on
October 1, or more frequently whenever events or substantive changes in circumstances indicate the assets might be impaired. Franchise operating rights are evaluated for impairment by comparing the carrying value of the intangible asset to its estimated fair value. We calculate the fair value of franchise operating rights using the multi-period excess earnings method an income approach which calculates the value of an intangible asset by discounting its future cash flows. The fair value is determined based on estimated discrete discounted future cash flows attributable to each franchise operating right intangible asset using assumptions consistent with internal forecasts. Key assumptions in estimating fair value under this method include, but are not limited to, revenue and subscriber growth rates (less anticipated customer churn), operating expenditures, capital expenditures (including any build out), market share achieved, contributory asset charge rates, tax rates and discount rate. The discount rate used in the model represents a weighted average cost of capital and the perceived risk associated with an intangible asset such as our franchise operating rights. The estimates and assumptions made in our valuations are inherently subject to significant uncertainties, many of which are beyond our control, and there is no assurance these results can be achieved. The primary assumptions for which there is a reasonable possibility of the occurrence of a variation which would significantly affect the measurement value include the assumptions regarding revenue growth, programming expense growth rates, the amount and timing of capital expenditures and the discount rate utilized. We also at least annually on October 1, evaluate our goodwill for impairment for each reporting unit (which generally are represented by geographical operations of cable systems managed by us). For evaluation of our goodwill, we utilize discounted cash flow analysis to estimate the fair value of each reporting unit and compare such value to the carrying amount of the reporting unit. In the event the carrying amount exceeds the fair value, we would be required to estimate the fair value of the assets and liabilities of the reporting unit as if the unit was acquired in a business combination, thereby revaluing goodwill. Any excess of the carrying value of goodwill over the revalued goodwill would be expensed as an impairment loss.
Fair Value Measurements
GAAP provides guidance for a framework for measuring fair value in the form of a fair value hierarchy which prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. Financial assets and liabilities are classified by level in their entirety based upon the lowest level of input that is significant to the fair value measurement. Level 1 inputs are quoted market prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 2 inputs are inputs other than quoted market prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 3 inputs are unobservable inputs for the asset or liability due to the fact there is no market activity. We record our interest rate swaps and interest rate caps at fair value on the balance sheet and perform recurring fair value measurements with respect to these derivative financial instruments. The fair value measurements of our interest rate swaps were determined using cash flow valuation models. The inputs to the cash flow models consist of, or are derived from, observable data for substantially the full term of the swaps. This observable data includes interest and swap rates, yield curves and credit ratings, which are retrieved from available market data. The valuations are then adjusted for our own nonperformance risk as well as the counterparty as required by the provisions of the authoritative guidance using a discounted cash flow technique which accounts for the duration of the interest rate 22
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swaps and our and the counterparty's risk profile. The fair value of the interest rate caps are calculated using a cash flow valuation model. The main inputs are obtained from quoted market prices, the LIBOR interest rate and the projected three months LIBOR. The observable market quotes are then input into the valuation and discounted to reflect the time value of cash. We also have non-recurring valuations primarily associated with (i) the application of acquisition accounting and (ii) impairment assessments, both of which require we make fair value determinations as of the applicable valuation date. In making these determinations, we are required to make estimates and assumptions which affect the recorded amounts, including, but not limited to, expected future cash flows, market comparables and discount rates, remaining useful lives of long-lived assets, replacement or reproduction costs of property and equipment and the amounts to be recovered in future periods from acquired net operating losses and other deferred tax assets. To assist us in making these fair value determinations, we may engage third- party valuation specialists. Our estimates in this area impact, among other items, the amount of depreciation and amortization, and any impairment charges we may report. Our estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain. A significant portion of our long-lived assets were initially recorded through the application of acquisition accounting and all of our long-lived assets are subject to periodic or event-driven impairment assessments.
Legal and other contingencies
Legal and other contingencies have a high degree of uncertainty. When a loss from a contingency becomes estimable and probable, a reserve is established. The reserve reflects management's best estimate of the probable cost of ultimate resolution of the matter and is revised as facts and circumstances change. A reserve is released when a matter is ultimately brought to closure or the statute of limitations lapses. The actual costs of resolving a claim may be substantially different from the amount of reserve we recorded. In addition, in the normal course of business, we are subject to various other legal and regulatory claims and proceedings directed at or involving us, which in our opinion will not have a material adverse effect on our financial position or results of operations or liquidity.
We exercise significant judgment in estimating programming expense associated with certain video programming contracts. Our policy is to record video programming costs based on our contractual agreements with our programming vendors, which are generally multi-year agreements that provide for us to make payments to the programming vendors at agreed upon market rates based on the number of customers to which we provide the programming service. If a programming contract expires prior to the parties' entry into a new agreement and we continue to distribute the service, we estimate the programming costs during the period there is no contract in place. In doing so, we consider the previous contractual rates, inflation and the status of the negotiations in determining our estimates. When the programming contract terms are finalized, an adjustment to programming expense is recorded, if necessary, to reflect the terms of the new contract. We also make estimates in the recognition of programming expense related to other items, such as the accounting for free periods, timing of rate increases and credits from service interruptions, as well as the allocation of consideration exchanged between the parties in multiple-element transactions. Significant judgment is also involved when we enter into agreements which result in us receiving cash consideration from the programming vendor, usually in the form of advertising sales, channel positioning fees, launch support or marketing support. In these situations, we must determine based upon facts and circumstances if such cash consideration should be recorded as revenue, a reduction in programming expense or a reduction in another expense category (e.g., marketing). 23
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From time to time, we engage in transactions in which the tax consequences may be subject to uncertainty. Examples of such transactions include business acquisitions and dispositions, including dispositions designed to be tax free, issues related to consideration paid or received, investments and certain financing transactions. Significant judgment is required in assessing and estimating the tax consequences of these transactions. We prepare and file tax returns based on interpretation of tax laws and regulations. In the normal course of business, our tax returns are subject to examination by various taxing authorities. Such examinations may result in future tax, interest and penalty assessments by these taxing authorities. In determining our income tax provision for financial reporting purposes, we establish a reserve for uncertain income tax positions unless such positions are determined to be more likely than not of being sustained upon examination, based on their technical merits. That is, for financial reporting purposes, we only recognize tax benefits taken on the tax return that we believe are more likely than not of being sustained. There is considerable judgment involved in determining whether positions taken on the tax return are more likely than not of being sustained. We adjust our tax reserve estimates periodically because of ongoing examinations by, and settlements with, the various taxing authorities, as well as changes in tax laws, regulations and interpretations. The consolidated income tax provision of any given year includes adjustments to prior year income tax accruals that are considered appropriate and any related estimated interest. Our policy is to recognize, when applicable, interest and penalties on uncertain income tax positions as part of income tax provision.
Homes Passed and Subscribers
We report homes passed as the number of residential units, such as single residence homes, apartments and condominium units passed by our broadband network and listed in our database. We report Video subscribers as the number of basic cable subscribers, excluding customers who only subscribe to HSD or Telephony services in this total. The following table summarizes homes passed, total customers and subscribers for our services as of each respective date (in thousands): Sep. 30 Dec. 31 Mar. 31 June 30 Sep. 30, Dec. 31, Mar. 31, June 30, 2012 2012 2013 2013 2013 2013 2014 2014 Homes passed 2,914 2,962 2,968 2,981 2,987 2,995 2,997 3,114 Total customers(1) 821 826 817 815 831 841 853 868 HSD subscribers 707 709 707 709 725 740 757 770 Video subscribers 710 705 691 682 691 694 694 699 Telephony subscribers 450 443 433 430 427 424 419 416
º Defined as number of customers who receive at least one of our HSD, Video
or Telephony services that we count as a subscriber, without regard to which or how many services they subscribe. Subscriber information for acquired entities is preliminary and subject to adjustment until we have completed our review of such information and determined it is presented in accordance with our policies. As described in note 3 of our condensed consolidated financial statements, we increased our ownership in
Anne Arundel Broadband, LLCto a 75% ownership interest on May 1and therefore have included their operational and financial results from May 1, 2014. While we take appropriate steps to ensure subscriber information is presented on a consistent and accurate basis at any given balance sheet date, we periodically review our policies in light of the variability we may encounter across our different markets due to the nature and pricing of products and services and billing systems. Accordingly, we may from time to time make appropriate adjustments to our subscriber information based on such reviews. 24
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Financial Statement Presentation
Our operating revenue is primarily derived from monthly charges for Video, HSD, and Telephony to residential and commercial customers, other commercial services, advertising and other revenues. º • º Video revenue consists of fixed monthly fees for basic, premium and digital cable television services and rental of video converter equipment, as well as fees from pay-per-view, video-on-demand and other events that involve a charge for each viewing. º •
º HSD revenue consists primarily of fixed monthly fees for data service
and rental of cable modems. º • º Telephony revenue consists primarily of fixed monthly fees for local service and enhanced services, such as call waiting, voice mail and measured and flat rate long-distance service. º • º Other commercial service revenue consists of session initiated
protocol, web hosting, metro Ethernet, wireless backhaul, advanced
collocation and cloud infrastructure services.
º Other revenue consists primarily of franchise and other regulatory
fees (which are collected by us but then paid to local authorities),
advertising, commissions related to the sale of merchandise by home
shopping services, fees from other services and installation services.
Over 90% of our revenues for the six months ended
June 30, 2014and 2013 are attributable to monthly subscription fees charged to our residential and commercial customers for our Video, HSD and Telephony services provided by our systems, respectively. Generally, these customer subscriptions may be discontinued by the customer at any time without penalty.
Cost and Expenses
Our expenses primarily consist of operating, selling, general and administrative expenses, depreciation and amortization expense and interest expense.
Operating expenses primarily include programming costs, data costs and transport costs and network access fees related to our HSD and Telephony services, cable service related expenses, costs of dark fiber sales, network operations and maintenance services, customer service and call center expenses, bad debt, billing and collection expenses, franchise fees and other regulatory fees. Selling, general and administrative expenses primarily include salaries and benefits of corporate and field management, sales and marketing personnel, human resources and related administrative costs.
Operating and selling, general and administrative expenses exclude depreciation and amortization expense, which is presented separately in the accompanying condensed consolidated statement of operations.
Depreciation and amortization expenses include depreciation of our broadband networks and equipment, buildings and leasehold improvements and amortization of other intangible assets with definite lives primarily related to acquisitions. Realized and unrealized gain on derivative instruments, net includes adjustments to fair value for the various interest rate swaps and caps we enter into on the required portions of our outstanding variable debt. As we do not use hedge accounting for financial reporting purposes, at the end of each reporting period, the adjustment to fair value of our interest rate swaps and caps are recorded to earnings.
We control our costs of operations by maintaining strict controls on expenditures. More specifically, we are focused on managing our cost structure by improving workforce productivity, increasing the effectiveness of our purchasing activities and maintaining discipline in customer
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acquisition. We expect programming expenses to continue to increase due to a variety of factors, including increased demands by owners of some broadcast stations for carriage of other services or payments to those broadcasters for retransmission consent and annual increases imposed by programmers with additional selling power as a result of media consolidation. We have not been able to fully pass these increases on to our customers nor do we expect to be able to do so in the future without a potential loss of customers.
Results of operations
The following table summarizes our results of operation for the three months ended
Three months ended June 30, Change 2014 2013 $ % Revenue
$ 319.8 $ 301.4 $ 18.46 % Costs and expenses: Operating (excluding depreciation and amortization) 182.4 165.5 16.9 10 % Selling, general and administrative 38.9 36.9 2.0 5 % Depreciation & amortization 64.1 63.2 0.9 1 % Management fee to related party 0.5 0.4 0.1 * 285.9 266.0 19.9 7 % Income from operations 33.9 35.4 (1.5 ) (4 )% Other income (expense): Interest expense (59.4 ) (57.9 ) (1.5 ) (3 )% Loss on extinguishment of debt - (57.3 ) 57.3 * Realized and unrealized gain on derivative instruments, net 0.8 1.2 (0.4 ) * Other (expense) income, net 0.2 (0.3 ) 0.5 * Loss before provision of income taxes (24.5 ) (78.9 ) 54.4 69 % Income tax benefit 16.7 - 16.7 * Net loss $ (7.8 ) $ (78.9 )71.1 90 %
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The following table summarizes our results of operation for the six months ended
Six months ended June 30, Change 2014 2013 $ % Revenue
$ 631.9 $ 597.8 $ 34.16 % Costs and expenses: Operating (excluding depreciation and amortization) 360.5 331.2 29.3 9 % Selling, general and administrative 69.0 71.7 (2.7 ) (4 )% Depreciation & amortization 130.3 128.0 2.3 2 % Management fee to related party 0.9 0.8 0.1 * 560.7 531.7 29.0 5 % Income from operations 71.2 66.1 5.1 8 % Other income (expense): Interest expense (117.2 ) (124.8 ) 7.6 6 % Loss on extinguishment of debt - (57.3 ) 57.3 * Realized and unrealized gain on derivative instruments, net 1.8 2.2 (0.4 ) * Other (expense) income, net 0.5 (0.2 ) 0.7 * Loss before provision of income taxes (43.7 ) (114.0 ) 70.3 62 % Income tax benefit 15.6 - 15.6 * Net loss $ (28.1 ) $ (114.0 )85.9 75 %
Three months ended
Revenue Revenue for the three months ended
June 30, 2014increased $18.4 millionor 6% as compared to revenue for the three months ended June 30, 2013as follows: Change 2014 2013 $ % (in millions) Residential subscription $ 264.1 $ 256.3 $ 7.83 % Commercial subscription 24.2 22.7 1.5 7 % Total subscription 288.3 279.0 9.3 3 % Other commercial services 6.1 3.8 2.3 61 % Other 25.4 18.6 6.8 37 % $ 319.8 $ 301.4 $ 18.46 % The increase in subscription revenue of $9.3 millionor 3% is due to the net effect of $14.9 millionincrease attributable to new customers offset by $5.6 milliondecrease in ARPU (which is calculated as the total subscription revenue divided by average monthly customers during the period). The increase in Other commercial services of $2.3 millionis primarily due to the inclusion of the revenue relating to the operations acquired in our Bluemile Assets acquisition. The increase in Other revenue is primarily due to (i) $4.7 millionincrease in customer related activity (installation, reactivation, service calls) due to increased customers in the period and (ii) increased franchise fee and other regulatory fees of $2.2 millionas a result of increased video and telephony revenue. 27
Table of Contents Operating expenses (excluding depreciation and amortization) Operating expenses (excluding depreciation and amortization) increased
$16.9 millionor 10% in the three months ended June 30, 2014, as compared to the three months ended June 30, 2013. The increase primarily relates to increases of $12.7 millionfor programming costs for the three months ended June 30, 2014. The increases in programming costs are primarily a result of annual contractual rate adjustments, including increases in amounts paid for retransmission consents and for new programming. Additionally, we experienced increases in customer service and technical operations expense mainly due to increased call volume and recent acquisitions for the three months ended June 30, 2014as compared to the three months ended June 30, 2013.
Selling, general and administrative (SG&A) expenses
SG&A expenses increased
Depreciation and amortization expenses
Depreciation and amortization expenses increased
$0.9 millionor 1% in the three months ended June 30, 2014, as compared to the three months ended June 30, 2013, primarily due to an increase in capitalized projects and the associated depreciation during the three months ended June 30, 2014, compared to the same period in 2013.
Management fee to related party expenses
We pay a quarterly management fee of approximately
Interest expense increased
$1.5 millionor 3% in the three months ended June 30, 2014, as compared to the three months ended June 30, 2013. The increase is due to increased debt outstanding for the quarter ended June 30, 2014compared to the quarter ended June 30, 2013, primarily from the incremental issuance on April 1, 2014of our $100.0 millionin principal Senior Notes, due 2019.
Loss on early extinguishment of debt
In connection with our
April 1, 2013, First Amendment refinancing of our prior Senior Secured Credit Facility we recorded a loss on extinguishment of debt representing the expensing of prior deferred financing costs of approximately $57.3 millionduring the three months ended June 30, 2013.
Realized and unrealized gain on derivative instruments, net
Realized and unrealized gain on derivative instruments was
$0.8 millionand $1.2 million, for the three months ended June 30, 2014and June 30, 2013, respectively. We do not use hedge accounting for financial reporting purpose so the adjustment to fair value of our interest rate swaps and caps are recorded to earnings. 28
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Six months ended
Revenue for the six months ended
Change 2014 2013 $ % (in millions) Residential subscription
$ 522.3 $ 507.8 $ 14.53 % Commercial subscription 47.7 45.3 2.4 5 % Total subscription 570.0 553.1 16.9 3 % Other commercial services 12.6 8.4 4.2 50 % Other 49.3 36.3 13.0 36 % $ 631.9 $ 597.8 $ 34.16 % The increase in subscription revenue of $16.9 millionor 3% is due to the total effect of $22.9 millionincrease attributable to new customers offset by $6.0decrease in ARPU (which is calculated as the total subscription revenue divided by average monthly customers during the period). The increase in Other commercial services of $4.2 millionis primarily due to the inclusion of revenue relating to the operations acquired in our Bluemile Assets acquisition. The increase in Other revenue is primarily due to (i) 7.6 million increase in customer related activity (installation, reactivation, service calls) due to increased customers in the period and (ii) increased franchise fee and other regulatory fees of $4.8 millionas a result of increased video and telephony revenue.
Operating expenses (excluding depreciation and amortization)
Operating expenses (excluding depreciation and amortization) increased
$29.3 millionor 9% in the six months ended June 30, 2014, as compared to the six months ended June 30, 2013. The increase primarily relates to increases of $19.7 millionfor programming costs for the six months ended June 30, 2014. The increases in programming costs are primarily a result of annual contractual rate adjustments, including increases in amounts paid for retransmission consents and for new programming. Additionally, we have an increase in franchise and other regulatory fees of $5.3 millionmainly due to our increase in video and telephony revenue for the six months ended June 30, 2014as compared to the six months ended June 30, 2013. We also experienced increases in customer service and technical operations expense mainly due to increased call volume and recent acquisitions for the six months ended June 30, 2014as compared to the six months ended June 30, 2013.
Selling, general and administrative (SG&A) expenses
SG&A expenses decreased
$2.7 millionor 4% in the six months ended June 30, 2014, as compared to the six months ended June 30, 2013. The decrease is primarily due to the impact of the synergies and efficiencies realized as a result of the acquisition of Knologyin 2012, partially offset by an increase of $1.5 millionin commercial sales related expense.
Depreciation and amortization expenses
Depreciation and amortization expenses increased
$2.3 millionor 2% in the six months ended June 30, 2014, as compared to the six months ended June 30, 2013, primarily due to an increase in capitalized projects and the associated depreciation during the six months ended June 30, 2014compared to the same period in 2013. 29
Table of Contents Management fee to related party expenses
We pay a quarterly management fee of approximately
Interest expense decreased
$7.6 millionor 6% in the six months ended June 30, 2014, as compared to the six months ended June 30, 2013. The decrease is due to lower overall average effective interest rates on our Senior Secured Credit Facilities during the six months ended June 30, 2014, versus overall average effective interest rates during the six months ended June 30, 2013. The above decreases are offset by the increased debt outstanding for the six months ended June 30, 2014compared to the six months ended June 30, 2013, primarily from the $100.0 millionin principal debt issue of the Senior Notes, due 2019.
Loss on extinguishment of debt
In connection with our
April 1, 2013, First Amendment refinancing of our prior Senior Secured Credit Facility we recorded a loss on extinguishment of debt representing the expensing of prior deferred financing costs of approximately $57.3 millionduring the six months ended June 30, 2013.
Realized and unrealized gain (loss) on derivative instruments, net
Realized and unrealized gain on derivative instruments was
$1.8 millionand $2.2 million, for the six months ended June 30, 2014and June 30, 2013, respectively. We do not use hedge accounting for financial reporting purpose so the adjustment to fair value of our interest rate swaps and caps are recorded to earnings.
Liquidity and Capital Resources
June 30, 2014, we had $174.5 millionin current assets, including $59.1 millionin cash and cash equivalents, and $276.6 millionin current liabilities. Our outstanding consolidated debt and capital lease obligations aggregated $3,101.3 million, of which $22.4 millionis classified as current in our condensed consolidated balance sheet. We are required to prepay principal amounts under our Senior Secured Credit Facilities credit agreement if we generate excess cash flow, as defined in the credit agreement. As of June 30, 2014we had borrowing capacity of $187.7 millionunder our Revolving Credit Facility and were in compliance with all our debt covenants. Accordingly, we believe that we have sufficient resources to fund our obligations and anticipated liquidity requirements in the foreseeable future.
Historical Operating, Investing, and Financing Activities
Net cash provided by operating activities increased
$38.6 millionfrom $74.2 millionfor the six months ended June 30, 2013to $112.8 millionfor the six months ended June 30, 2014. The increase in net cash provided by operating activities was primarily due to a decrease in net loss of $85.9 millionand a decrease of $5.8 millionin changes in operating assets and liabilities for the six months ended June 30, 2014. Offsetting this increase was $57.3 millionchange in noncash adjustment related to loss on extinguishment of debt from the six months ended June 30, 2013. 30
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Net cash used in investing activities increased
$33.9 millionfrom $89.5 millionfor the six months ended June 30, 2013to $123.4 millionfor the six months ended June 30, 2014, primarily due to a $28.8 millionnet increase in capital expenditures for the three months ended June 30, 2014.
Net cash provided by financing activities increased
$32.3 millionfrom $20.5 millionfor the six months ended June 30, 2013to $52.8 millionfor the six months ended June 30, 2014. The increase was attributable to an increase in funds received from the $100.0 millionadditional 10.25% Senior Notes issued April 1, 2014. The increase was offset by payments on borrowings outstanding under our Senior Secured Credit Facility.
Capital expenditures were
Capital expenditures will continue to be driven primarily by customer demand for our services. In the event we may have higher-than-expected customer demand for our services, while resulting in higher revenue and income from operations, such increased demand may also increase our projected capital expenditures.