ITEM 1. BUSINESS
Unless the context requires otherwise, references in this Form 10-K to the Company refer to Atlantic Broadband Finance, LLC and references such as “we”, “us” and “our” refer to Atlantic Broadband Finance, LLC together with its consolidated subsidiaries.
History
Our Company was formed in Delaware on August 26, 2003. We are a wholly-owned subsidiary of Atlantic Broadband Holdings I, LLC (the “Parent”). Our Company and the Parent are wholly-owned indirect subsidiaries of Atlantic Broadband Group, LLC.
On September 3, 2003, we entered into a definitive asset purchase agreement with affiliates of Charter Communications, Inc. to purchase certain cable systems in Pennsylvania, Florida, Maryland, West Virginia, Delaware and New York (the “Systems”) for approximately $738.1 million, subject to closing adjustments (the “Acquisition”). We obtained equity and debt financing to fund the Acquisition, which was consummated on March 1, 2004.
On July 13, 2006, we entered into a definitive asset purchase agreement to purchase substantially all of the assets of G Force LLC, owner of certain cable systems in South Carolina for approximately $62.0 million. We obtained additional debt financing and issued a note payable to the seller of the assets to fund this transaction which was consummated on November 1, 2006.
As of December 31, 2006, the Systems passed a total of approximately 494,000 homes and served approximately 231,000 Equivalent Basic Units (“EBUs”). The Systems are comprised of four operating clusters: the Western Pennsylvania Cluster totaling approximately 139,000 EBUs in the localities of Johnstown, Altoona, Uniontown and Bradford, PA and Cumberland, MD; the Miami Beach Cluster totaling approximately 50,000 EBUs in Miami Beach, Florida; the Maryland/Delaware Cluster totaling approximately 21,000 EBUs in various communities on the Delmarva peninsula; and the Aiken, SC cluster totaling approximately 21,000 EBUs. We are the nation’s 15th largest cable television system operator.
The Systems are comprised of approximately 7,500 miles of network plant passing approximately 494,000 homes, resulting in an average density of approximately 66 homes per mile. As of December 31, 2006, approximately 95% of the Systems’ homes passed have been upgraded to 550 MHz or higher bandwidth capacity and approximately 71% of homes passed have been upgraded to 750 MHz or higher bandwidth capacity. In addition, approximately 95% of the homes passed in the Systems currently are Internet-ready and two-way communications capable and approximately 61% of the homes passed are telephone capable.
The Systems represent a mix of stable, mature systems in Western Pennsylvania and high growth potential systems in Miami Beach, Maryland/Delaware and Aiken. In the Western Pennsylvania Cluster, the systems enjoy high basic subscriber penetration as well as basic subscriber churn levels well below the national average. In the Miami Beach, Maryland/Delaware and Aiken Clusters, we believe there is significant potential for new homes growth, as well as other system specific opportunities.
We have transformed the Systems into an actively-managed, Internet-led, marketing-focused broadband service provider. We believe that the Systems have numerous favorable characteristics, including a technologically advanced cable network, a presence in several attractive market areas, above-average basic subscriber penetration levels, low historic basic subscriber churn and strong potential growth in high-speed data revenue. Our management team is pursuing a focused commitment to strict cost controls and prudent capital management which will further improve the existing strengths of the Systems. We believe that a combination of our operating approach and the Systems’ attributes will enhance our ability to acquire and retain customers and increase system revenues and cash flow.
Business Strategy
Our strategy is to become the leading full service provider of entertainment, information and communications services for the communities served by the Systems. We believe that bundling high-speed data with new and existing multi-channel video services, such as analog, digital, high-definition and voice offerings, will provide a strong competitive product offering versus other entertainment and information service providers, particularly DBS and DSL providers. The key elements of our business strategy are to:
Develop Compelling Value-Driven Service Offerings Focusing on High-Speed Data and Telephony Service
We believe that our high-speed data and telephony service has the potential to provide a substantial portion of our revenue growth in the near future and will be our most effective means of enhancing our ability to acquire and retain customers. Our cable network allows us the flexibility to offer high-speed data and telephony services with a wide range of high-speed data access speeds to match our customers’ varying needs for addressable download speed in addition to unlimited local and long distance telephone service at an affordable cost. By leveraging this capability, we have developed bundled tiered high-speed data, telephony and video service offerings, which we expect will continue to expand our base of high-speed data customers and enable us to compete effectively against DBS and DSL providers.
We also focus on opportunities to improve the quality and attractiveness of our analog and digital video offerings to our customers. Our digital video platform already enables a significant number and variety of channels throughout the Systems, giving our customers the ability to customize their digital channel lineup with a range of content-unique digital tiers, including multiplexed premium offerings such as HBO and Showtime. We offer our expanded analog and digital offerings à la carte and on a bundled basis to create flexibility and value options for our customers.
We carry the local broadcast affiliates of the national television networks in all of our markets, often giving us a competitive advantage over DBS. Additionally, we provide locally produced and oriented programming that offers, among other things, community information, local government proceedings and local specialty interest shows. In some of our markets, we are the only broadcaster of local college and high school sporting events, which allows us to provide important programming that builds customer loyalty. We also offer local service packages, such as Hispanic programming tiers in our Miami Beach Cluster that appeal to our customers’ ethnic and language backgrounds, either as part of a bundled package or on an à la carte basis.
Develop Innovative, Locally-Tailored Marketing Programs and Sales Initiatives
We will continue to develop and implement a variety of innovative marketing techniques to attract new customers, maintain existing customers and increase revenue per customer. We introduced marketing programs tailored to local customer preferences which are designed to educate customers about our advanced products and services and the advantages of those products and services. Our marketing efforts will continue to focus on promoting tiered bundled high-speed data and video services that provide value, choice and convenience to our customers. We market our products principally through direct mail, door-to-door sales and telemarketing, as well as through media advertising, e-marketing, consumer electronics retailers and our local customer care and bill payment centers.
Maximize Customer Satisfaction with Superior Customer Care and Technical Service
To maximize our customer satisfaction and loyalty, we strive to provide superior customer care and reliable, high-quality technical support. We implemented a wireless dispatch system for our service technicians during the first quarter of 2005, which has improved on-time service call performance and shortened customer waiting time. Additionally, we expect this wireless dispatch system to substantially improve technician productivity and reduce future operating costs.
We strictly adhere to the highest level of customer service, which we constantly monitor by measuring daily call-center performance metrics, customer feedback and local market research. In addition, we are dedicated to fostering strong relations in the communities we serve. We sponsor local charities and community causes through staged events and promotional campaigns. A significant number of our customers visit their local office on a monthly basis, providing us the opportunity to interact with our customers face-to-face and improve our customer relations. Our localized customer care initiatives create substantial marketing and promotion opportunities. Our emphasis on customer service and strong community involvement leads to higher customer satisfaction, increased product sales, reduced customer churn and strong franchise relationships.
We will continue to invest additional capital in our cable network and customer care centers as necessary to maintain superior technical and customer care support and address our customers’ needs for additional broadband products and services.
The Systems
As of December 31, 2006, the Systems passed approximately 494,000 homes and served approximately 231,000 EBUs in Pennsylvania, Florida, Maryland, West Virginia, Delaware, New York and South Carolina. The table below provides the overview of selected operating and technical data for the Systems as of December 31, 2006:
(1) EBU is a reference to “equivalent basic units”, which is a term used in the cable industry to reflect an adjusted number of total basic subscribers. The total number of EBUs includes (i) non-bulk residential subscribers, each of which represents one EBU and (ii) total basic commercial service subscribers and bulk subscribers in multi-family dwelling units, which are calculated on an equivalent basic unit basis by dividing the commercial service price of bulk price charged to each subscriber by the most prevalent price charged to non-bulk residential subscribers in that market for the comparable tier of service.
(2) The number of basic subscribers includes the reported number of non-bulk basic subscribers for the Systems, the reported number of gross bulk subscribers in the Miami Beach Cluster and an estimated number of gross bulk subscribers in the Western Pennsylvania and Maryland/Delaware Clusters.
Western Pennsylvania Cluster
Overview. The Western Pennsylvania Cluster is comprised of four separate cable systems in the localities of Johnstown/Altoona, PA, Uniontown, PA, Cumberland, MD and Bradford, PA. As of December 31, 2006, these systems pass approximately 238,000 homes and serve approximately 139,000 EBUs. These systems comprise a total of approximately 4,500 miles of network plant with 24 headends. The Western Pennsylvania Cluster represents approximately 48.3% of the total homes passed and 60.0% of the total EBUs in the Systems as of December 31, 2006.
Through December 2006, we have completed significant capital upgrades on these systems, which primarily involved (i) activating the Uniontown system for two-way communications capability, (ii) offering cable telephony services in two of the four systems and (iii) completing upgrades and enhancements to the region’s customer care center. After the upgrade, approximately 94% of homes passed in Western Pennsylvania are now upgraded to 550 MHz or higher bandwidth capacity, approximately 67% of homes passed are now upgraded to 750 MHz or higher bandwidth capacity, approximately 95% of homes passed are now Internet-ready and two-way communications capable and approximately 49% of homes passed are telephone capable. We will continue to invest in the Cluster during 2007 to allow us to offer telephony services in the remaining two systems, as well as activating another approximately 3,300 homes for two-way communications capability.
Johnstown/Altoona, PA. As of December 31, 2006, we passed approximately 106,000 homes and served approximately 63,000 EBUs in the Johnstown/Altoona, PA cable system. The two largest cities served by the cable system, Johnstown and Altoona, have local populations of approximately 230,000 and 129,000, respectively. The mean household income for the area is approximately $40,000 per year. Key local employers in the area include: University of Pittsburgh Medical Center; Walmart; and the Pennsylvania state government.
The Johnstown/Altoona cable system has been substantially upgraded with over 91% of homes passed by a 750 MHz cable network from three headends. Approximately 96% of homes passed are also Internet-ready and two-way communications capable, while approximately 91% of homes passed are telephone capable. Prior to July 2003, the Johnstown and Altoona cable system was operated separately, but the two systems were interconnected by fiber and now operate as a single system with a single channel line-up.
Uniontown, PA. As of December 31, 2006, we passed approximately 61,000 homes and served approximately 33,000 EBUs in the Uniontown, PA cable system. The largest city served by the Uniontown cable system is Uniontown, PA which has a local population of 12,000. The mean household income for the area is approximately $34,000 per year. Key local employers include: Uniontown Hospital; Teletech Holdings; Uniontown Newspapers; and O.C. Cluss Lumber.
Approximately 98% of homes passed in the Uniontown cable system have been upgraded to a 550 MHz or better cable network from two headends, and with the completion of our upgrade approximately 98% of homes passed are now Internet-ready and two-way communications capable.
Bradford, PA. As of December 31, 2006, we passed approximately 39,000 homes and served approximately 21,000 EBUs in the Bradford, PA cable system. The two largest cities served by the Bradford cable system are Warren, PA and Bradford, PA, with populations of 10,000 and 9,000, respectively. The mean household income for the area is approximately $40,000 per year. Key local employers in the area include: Bradford Hospital; Zippo; W.R.K Case Cutlery; United Refining; Blair Group; Northwest Bancorp; and Whirley Industries.
Approximately 95% of homes passed in the Bradford cable system have been upgraded to a 550 MHz or better cable network from five headends, and with the completion of our upgrade approximately 94% of homes passed are now Internet-ready and two-way communications capable.
Cumberland, MD. As of December 31, 2006, we passed approximately 32,000 homes and served approximately 22,000 EBUs in the Cumberland, MD cable system. The largest market served by the Cumberland system is the Cumberland, MD/WV area with a local population of approximately 102,000. The mean household income for the area is approximately $39,000. Key local employers include: Memorial Hospital; Sacred Heart Hospital; CSX Transportation; LM Service Co.; and Hunter Douglas Fabrications.
Approximately 93% of homes passed in the Cumberland cable system have been upgraded to a 550 MHz or better cable network from four headends, approximately 86% of homes passed are Internet-ready and two-way communications capable 750 MHz cable networks and approximately 65% of homes passed are telephone capable.
Miami Beach Cluster
The Miami Beach Cluster passes approximately 149,000 homes, and as of December 31, 2006, the cluster served approximately 50,000 EBUs from a single headend. Unlike our other clusters, many of our subscribers in the Miami Beach Cluster are served under multi-year “bulk” video agreements, whereby all of the residents in a Multi-Dwelling Unit (“MDU”) would receive discounted basic or expanded basic cable service and typically pay subscription fees as part of monthly expenses paid to the MDU. This discounting results in a disparity between the number of EBUs and the actual number of customers served. In fact, the Miami Beach system actually serves approximately 90,000 subscribers, for a basic penetration rate of approximately 61%. We believe it is advantageous to have a larger base of actual subscribers comprising our EBU count in Miami Beach as we believe there exists an opportunity to up-sell additional high-speed data and other video services which are generally sold on an undiscounted basis. We also believe other “bulk” accounts benefits include 100% penetration, no churn and incrementally lower connection and marketing cost per added EBU during the term of the MDU’s contract. These benefits serve as strong competitive advantages over DBS providers. We project Miami Beach to continue to be a high-performing system due to the combination of upgraded network plant, attractive demographics and historically strong home growth in the market area.
Miami Beach, the largest city served by the Miami Beach Cluster, has a total population of approximately 89,000. The mean household income in Miami Beach is approximately $54,000 per year. Historically, Miami Beach was principally a retirement community. However, during the period from 1980 to 2000, the median age of the local Miami Beach population declined from 65 years to 39 years, and the community now includes a significant number of affluent young urban professionals. The Miami Beach market also has a significant number of additional residents that either live in the area seasonally or maintain vacation homes in the market.
Miami Beach’s largest employers include the hotel, government, health care, entertainment and retail industries. International companies, particularly in the entertainment field, are also establishing a larger presence in Miami Beach. Key local employers include: Mount Sinai Medical Center (Florida); Loews Hotels; Parkway Regional Medical Center; and LNR Property. The economy of Miami Beach also benefits from its location between Miami and Ft. Lauderdale, and many of Miami Beach’s residents work in these large nearby communities.
The second largest city served by the Miami Beach system is Aventura, FL, which has a population of approximately 27,000. The mean household income in Aventura is approximately $75,000 per year. Key local employers in Aventura include: Aventura Hospital and Medical Center; William’s Island Ocean Club; and The Pritikin Longevity Center.
Miami Beach is a single headend system with approximately 416 plant miles for an average density of 357 homes per mile. The rebuild of the network was completed several years ago, and approximately 55% of the plant miles are served by a 750 MHz network, while the remaining 45% of plant miles are served by a 870 MHz network. 100% of the homes passed in the system are Internet-ready and two-way communications capable.
Maryland/Delaware Cluster
As of December 31, 2006, the Maryland/Delaware Cluster passed approximately 57,000 homes and served approximately 21,000 EBUs. The largest cities served by the Maryland/Delaware Cluster include Perryville, Chesapeake City and Kent Island, Maryland, and Middletown, Delaware. The population of these four largest cities, in aggregate, totals approximately 34,000. The mean household income in Maryland/Delaware Cluster is approximately $55,000 per year. Key local employers in the area include: Chesapeake Amusements; Washington College, Chesterton Hospital, Dann Marine Towing; J&J Furniture; Delta Lumber; Middletown Valley Bank; and the Naval Research Laboratory.
The Maryland/Delaware Cluster utilized three headends with approximately 1,300 miles of plant for an average density of 42 homes per mile. During 2005, we consolidated these headends into one to provide better operating efficiencies within the system. The cluster had not been significantly upgraded prior to our ownership with only approximately 24% of homes passed by a 550 MHz or better cable network, and none of the homes passed in the system were Internet-ready and two-way communications capable prior to our acquisition. By the end of 2005 we had completed our upgrade of these systems, with 100% of homes passed now upgraded to 550 MHz or higher bandwidth capacity and 100% of homes passed Internet-ready and two-way communications capable. During 2006, we further upgraded the Cluster to offer cable telephony service to approximately 61% of homes passed
Aiken Cluster
As of December 31, 2006, the Aiken Cluster passed approximately 50,000 homes and served approximately 21,000 EBUs. The largest city served by the Aiken Cluster is the City of Aiken, SC, with a population of approximately 27,000 and median household income of approximately $49,000. Key local employers in the area include: Westinghouse Savannah River Co., Avondale, Inc., Bechtel Savannah River, Inc.and Kimberly-Clark Corp.
The Aiken Cluster currently utilizes four headends with approximately 1,200 plant miles for an average density of 41 homes per mile. The Cluster has been only partially upgraded to date, with only 75% of the system internet-ready and two-way communications capable, with no cable telephony service available. We estimate spending approximately $7 million during 2007 to complete the upgrade of the system. After our planned upgrade approximately 100% of homes passed will be internet and phone ready. With the completion of the upgrade, we expect to drive subscriber and penetration growth by aggressively promoting high-speed data, telephone and improved video services through locally-driven marketing campaigns.
Video Products and Services
We offer our customers a full array of traditional cable television video services and programming offerings. We tailor both our basic channel line-up and our additional channel offerings to each of our clusters in response to demographics, programming preferences, competition and local regulation. We market analog and digital cable services to our customer base across the Systems. Premium channels, which are offered individually or in packages of several channels, are also available as add-ons to our basic and expanded basic video service. We sell our video programming services on a subscription basis, with prices and related charges that vary primarily based on the type of services selected, whether the services are sold as a “bundle” with our high-speed data service or on an à la carte basis, and the equipment necessary to receive the services.
Our video service offerings include the following:
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Basic Service. All of our customers receive the basic level of service, which generally consists of local broadcast television and local community programming, including government and public access channels, and may include a limited number of satellite-delivered channels.
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Expanded Basic Service. This expanded level of service includes a group of satellite-delivered or non-broadcast channels such as ESPN, CNN, Discovery Channel, Lifetime, TNT, A&E and Bravo.
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Premium Channels. These channels provide unedited, commercial-free movies, sports and other special event entertainment programming such as HBO, Cinemax and Showtime. We offer subscriptions to these channels either as a single channel analog service or as a multi-channel digital service.
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Pay-Per-View. These channels allow analog and digital customers to pay to view a single showing of a recently released movie or a one-time special sporting event or music concert on an unedited, commercial-free basis.
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Video on Demand. This service allows digital customers to choose from a library of hundreds of movies and other programming and to view them at anytime that is convenient for them. Video on Demand is currently available in the Miami Beach Cluster, and will become available in 2007 to the Maryland/Delaware and portions of the Western PA Clusters.
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Digital Tiers. We offer digital service to our customers in several different service combination packages. All digital packages include a digital set-top terminal, an interactive electronic programming guide, multiple channels of CD-quality digital music, and an expanded menu of pay-per-view channels from additional video channels. We also offer our customers certain digital packages with one or more premium channels of their choice with “multiplexes.” Multiplexes give customers access to several different versions of the same premium channel which are varied as to time of broadcast (such as East and West coast time slots) or programming content theme (such as westerns or romance). Some digital tier packages are focused on the interests of a particular customer demographic and emphasize, for example, sports, movies, family or ethnic programming.
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High-Definition Television. High-definition television is currently available in the Miami Beach and Maryland/Delaware Clusters, in the Johnstown/Altoona and Cumberland , Pennsylvania systems and in portions of the Aiken Cluster. We anticipate offering high-definition television in additional markets for a limited number of basic and premium channels that are offered in high-definition. High-definition television provides our digital customers with video services at a higher resolution than standard television.
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Digital Video Recorders (“DVRs”). We offer our customers digital converters that have digital video recording capability. Using the interactive program guide, our customers with DVRs can record programming in the hard drive component of the digital converter and view recorded programming using the play, pause, rewind and fast forward functions. The DVR can also pause live television, and rewind or fast-forward it, as well as record one show while watching another, or record two shows simultaneously. The customers also can choose DVRs which are HDTV-capable. We began deploying DVRs in certain of our cable system in the fourth quarter of 2004, and have expanded this offering to approximately 93% of our homes passed by the end of 2006.
High-Speed Data Service
As of December 31, 2006, the Systems had launched high-speed data service passing approximately 469,000 homes and had approximately 91,000 residential customers for a penetration of Internet-ready and two-way communications capable homes passed of approximately 19%. As of December 31, 2006, approximately 95% of the homes passed in the Systems have access to our high-speed data service.
We believe significant incremental revenue will be generated by expanding the high-speed data penetration of the Systems. This growth potential exists due to the natural demand for the high-speed data product generally, as well as the relative under-penetration in the Systems versus the industry average. High-speed data service is one of the fastest growing products in the cable television industry, with total U.S. subscribers having grown at an annual rate of 54.1% between 2000 and 2004. Industry analysts forecast U.S. high-speed data subscriber growth to continue at an 16.5% projected annual rate between 2004 and 2008.
We believe the relative under-penetration of high-speed data services in the Systems relates to a historical lack of focus on both maximizing the number of high-speed data capable homes and the high-speed data penetration of those homes. With respect to the Systems’ existing base of two-way capable homes, there have not historically been any particular marketing initiatives focusing on high-speed data service separately from the overall suite of video services. For example, in the Miami Beach Cluster, where
management had traditionally been focused on adding bulk video accounts in new MDUs, high-speed data penetration is less than half the national average. Lastly, as high-speed data access becomes increasingly important for conducting business in commercial establishments, we have only recently begun to market high-speed data services to many of the commercial businesses passed by the Systems.
We offer multiple tiers of high-speed data service. Service tiers were developed to appeal to a range of potential customers based on the addressable download speeds required by different customer groups. The most affordable service is designed to appeal to those customers currently using dial-up Internet service by taking advantage of the “always on” feature of our high-speed data service. Our “premium” high-speed data service offers superior speeds to DSL and appeals to more sophisticated high-speed data services users. Over time, we will continue to evaluate opportunities to further tier our high-speed data service or offer additional bandwidth to our customers in order to maximize potential revenue and maintain strong data penetration. Customers have the option to purchase or rent a cable modem from us or purchase it directly from a retailer.
We provide all of the back office functions for the Systems’ high-speed data service including provisioning, email, domain name server, news and high-speed data access, multiple e-mail addresses and the ability for customers to create a personal home page. We also plan to offer several additional value added services such as home networking, remote access, firewall/virus protection, content filtering, remote storage and net backup that will provide additional revenue potential.
Telephony
In the first quarter of 2006, we began the rollout of our cable telephony service in certain of our cable systems. Our service uses technology that makes it possible to have a telephone conversation over a dedicated Internet Protocol (“IP”) network instead of dedicated voice transmission lines. This allows the elimination of circuit switching and the associated waste of bandwidth. Instead, packet switching is used, whereby IP packets with voice data are sent over the network only when data needs to be sent, for example when a caller is talking. IPs advantages over traditional telephony include: lower costs per call, especially for long-distance calls; lower infrastructure costs, as once the IP infrastructure is installed, little or no additional telephony infrastructure is needed and new advanced features.
Our telephony service competes primarily with the phone service offered by the respective incumbent local telephone company. Our service’s features include: unlimited long-distance calling throughout the U.S.; ability to keep the customers’ existing telephone number where local number telephone portability is supported; the ability to access enhanced Emergency 911 dialing and the ability to use existing telephones and in-house wiring.
In 2005, we entered into an agreement with Net2Phone Cable Telephony, LLC (“Net2Phone”) whereby Net2Phone assists us with provisioning capabilities and provides us with switching and termination of traffic to the public switched telephone network, delivery of enhanced Emergency 911 service, local number portability and operator and directory services.
As of December 31, 2006, approximately 301,000 of our homes passed had telephone capability and we had approximately 12,000 subscribers for a penetration of approximately 4%. We expect to offer cable telephony services to approximately 95% of our homes passed by the end of 2007.
Other Products and Services
Commercial Business Opportunity
We believe that there is a high level of demand for high-speed data access by the business community in the Systems. We receive numerous inquiries regarding the availability of commercial high-speed data service in areas where residential service has been launched. Our target market in the commercial sector is small to medium-sized businesses with between five and 100 employees. We currently provide “tiered” high-speed data service to the business community based on data throughput speeds. Commercial customers choose from those tiered services to best meet their requirements and budgets. We also opportunistically pursue large business and corporate customers located within our network footprint requiring: (i) wide area networks, (ii) point-to-point data services and (iii) virtual private networks. These services are offered where we have excess fiber or capacity on our network or where the contract with the customer provides an adequate return on investment.
Advertising
The Systems receive revenue from the sale of local advertising on satellite-delivered channels such as CNN, MTV, USA Network, ESPN, Lifetime, Nickelodeon and TBS. Advertising sales accounted for 3.2% and 2.9% of the Systems’ combined revenue for the years ended December 31, 2005 and 2006, respectively.
Technical Overview
As of December 31, 2006, the Systems were comprised of approximately 7,500 miles of network plant serving approximately 231,000 EBUs and passing approximately 494,000 homes resulting in a density of approximately 66 homes per mile. As of that date, the Systems were made up of an aggregate of 30 headends. As of December 31, 2006, approximately 95% of our homes were passed by networks with 550 MHz or higher bandwidth capacity, approximately 95% of homes passed were Internet-ready and two-way communications capable and approximately 61% of homes passed were telephone-ready.
Our network design is an analog and digital two-way active network with fiber optic cable carrying signals from the headend to the distribution point within our customers’ neighborhoods. The signals are transferred to our coaxial cable network at the node for delivery to our customers. The fiber system is capable of subdividing the nodes if traffic on the network requires additional capacity.
We believe that active use of fiber optic technology as a supplement to coaxial cable plays a major role in expanding channel capacity and improving the performance of the Systems. Fiber optic strands are capable of carrying hundreds of video, data and voice channels over extended distances without the extensive signal amplification typically required for coaxial cable. We will continue to deploy fiber optic cable as warranted to further reduce amplifier cascades which will improve picture quality, system reliability and reduce system maintenance cost.
A direct result of this extensive use of fiber optic cable is an improvement in picture quality and a reduction of outages because system failures will be both significantly reduced and will impact far fewer customers when outages do occur. Our design allows the Systems to have the capability to run multiple separate channel line-ups from a single headend and to insert targeted advertisements into specific neighborhoods.
Sales and Marketing
We have achieved higher sales and marketing success by maximizing revenues per subscriber through the use of tiered high speed data and video bundling tactics. After building the channels of direct sales, telemarketing, web based and retail we have significantly increased subscribers in high speed data. With the introduction of sophisticated segmentation we have more than doubled our sales rates and reduced our cost per sale.
We have developed and implemented sales focused compensation structures in our entire customer facing employee functions. With the introduction of ongoing sales and product training programs we have dramatically improved our ability to upgrade our existing base.
We have successfully implemented campaign tracking that enables us to track performance from the initial customer contact through the first full year of the customer relationship. We have successfully implemented in-house developed multimedia marketing campaigns that have an average payback of 6 months or less.
Programming
We believe that offering a wide variety of programming is an important factor that influences a customer’s decision to subscribe to and retain our cable services. We rely on market research, customer demographics and local programming preferences to determine channel offerings in each of our markets. We obtain the majority of our expanded basic, digital tier and premium programming from the NCTC. The NCTC is a national cooperative of cable television service operators which collectively negotiates and administers master affiliation agreements with cable television programming networks on behalf of its member companies. Through joint purchasing and negotiation, the NCTC is able to take advantage of volume discounts offered by programming networks for the purchase of these services. We also obtain basic and premium programming from a number of suppliers, usually pursuant to a written contract. Our programming contracts generally continue for a fixed period of time, usually from three to six years, and are subject to negotiated renewal. Some program suppliers offer financial incentives to support the launch of a channel and ongoing marketing support or launch fees. We also attempt to negotiate volume discount pricing structures. Programming costs are paid each month based on calculations performed by us and are subject to adjustment based on periodic audits performed by the program suppliers.
Programming is typically made available to us for a flat fee per customer with discounts available for channel placement or service penetration. Some channels may be available without cost to us for a limited period of time, after which we generally must pay for the programming. For home shopping channels, we receive a percentage of the amount spent in home shopping purchases by our customers on channels we carry.
Cable programming costs have generally increased in excess of customary inflationary and cost-of-living type increases and they are expected to continue to increase due to a variety of factors, including:
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additional programming being provided to customers as a result of system upgrades that increase channel capacity;
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increased cost to produce or purchase cable programming;
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increased cost for certain previously discounted programming; and
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inflationary or negotiated annual cost increases.
In particular, sports programming costs have increased significantly over the past several years. In addition, contracts to purchase sports programming sometimes contain built-in cost increases for programming added during the term of the contract.
Historically, many cable television operators have been able to offset increased programming costs through increased prices to their customers. However, with the impact of competition and other marketplace factors, there is no assurance that we will be able to do so in the future. In order to maintain margins despite increasing programming costs, we plan to continue to migrate certain program services from our analog level of service to our digital tiers. We expect that this migration will result in enhanced quality of programming offered on digital tiers and provide our video customers more value and more choice. These service migrations will likely result in an expansion in the number of our digital packages, which we believe will provide more options to bundle services and cover the increased programming expenses. Additionally, as our customers migrate to the digital tier packages, the customer base upon which we pay the increased product costs will proportionately decrease. Generally, to the extent that a reduced number of customers receive a given channel, our costs of providing that channel in our line-up decreases under our programming agreements, although we may lose the benefit of certain volume discounts.
We also obtain most broadcast programming through retransmission consent agreements. Our current agreements generally run through December 2008 and do not require payment of a flat per subscriber fee for retransmission of the broadcaster’s analog signal, but in some cases involve the exchange of other types of consideration such as limited grants of advertising time or, when applicable, limited video on-demand (“VOD”) launch fees. We carry a number of our broadcast programming on short term agreements and expect to negotiate long term agreements during 2007 and 2008. We expect to be subject to increasing cash demands by broadcasters in exchange for their required consent for the retransmission of broadcast programming to our subscribers. We cannot predict the impact of these negotiations or the effect on our business operations should we fail to obtain the required consents. These negotiations may result in increased burden for carriage or the loss of some broadcast programming.
Franchises
The Company operates pursuant to a total of 267 franchises, permits and similar authorizations issued by local and state governmental authorities. Each franchise is awarded by a governmental authority and such governmental authority often must approve a transfer to another party. Most franchises are subject to termination proceedings in the event of a material breach. In addition, most franchises require us to pay the granting authority a franchise fee of up to 5.0% of gross revenues as defined in the various agreements, which is the maximum amount that may be charged under the applicable federal law. We are entitled to and generally attempt to pass these fees through to our customers.
Prior to the scheduled expiration of most franchises, we will initiate renewal proceedings with the granting authorities. When the cable operator timely requests renewal, the Communications Act provides for an orderly franchise renewal process in which granting authorities may not unreasonably withhold renewals. In connection with the franchise renewal process, many governmental authorities require the cable operator to make certain commitments. Approximately 33% of our existing franchises will expire within the next three years; and approximately 13% of our existing franchises are expired but are in the process of being renewed. Historically, we have been able to renew the Systems’ franchises without incurring significant costs, although any particular franchise may not be renewed on commercially favorable terms or otherwise. Our failure to obtain renewals of our franchises, especially those in the areas where we have the most customers, could have a material adverse effect on our business, results of operations and financial condition.
Under the Telecommunications Act of 1996 (the “1996 Telecom Act”), state and local authorities are prohibited from limiting, restricting or conditioning the provision of telecommunications services through a cable franchise agreement, or taking other actions that prohibit or have the effect of prohibiting the ability of any entity to provide any interstate or intrastate telecommunications service. States may, however, impose “competitively neutral” requirements to preserve and advance universal service, protect the public safety and welfare, ensure the continued quality of telecommunications services, and safeguard the rights of consumers, and
state and local governments also retain their authority to manage the public rights-of-way and may require reasonable, competitively neutral compensation for management of the public rights-of-way when cable operators provide telecommunications service. Granting authorities may not require a cable operator to provide telecommunications services or facilities, other than institutional networks, as a condition of an initial franchise grant, a franchise renewal, or a franchise transfer. The 1996 Telecom Act also limits franchise fees to an operator’s cable-related revenues and clarifies that they do not apply to revenues that a cable operator derives from providing telecommunications services.
Competition
Cable systems face increasing competition from a variety of alternative entertainment and information delivery sources and alternative methods of receiving and distributing their core video business. Both wireline and wireless competitors have made inroads in competing against incumbent cable operators. We face competition in the areas of price, services, and service reliability. We compete with other providers of television signals and other sources of home entertainment. In addition, as we continue to expand into additional services including telephony and high-speed data Internet services, we face competition from other providers of each type of service. We operate in a highly competitive business environment which can adversely affect our business and operations.
DBS
DBS is a significant competitor to cable systems. The DBS industry has experienced continued growth over the last several years, exceeding the subscriber growth rate of the cable television industry. According to recent government and industry reports the two established DBS providers, DIRECTV, Inc. and EchoStar Communications Corporation are now the second and third largest multichannel video programming distributors (“MVPDs”) in the United States, serving nearly 28% of all MVPD subscribers. These providers have each entered into joint marketing agreements with major telecommunications companies to offer bundled packages combining phone service, DBS and DSL services.
The video services provided by DBS providers are comparable, in many respects, to our analog and digital video services, and DBS subscribers can obtain satellite receivers with digital video recorders from these providers. These providers are currently transmitting local broadcast signals in the markets we serve as well. We believe the two established major DBS competitors have been especially competitive at the lower end pricing. DBS providers have a national service and are able to establish a national image and branding with standardized offerings, which together with their ability to avoid franchise fees of up to 5% of revenues, leads to greater efficiencies and lower costs in the lower tiers of service. However, we believe that most consumers continue to prefer our stronger local presence in our markets. We also believe that our bundled premium packages are price competitive with DBS packages and that many consumers prefer our ability to economically bundle video with high-speed data and telephone services.
DSL
The deployment of DSL allows high-speed data access to subscribers at data transmission speeds greater than those available over conventional telephone lines. DSL service therefore is competitive with high-speed data access over cable systems. Several telephone companies which already have plants, an existing customer base, and other operational functions in place (such as, billing, service personnel, etc.) and other companies offer DSL service. Verizon Communications, Inc. provides DSL service in the Western Pennsylvania and Maryland/Delaware Clusters. In the Miami Beach and Aiken Clusters, AT&T provides a competitive DSL service which is generally available. We believe that, in each of our clusters, our bundled offerings of data , video and, where available, telephone services, superior customer service and local presence will allow us to compete effectively for additional market share.
We believe that pricing for residential and commercial high-speed data services in our Clusters is generally comparable to that for similar DSL services and that some residential customers prefer our ability to bundle high-speed data services with video services. However, certain DSL providers offer progressive price reductions for high-speed data access together with speed increases, and DSL providers may currently be in a better position to offer high-speed data services to businesses since their networks tend to be more complete in commercial areas. They also have the ability to bundle telephony with high-speed data services for a higher percentage of their customers, which is appealing to many consumers. Recent joint marketing arrangements between DSL providers and DBS providers may allow some additional bundling of services.
Overbuilds and ILEC Deployments
Cable television systems are operated under non-exclusive franchises granted by local authorities. More than one cable system may legally be built in the same area, and that competing franchise might contain terms and conditions more favorable than those afforded to the incumbent cable operator. A number of states have enacted legislation easing the regulatory obligations of telephone
companies seeking cable franchises. The FCC has recently issued an order creating rules to ensure reasonable franchising processes for new video market entrants. The US Congress has also considered such measures recently. In addition, entities willing to establish an open video system, under which they offer unaffiliated programmers non-discriminatory access to a portion of the System’s cable system, may be able to avoid local franchising requirements. Well-financed businesses from outside the cable industry, such as local exchange telephone companies and public utilities that already possess fiber optic and other transmission lines in the areas they serve, are competitors in certain areas.
The ILECS, notably Verizon and AT&T, continue to build fiber optic networks to deploy video services in substantial portions of their service areas, in addition to their joint marketing agreements with DBS providers. The fiber technologies they are using are capable of carrying two-way video, high speed data with substantial bandwidth and telephone services, each of which is comparable to the services we offer. These companies also have the ability to bundle wireless services provided by owned or affiliated companies.
We face limited cable competition from Comcast Corporation in two communities, Aventura and the southern section of Miami-Dade County, in our Miami Beach Cluster. In each case, our cable system is the newer system which is the “overbuilder” over the incumbent non Comcast system. As of December 31, 2006, the Aventura and South Miami systems served approximately 2,000 and 5,300 EBUs, respectively. We believe that we will continue to compete effectively against Comcast in these systems.
In the Maryland/Delaware cluster, Verizon has obtained overlapping franchises in the Middletown, DE areas where we serve approximately 6,300 video subscribers. Verizon has constructed or is in the process of constructing a fiber network in these areas. This network offers high speed Internet and voice services as well as video services, each of which is comparable to the services we offer.
Cable Telephony
We have rolled out our cable telephony service to residential customers in certain markets beginning in January 2006 and will continue expanding to additional markets in subsequent years. Our telephony service provides both local, long-distance and international calling together with popular features including voicemail. As such, it directly competes with the incumbent local telephone company and long-distance service providers. Other competitors include competitive local exchange carriers, which are non-incumbent local phone companies that provide local services and access to long-distance services over their own networks or over leased networks, wireless telephone carriers and IP-based service providers. IP phone is becoming more widely deployed by an increasing number of telecommunication service providers, which may result in heightened competition for our cable telephony service. We believe the addition of cable telephony to our video and high-speed data service bundles will help us compete with other providers of bundled services, including telephone companies that offer bundled video services on fiber networks, or bundle DBS video with their voice and data services, and the new providers of IP phone service.
Other Competitors
We face competition from broadcast television. Traditionally, cable television has provided better picture quality and more channel offerings than broadcast television. However, the recent licensing of digital spectrum by the FCC will provide traditional broadcasters with the ability to deliver high-definition television pictures and multiple digital-quality program streams, as well as advanced digital services such as subscription video and data transmission.
In addition, although competition from telephone companies is currently quite limited, local exchange carriers do provide facilities for the transmission and distribution of voice and data services, including high-speed data services, in competition with our existing or potential interactive services ventures and businesses. We are also subject to competition from utilities which possess fiber optic transmission lines capable of transmitting signals with minimal signal distortion. Utilities are also developing broadband over power line technology, which will allow the provision of high-speed data and other broadband services to homes and offices.
Additional competition is posed by satellite master antenna television (SMATV) systems, which currently benefit from operating advantages not available to franchised cable systems, including fewer regulatory burdens and no requirement to service low density or economically depressed communities. These private cable systems offer local broadcast and many of the same satellite delivered programming offered by franchised cable operators. They may enter into exclusive agreements with MDUs and thereby possibly preclude operators of franchise systems from serving residents of such private complexes.
A number of municipalities have recently announced plans to deploy “Wi-Fi” networks, which will make broadband Internet services available to residents, businesses and visitors. In the Miami Beach cluster, the City of Miami Beach has awareded a contract and Miami-Dade County has initiated a process to deploy Wi-Fi networks which may offer broadband services to non-municipal users, including residents, in competition with our high speed Internet services.
Other wireless program distribution services, such as multichannel multipoint distribution systems (MMDS) or “wireless cable,” generally provide many of the programming services provided by cable systems, and digital compression technology increases significantly the channel capacity of their systems. Both analog and digital MMDS services, however, require unobstructed “line of sight” transmission paths and MMDS ventures have been quite limited to date.
New technologies and initiatives of Internet Service Providers (“ISPs”), program and content providers, mobile telephone companies and others increasingly enable the delivery of video programming content to computers, telephones and other devices in competition with our video and high speed Internet services.
We cannot predict the likelihood of success of these or any other services offered by our competitors or the impact of such competitive ventures on our business and operations.
Regulation and Legislation
The following summary addresses the key regulatory developments and legislation affecting the cable industry.
The operation of a cable system is extensively regulated by 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 1996 Telecom Act altered the regulatory structure governing the nation’s communications providers. It removed barriers to competition in both the cable television market and the local telephone market. Among other things, it reduced the scope of cable rate regulation and encouraged additional competition in the video programming industry by allowing local telephone companies to provide video programming in their own telephone service areas. Congress and the FCC have frequently revisited the subject of cable regulation. Future legislative and regulatory changes could adversely affect our operations.
Cable Rate Regulation
The Cable Television Consumer Protection and Competition Act of 1992 (the “1992 Cable Act”), imposed an extensive rate regulation regime on the cable television industry, which limited the ability of cable companies to increase subscriber fees. Under that regime, all cable systems were subjected to rate regulation, unless they faced “effective competition” in their local franchise area. Federal law defines “effective competition” on a community-specific basis as requiring satisfaction of certain conditions. Historically, these conditions were not typically satisfied; hence, most cable systems potentially are subject to rate regulation. An “effective competition” determination has been made for only a small number of our cable franchises. However, with the rapid growth of DBS, it is likely that additional cable systems may qualify for “effective competition” and thereby avoid further rate regulation.
Although the FCC established the underlying regulatory scheme, local government units, commonly referred to as local franchising authorities, are primarily responsible for administering the regulation of the lowest level of cable service-the basic service tier, which typically contains local broadcast stations and public, educational, and government access channels. Before a local franchising authority begins basic service rate regulation, it must certify to the FCC that it will follow applicable federal rules. Many local franchising authorities have voluntarily declined to exercise their authority to regulate basic service rates, although it is possible that additional localities served by the Systems may choose to obtain certification and regulate basic cable rates in the future. Local franchising authorities also have primary responsibility for regulating cable equipment rates. Under federal law, charges for various types of cable equipment must be unbundled from each other and from monthly charges for programming services.
For regulated cable systems, the basic service tier, equipment and installation rate increases are governed by a complicated price cap scheme devised by the FCC that allows for the recovery of inflation and certain increased costs, as well as providing some incentive for system upgrades. Operators also have the opportunity to bypass this “benchmark” regulatory scheme in favor of traditional “cost-of-service” regulation in cases where the latter methodology appears favorable. Cost-of-service regulation is a traditional form of rate regulation, under which a utility is allowed to recover its costs of providing the regulated service, plus a reasonable profit.
Federal law requires that the basic service tier be offered to all cable subscribers and limits the ability of operators to require purchase of any cable programming service tier if a customer seeks to purchase premium services offered on a per- channel or
per-program basis. The 1996 Telecom Act also relaxes existing “uniform rate” requirements by specifying that uniform rate requirements do not apply where the operator faces “effective competition,” and by exempting bulk discounts to MDUs, although complaints about predatory pricing still may be made to the FCC.
Cable Entry into Title II Telecommunications
The 1996 Telecom Act created a more favorable environment for cable operators and other new entrants to provide Title II common carrier telecommunications service. It provides that no state or local laws or regulations may prohibit or have the effect of prohibiting any entity from providing any interstate or intrastate telecommunications service. States are authorized, however, to impose “competitively neutral” requirements regarding universal service, public safety and welfare, service quality, and consumer protection. State and local governments also retain their authority to manage the public rights-of-way and may require reasonable, competitively neutral compensation for management of the public rights-of-way when cable operators provide telecommunications service. The favorable pole attachment rates afforded cable operators under federal law can be gradually increased by utility companies owning the poles if the operator provides telecommunications service, as well as cable service, over its plant. The FCC clarified that a cable operator’s favorable pole rates are not endangered by the provision of high-speed data access based on the FCC’s conclusion that high-speed data access is not a “telecommunications service” and is instead an “interstate information service.” In June of 2005, the United States Supreme Court affirmed the FCC’s ruling.
Pole Attachments
The Telecom Act requires phone companies and other utilities (other than those owned by municipalities or cooperatives) to provide cable systems with nondiscriminatory access to any pole or right-of-way controlled by the utility. The rates that utilities may charge for such access are regulated by the FCC, or, alternatively, by states that certify to the FCC that they regulate such rates. Only one state in which we have cable systems has certified that it regulates pole rates. There is always the possibility that the FCC or a state could permit the increase of pole attachment rates paid by cable operators. Additionally, higher pole attachment rates apply to pole attachments that are subject to the FCC’s telecommunications services pole rates. The applicability of and method of calculating those rates for cable systems over which various phone services are transmitted remain unclear, and there is a risk that we will face significantly higher pole attachment costs as our telephone business expands.
Internet Service
Over the past several years, proposals have been advanced at the FCC and Congress that would require cable operators to provide non-discriminatory access to unaffiliated Internet service providers and online service providers. Several local franchising authorities actually adopted mandatory “open access” requirements, but various federal courts rejected each of these actions, relying on different legal theories. Recently, the FCC and the US Congress have considered “net neutrality” proposals which may impose industry-wide requirements on cable operators and other network providers.
In March 2002, the FCC ruled that cable modem service (that is, the provision of high-speed data access over cable system infrastructure) is an interstate information service, rather than a cable or telecommunications service. This ruling was affirmed by the United States Supreme Court in June, 2005. This classification has left cable modem service exempt from the burdens associated with traditional cable and telecommunications regulation. Indeed, the FCC held that revenue derived from cable modem service should not be added to franchise fee payments already limited by federal law to 5% of traditional cable service revenue. The FCC tentatively concluded that there was no other statutory basis for local franchise authorities to assess a fee on cable modem service. As a result of this ruling, we do not collect franchise fees for high-speed data service. However, our high speed Internet service is subject to certain regulatory obligations. In August 2005, the FCC adopted rules requiring providers of high speed Internet access service to comply with the Communications Assistance for Law Enforcement Act (“CALEA”). By May 2007, the FCC requires such providers to implement certain network capabilities to assist law enforcement in conducting surveillance. We expect that our high speed Internet service will comply with these new requirements.
Both Congress and the FCC are considering several “network neutrality” proposals. During the 2005-2006 Congressional term, several net-neutrality provisions were considered which may have operated to limit the ability of broadband network providers to adopt pricing and network management policies based on different uses of the Internet. None of these provisions were adopted, however similar legislation has been introduced in the current Congressional term. In August 2005, the FCC issued a non-binding policy statement stating four principles intended to guide its policymaking regarding high speed Internet and other related services. The FCC has made these principles binding as to certain companies as a condition to their merger. To date, the FCC has not adopted these generally as binding rules. Action by either Congress or the FCC in adopting new federal laws or regulations could limit our ability to manage its high speed Internet business and facilities profitably or efficiently.
Voice over Internet Protocol (“VoIP”)
We offer telephone service using VoIP packet cable technology in partnership with a third party supplier, Net2Phone, a division of IDT Corporation. In November 2004, the FCC ruled that certain VoIP services are jurisdictionally interstate and not subject to state or local utility regulation, however this ruling has been appealed. The FCC has imposed additional regulatory requirements on VoIP services including Enhanced 911 capabilities and customer disclosure, CALEA obligations effective in May 2007 and Universal Service payment obligations with respect to the interstate and international portions of the service. Recently, the FCC ruled favorably with respect to the obligations of LEC’s to interconnect with VoIP providers. The FCC has initiated other rulemakings to consider whether to impose other types of common carrier obligations on VoIP service providers.
Telephone Company Entry into Cable Television
The 1996 Telecom Act allows telephone companies to compete directly with cable operators by repealing the historic telephone company/cable cross-ownership ban. Local exchange carriers can now compete with cable operators both inside and outside their telephone service areas with certain regulatory safeguards. Because of their resources, local exchange carriers could be formidable competitors to traditional cable operators. Various local exchange carriers already are providing video programming services within their telephone service areas through a variety of distribution methods.
A number of major telephone companies, including Verizon Communications and AT&T (formerly known as SBC), are deploying “fiber to the home” for the purposes of offering broadband video services in addition to voice and Internet services. A number of states have enacted legislation or are currently considering legislation to ease the regulatory obligations of telephone companies seeking cable franchises. The FCC has recently adopted an order ensuring “reasonable” franchise processes for new video entrants and the US Congress are also considering measures to ease franchising requirements for new entrants, including local phone companies to create a “nationwide franchise.”
Under the 1996 Telecom Act, local exchange carriers or any other cable competitor providing video programming to subscribers through broadband wire should be regulated as a traditional cable operator, subject to local franchising and federal regulatory requirements. If the local exchange carrier or other cable competitor elects to deploy its broadband plant as an open video system, the competitor must reserve two-thirds of the system’s activated channels for unaffiliated entities. Even then, the FCC revised its open video system policy to leave franchising discretion to state and local authorities. It is unclear what effect this ruling will have on the entities pursuing open video system operation.
Although local exchange carriers and cable operators can now expand their offerings across traditional service boundaries, the general prohibition remains on local exchange carrier buyouts of cable systems serving an overlapping territory. Cable operator buyouts of overlapping local exchange carrier systems, and joint ventures between cable operators and local exchange carriers in the same market, also are prohibited. The 1996 Telecom Act provides a few limited exceptions to this buyout prohibition, including a carefully circumscribed “rural exemption.” The 1996 Telecom Act also provides the FCC with the limited authority to grant waivers of the buyout prohibition.
Electric Utility Entry into Telecommunications/Cable Television
The Energy Policy Act of 2005 repealed the Public Utility Holding Company Act of 1935 effective February 8, 2006, easing the legal and regulatory obstacles to utility ownership of other businesses not functionally related to the utility business, including broadband communications. Like telephone companies, electric utilities have substantial resources at their disposal, and could be formidable competitors to traditional cable systems. Several such utilities have been granted broad authority by the FCC to engage in activities which could include the provision of video programming. A number of electric utilities have also announced various efforts to deploy broadband over Power Line (“BPL”) services and the FCC has instituted a rulemaking to address BPL radio frequency issues.
Additional Ownership Restrictions
The 1996 Telecom Act eliminated a statutory restriction on broadcast network/cable cross-ownership, but left in place existing FCC regulations prohibiting local cross-ownership between co-located television stations and cable systems. The District of Columbia Circuit Court of Appeals subsequently struck down this remaining broadcast/cable cross-ownership prohibition, and the FCC has now eliminated the prohibition.
Pursuant to the 1992 Cable Act, the FCC adopted rules precluding a cable system from devoting more than 40% of its activated channel capacity to the carriage of affiliated national video program services. Also pursuant to the 1992 Cable Act, the FCC adopted rules that preclude any cable operator from serving more than 30% of all U.S. domestic multichannel video subscribers, including cable and direct broadcast satellite subscribers. The D.C. Circuit Court of Appeals struck down these vertical and horizontal ownership limits as unconstitutional, concluding that the FCC had not adequately justified the specific rules (i.e., the 40% and 30% figures) adopted. The FCC is now considering replacement regulations.
Must Carry/Retransmission Consent
The 1992 Cable Act contains broadcast signal carriage requirements. Broadcast signal carriage is the transmission of broadcast television signals over a cable system to cable customers. These requirements, among other things, allow local commercial television broadcast stations to elect once every three years between “must carry” status or “retransmission consent” status. Less popular stations typically elect must carry, which is the broadcast signal carriage rule that allows local commercial television broadcast stations to require a cable system to carry the station. More popular stations, such as those affiliated with a national network, typically elect retransmission consent which is the broadcast signal carriage rule that allows local commercial television broadcast stations to negotiate for payments or other consideration for granting permission to the cable operator to retransmit the stations. Retransmission consent demands may require substantial payments or other concessions. Either option has a potentially adverse effect on our business. The burden associated with broadcast carriage may increase substantially if the FCC or the Congress enacts regulations or legislation that requires cable systems to simulcast the analog and digital signal of a broadcaster, and/or to multicast the digital signal of a broadcaster within a 6mhz spectrum. This burden would reduce capacity available for more popular video programming and new Internet and telecommunication offerings. The Congress has set February 2009 as the deadline for the completion of the conversion to digital. Further proceedings or congressional legislation could produce additional carriage obligations. The FCC tentatively decided against imposition of dual digital and analog must carry in a January 2001 ruling and confirmed that ruling in a February 2005 order. The FCC also confirmed its initial ruling that, whenever a digital broadcast signal does become eligible for must carry, a cable operator’s obligation is limited to carriage of a single digital video signal.
Cable Equipment Issues
The FCC has adopted regulations aimed at promoting the retail sale of set-top boxes and other equipment that can be used to receive digital video services. Currently, most cable subscribers access these services using a leased set-top box that integrates cable access security with other operating functions. Subscribers may also obtain digital video services through a separate piece of equipment, known as a cableCARD, that connects to digital cable devices purchased at retail. Effective July 2007, cable operators must cease placing into service new set-top boxes with integrated security. At that time, newly developed leased set-top boxes must use a separate piece of equipment (typically a cableCARD) to provide access to digital video services. A federal court upheld the ban on integrated set-top box security in August 2006, leaving any subsequent relief to the FCC. We and other cable companies subject to the ban are currently seeking FCC waivers to exempt some limited function set-top boxes form the ban and/or to extend the deadline to accommodate newer security technology that can be downloaded to leased set-top boxes as well as retail equipment. A number of waiver requests for limited-function set-top boxes were denied by the FCC’s Media Bureau in January 2007 and have been filed for reconsideration by the full FCC. There is no assurance that our or any request will be granted. If the FCC does not extend the deadline and does not grant our waiver request, we will be forced to incur added costs in purchasing cableCARD-enabled set-top boxes and the associated cableCARDs.
Access Channels
Local franchising authorities can include franchise provisions requiring cable operators to set aside certain channels for public, educational and governmental access programming. Federal law also requires cable systems to designate a portion of their channel capacity, up to 15% in some cases, for commercial leased access by unaffiliated third parties. The FCC has adopted rules regulating the terms, conditions and maximum rates a cable operator may charge for commercial leased access use.
Access to Programming
To spur the development of independent cable programmers and competition to incumbent cable operators, the 1992 Cable Act imposed restrictions on the dealings between cable operators and cable programmers. Of special significance from a competitive business position, the 1992 Cable Act restricts video programmers affiliated with cable companies from discriminating in prices, terms and conditions as between multichannel video programming distributors. The 1992 Cable Act also limits the ability of vertically integrated cable programmers to enter into exclusive programming arrangements with cable companies, though this provision does not apply to DBS operators. The FCC extended this exclusivity prohibition to October 2007.
Several other provisions of law and FCC regulation also impact cable operators’ access to programming. Pursuant to the Satellite Home Viewer Improvement Act, and the more recent Satellite Home Viewer Reauthorization Act, the FCC has adopted regulations governing retransmission consent negotiations between broadcasters and all multichannel video programming distributors, including cable and DBS. These provisions generally require broadcasters and MVPDs to negotiate in good faith for the retransmission of broadcast signals. More recently, the FCC conditioned News Corp.’s acquisition of a controlling interest in Hughes Electronics by requiring certain News Corp.-owned entities (both broadcast television stations and cable programming networks) to enter into binding arbitration with multichannel video programming distributors when carriage negotiations fail.
Inside Wiring; Subscriber Access
In an order dating back to 1997 and largely upheld in a 2003 reconsideration order, the FCC established rules that require an incumbent cable operator upon expiration of a MDU service contract to sell, abandon or remove “home run” wiring that was installed by the cable operator in an MDU building. These inside wiring rules are expected to assist building owners in their attempts to replace existing cable operators with new programming providers who are willing to pay the building owner a higher fee, where such a fee is permissible. In another proceeding, the FCC has preempted restrictions on the deployment of private antennas on property within the exclusive use of a condominium owner or tenant, such as balconies and patios. This FCC ruling may limit the extent to which we, along with MDU owners, may enforce certain aspects of MDU agreements which otherwise prohibit, for example, placement of direct broadcast satellite receiver antennas in MDU areas under the exclusive occupancy of a renter. These developments may make it more difficult for us to provide service in MDUs.
Other Communications Act Provisions and Regulations of the FCC
In addition to the Communications Act provisions and FCC regulations noted above, there are other cable service-related statutory provisions and regulations of the FCC covering such areas as:
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subscriber privacy;
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programming practices, including, among other things:
(1) blackouts of programming offered by a distant broadcast signal carried on a cable system that duplicates the programming for which a local broadcast station has secured exclusive distribution rights,
(2) local sports blackouts,
(3) indecent programming,
(4) lottery programming,
(5) political programming,
(6) sponsorship identification,
(7) children’s programming advertisements, and
(8) closed captioning;
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registration of cable systems and facilities licensing;
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maintenance of various records and public inspection files;
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aeronautical frequency usage;
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lockbox availability;
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antenna structure notification;
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tower marking and lighting;
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consumer protection and customer service standards;
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technical standards;
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equal employment opportunity;
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consumer electronics equipment compatibility; and
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emergency alert systems.
Copyright Licensing
Cable television systems are subject to federal copyright licensing covering carriage of television and radio broadcast signals. In exchange for filing certain reports and contributing a percentage of their revenues to a federal copyright royalty pool that varies depending on the size of the system, the number of distant broadcast television signals carried, and the location of the cable system, cable operators can obtain blanket permission to retransmit copyrighted material included in broadcast signals. The possible modification or elimination of this compulsory copyright license is the subject of continuing legislative and administrative review and could adversely affect our ability to obtain desired broadcast programming. We cannot predict the outcome of this activity. Further, the Copyright Office has not made any determination as to how compulsory license will apply to digital broadcast signals and services. Copyright clearances for non-broadcast programming services are arranged through private negotiations.
Cable operators distribute locally originated programming and advertising that use music controlled by the two principal major music performing rights organizations, the American Society of Composers, Authors and Publishers and Broadcast Music, Inc. The cable industry has had a long series of negotiations and adjudications with both organizations. Although we cannot predict the ultimate outcome of these industry proceedings or the amount of any license fees we may be required to pay for past and future use of association-controlled music, we do not believe such license fees will be significant to our business and operations.
State and Local Regulation
Cable systems generally are operated pursuant to non-exclusive franchises granted by a municipality or other state or local government entity in order to cross public rights-of-way. Federal law prohibits local franchising authorities from granting exclusive franchises or from unreasonably refusing to award additional franchises. Cable franchises generally are granted for fixed terms and in many cases include monetary penalties for non-compliance and may be terminable if the franchisee fails to comply with material provisions.
The specific terms and conditions of franchises vary materially between jurisdictions. Each franchise generally contains provisions governing cable operations, franchise fees, system construction and maintenance obligations, system channel capacity, design and technical performance, customer service standards, and indemnification protections. A number of states subject cable systems to the jurisdiction of centralized state governmental agencies, some of which impose regulation of a character similar to that of a public utility. Although local franchising authorities have considerable discretion in establishing franchise terms, there are certain federal limitations. For example, local franchising authorities cannot insist on franchise fees exceeding 5% of the system’s gross cable-related revenues, cannot dictate the particular technology used by the system, and cannot specify video programming other than identifying broad categories of programming. Certain states, such as Florida, impose broadly applied telecommunications taxes.
Federal law contains renewal procedures designed to protect incumbent franchisees against arbitrary denials of renewal. Even if a franchise is renewed, the local franchising authority may seek to impose new and more onerous requirements such as significant improvements in service or increased franchise fees as a condition of renewal. Similarly, if a local franchising authority’s consent is required for the purchase or sale of a cable system or franchise, the local franchising authority may attempt to impose more burdensome or onerous franchise requirements as a condition for providing its consent. Historically, most franchises have been renewed for and consents granted to cable operators that have provided satisfactory services and have complied with the terms of their franchise.
There has been considerable state and federal legislative and administrative activity aimed at easing entry and franchise burdens for new cable competitors, including the ILECs. The FCC recently adopted an order to ensure that the local franchising process does not unreasonably interfere with competitive entry In the 2005-2006 session, Congress considered telecommunications reform legislation which would significantly reduce the franchising burdens of competitors, and we expect the Congress will again consider such reforms in the current session. A number of states, including South Carolina, have enacted state-wide franchising status, and a number of states, including Pennsylvania and Florida, are considering similar legislation.
Seasonality
Use and consumption of our products do not fluctuate significantly due to seasonality.
Employee and Labor Relations
Our Company has approximately 623 full time employees. Of these employees, approximately 136 are covered by collective bargaining agreements at six locations. We consider our relations with our employees to be satisfactory.
ITEM 1A.
ITEM 1A. RISK FACTORS
Risks Related to Our Business
You should carefully consider the following factors in addition to other information in this Report in evaluating our Company and our business.
Our substantial leverage may impair our financial condition and we may incur significant additional debt.
As of December 31, 2006, our total consolidated debt was $536.3 million.
Our substantial debt could have important consequences to you, including:
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increasing our vulnerability to general adverse economic and industry conditions;
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limiting our ability to obtain additional financing to fund future working capital requirements, capital expenditures, and other general corporate requirements;
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requiring a substantial portion of our cash flow from operations for the payment of interest on our debt, thus reducing our ability to use our cash flow to fund working capital, capital expenditures, acquisitions and general corporate requirements;
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limiting our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate; and
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placing us at a competitive disadvantage compared to other less-leveraged competitors.
Subject to specified limitations, we are able to borrow up to an additional $63.6 million under our senior secured credit facilities. If new debt is added to our current debt levels, the related risks that we now face could intensify.
Servicing our debt will require a significant amount of cash, and our ability to generate sufficient cash depends upon many factors, some of which are beyond our control.
Our ability to make payments on and refinance our debt and to fund planned capital expenditures depends on our ability to generate cash flow in the future. To some extent, this is subject to general economic, financial, competitive, legislative and regulatory factors and other factors that are beyond our control. Our business may not continue to generate cash flow at current levels. If we are unable to generate sufficient cash flow from operations in the future to service our debt, we may have to refinance all or a portion of our existing debt or obtain additional financing. A refinancing of this kind may not be possible, and we may be unable to obtain additional financing. The inability to obtain additional financing could have a material adverse effect on our financial condition and on our ability to meet our obligations.
Covenant restrictions under our indebtedness may limit our ability to operate our business.
Our senior secured credit facilities, the indenture governing our 9 3/8% senior subordinated notes (the “Notes”) and certain of our other agreements relating to our indebtedness contain, among other things, covenants that may restrict our and our restricted subsidiaries’ ability to finance future operations or capital needs or to engage in other business activities. Our senior secured credit facilities restrict and the indenture restricts, among other things, our ability and the ability of our restricted subsidiaries to:
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incur additional indebtedness;
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incur indebtedness senior to the notes, but junior to other debt;
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make restricted payments;
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create certain liens;
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restrict payments by our subsidiaries to us;
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enter into transactions with affiliates; and
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merge or consolidate or transfer and sell assets.
In addition, our senior secured credit facilities require us to maintain specified financial ratios and satisfy certain financial condition tests that may require that we take action to reduce our debt or to act in a manner contrary to our business objectives. Events beyond our control, including changes in general economic and business conditions, may affect our ability to meet those financial ratios and financial condition tests. We may be unable to meet those tests, and the senior secured lenders may not waive any failure to meet those tests.
A default under the indenture governing the Notes or under our senior secured credit facilities could result in an acceleration of our indebtedness or a foreclosure on the membership interests of our operating subsidiaries, which would have a material adverse effect on our business, financial condition and results of operations.
The indenture governing the Notes and the credit agreement governing our senior secured credit facilities contain numerous financial and operating covenants. The breach of any of these covenants will result in a default under the indenture or credit agreement which could result in the indebtedness under our indenture or credit agreement becoming immediately due and payable. If this were to occur, we would be unable to adequately finance our operations. In addition, a default under our indenture or the credit agreement governing our senior secured credit facilities could result in a default or acceleration of our other indebtedness subject to cross-default provisions. If this occurs, we may not be able to pay our debts or borrow sufficient funds to refinance them. Even if new financing is available, it may not be on terms that are acceptable to us. The membership interests of our operating subsidiaries were pledged as security under our senior secured credit facilities. A default under our senior secured credit facilities could result in a foreclosure by the lenders on the membership interests pledged thereunder. Because we are dependent upon our operating subsidiaries for all of our revenues, a foreclosure by the lenders under the senior secured credit facilities would have a material adverse effect on our business, financial condition and results of operations.
If we are unsuccessful in growing our business, our financial condition and results of operations could be adversely affected.
If we are unable to grow our cash flow sufficiently, we may be unable to expand our business or to fund our other liquidity needs. We expect that a substantial portion of our future growth will be achieved through revenues from increased penetration of our products and services. We may not be able to offer these products and services successfully to our customers, and these products and services may not generate adequate revenues. If we are unable to grow our cash flow sufficiently, our financial condition and results of operations could suffer materially.
Our financial statements reflect a net loss and we expect to continue to experience net losses. Consequently, we may not have the ability to finance future operations.
We reported a net loss of $10.2 million for the year ended December 31, 2006, and we expect to report net losses in the foreseeable future. We expect net losses to continue as a result of significant interest costs and depreciation and amortization costs. Future net losses could impair our ability to finance our operations in the future or refinance our indebtedness at maturity.
We depend on third-party service suppliers for certain of our services.
We depend on third parties to provide certain programming and billing services, as well as capital equipment for certain of our services. In addition, we depend on third-party plant construction contractors in areas of new homes growth. If demand for these services exceeds our suppliers’ capacity or if our suppliers experience operating or financial difficulties, our ability to provide these advanced services might be adversely affected, which could negatively impact our growth, financial condition and results of operations. In addition, the inability of these vendors to provide equipment or services might result in additional costs to us, including the cost to negotiate alternative vendor relationships, the cost to develop the capacity to provide the equipment and services ourselves and the loss of customers as a result of our inability to provide such advanced services or an interruption of service following a vendor’s cessation of service. We are working to establish alternative vendors for services that we consider critical, but we may not be able to establish such relationships or obtain such equipment and services on a equally favorable basis.
We operate in a very competitive business environment which can adversely affect our business and operations.
The industry in which we operate is highly competitive. In some instances, we compete against companies with fewer regulatory burdens, easier access to financing, greater personnel resources, greater brand name recognition and long-standing relationships with regulatory authorities and customers. Our principal competitor for video services throughout our territory is DBS and, in markets where it is available, our principal competitor for high-speed data services is DSL. Competition from DBS, including intensive marketing efforts and aggressive pricing, may have an adverse impact on our ability to retain customers. Local telephone companies and electric utilities also are permitted to compete in our market areas. The subscription television industry also faces competition from free broadcast television and from other communications and entertainment media including on-line, Internet-based and cellular video entertainment. An increase in the loss of customers to DBS or other alternative video and high-speed data services could have a material negative effect or our business. With respect to our high-speed data services, we face competition, including intensive marketing efforts and aggressive pricing, from telephone companies and other providers of “dial-up” and DSL. DSL service is competitive with high-speed data service over cable systems. Several telephone companies (which already have telephone lines into the household, an existing customer base and other operational functions in place) and other companies offer DSL service. Our phone service faces competition from the local LECs, as well as other providers such as cellular and VoIP providers such as Vonage.
We face limited competition from Comcast Corporation in Aventura and southern sections of Miami-Dade County in our Miami Beach Cluster. In each case, our system is the newer “overbuilder” over the non-upgraded Comcast system. Although we are not aware of any plans by Comcast to upgrade its Aventura system, we believe that Comcast plans to upgrade its South Miami system to provide two-way communications capability. In each case, we may be unable to continue to compete effectively against the Comcast systems. In the Maryland/Delaware cluster, Verizon has obtained overlapping franchises in the Middletown, DE area where we serve approximately 6,300 video subscribers. Verizon has constructed or is in the process of constructing a fiber network in these areas. This network will offer high speed Internet and voice services as well as video services.
We expect that future advances in communications technology could lead to the introduction of new competitors, products and services that may compete with the business of the Systems. For example, broadband over power lines could emerge as a competitor to our services. Additionally, if we expand and introduce new and enhanced telecommunications services, the Systems will be subject to competition from new and established telecommunications providers. We cannot predict the extent to which competition may effect the business and operations of the Systems in the future.
Our business could be adversely affected by labor disputes.
Approximately 21% of the Systems’ employees are represented by several unions under collective bargaining agreements. While we intend to negotiate in good faith with the labor unions regarding new labor contracts, any negotiations we may undertake with such unions may not result in outcomes satisfactory to us. We may also experience work stoppages, strikes or slowdowns at the Systems. A prolonged work stoppage, strike or slowdown could have a material adverse effect on our business.
The loss of any of our key executives could adversely affect our ability to manage our business.
Our success is substantially dependent upon the retention and the continued performance of our executive officers. Many of these executive officers are uniquely qualified in their areas of expertise, making it difficult to replace their services. The loss of the services of any of these officers could adversely affect our growth, financial condition and results of operations.
The interests of our equityholder may not be aligned with the interests of the holders of the Notes.
Entities associated with ABRY Partners beneficially own securities representing approximately 80% of the voting equity interests of Atlantic Broadband Group, LLC and therefore indirectly control our affairs and policies. Circumstances may occur in which the interests of our equityholder could be in conflict with the interests of the holders of the Notes. In addition, our equityholder may have an interest in pursuing acquisitions, divestitures, capital expenditures or other transactions that, in their judgment, could enhance their equity investment, even though these transactions might involve risks to the holders of the notes. See “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” and “Certain Relationships and Related Transactions.”
Risks Related to the Industry
Our industry is characterized by technological developments which could place significant capital expenditure requirements on us. If we cannot satisfy these requirements, our growth, results of operations and financial condition could suffer materially.
The cable television business is characterized by rapid technological change and the introduction of new products and services. We may not be able to fund the capital expenditures necessary to keep pace with technological developments, and we may not successfully anticipate the demand of our customers for products and services requiring new technology. Additionally, many developers of advanced products and services do not have a long operating history. As a result, if these developers experience financial difficulties, our ability to offer these advanced products and services could be adversely affected. Our inability to upgrade, maintain and expand the Systems and provide advanced services in a timely manner, or to anticipate the demands of the marketplace, could adversely affect our ability to compete. Consequently, our growth, financial condition and results of operations could suffer materially.
We may not have the ability to pass increases in programming costs on to our customers, which would adversely affect our cash flow and operating margins.
Programming is expected to be our largest operating expense item. In recent years, the cable industry has experienced a rapid escalation in the cost of programming, particularly sports programming. This escalation may continue, and we may not be able to pass programming cost increases on to our customers. The inability to pass these programming cost increases on to our customers would have an adverse impact on our cash flow and operating margins. In addition, as we upgrade the channel capacity of the Systems and add programming to our basic, expanded basic and digital service offerings, we may face additional market constraints on our ability to pass programming costs on to our customers. The inability to pass these costs increases on to our customers could materially adversely affect our profitability. We are also subject to increasing financial and other demands by broadcasters to obtain the required consent for the transmission of broadcast programming to our subscribers. We cannot predict the financial impact of these demands or the effect on our subscriber count should we be required to stop offering this programming.
Our business is subject to extensive governmental legislation and regulation. The applicable legislation and regulations, and changes to them, could adversely affect our business by increasing our expenses.
Regulation of the cable industry has increased the administrative and operational expenses and limited the revenues of cable systems. Cable operators are subject to, among other things:
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subscriber privacy regulations;
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limited rate regulation;
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requirements that, under specified circumstances, a cable system carry a local broadcast station or obtain consent to carry a local or distant broadcast station;
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rules for franchise renewals and transfers;
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regulations concerning the content of programming offered to subscribers;
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the manner in which program packages are marketed to subscribers;
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the use of cable system facilities by local franchising authorities, the public and unrelated entities;
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cable system ownership limitations and program access requirements;
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payment of franchise fees to local franchising authorities;
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payment of federal universal service assessments for any end user revenues from interstate and international telecommunications services and telecommunications provided to a third party for a fee, and other state and federal telecommunications fees; and
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regulations governing other requirements covering a variety of operational areas such as equal employment opportunity, technical standards and customer service requirements.
In addition, despite deregulation of expanded basic cable programming packages, cable rate increases could give rise to further regulation. The FCC and the United States Congress continue to be concerned that cable rate increases are exceeding inflation. It is
possible that either the FCC or the United States Congress will again restrict the ability of cable system operators to implement rate increases. Should this occur, it would impede our ability to raise our rates. If we are unable to raise our rates in response to increasing costs, our financial condition and results of operations could be materially adversely affected.
We could be materially disadvantaged if we remain subject to legal and regulatory constraints that do not apply equally to our competitors. For instance, the FCC recently adopted rules benefiting our competitors to ensure that the local franchising process does not unreasonably interfere with competitive entry, and several states have enacted legislation to ease the franchising obligations of new entrants. In addition, both the Congress and the FCC are considering various forms of “network neutrality” regulation which may have the impact of restricting our ability to manage our network efficiently.
Local franchise authorities have the ability to impose additional regulatory constraints on our business, which could further increase our expenses.
In addition to the franchise agreement, cable authorities in some jurisdictions have adopted cable regulatory ordinances that further regulate the operation of cable systems. This additional regulation increases our expenses in operating our business. Local franchising authorities may impose new and more restrictive requirements. Local franchising authorities that are certified by the FCC to regulate rates for basic cable service also have the power to reduce rates and order refunds on the rates charged for basic services.
Additionally, many aspects of these regulations are currently the subject of judicial proceedings and administrative or legislative proposals. There are also ongoing efforts to amend or expand the federal, state and local regulation of some of our cable systems, which may compound the regulatory risks we already face. Certain states and localities are considering new telecommunications taxes that could increase operating expenses. We cannot predict whether in response to these efforts any of the states or localities in which we now operate will expand regulation of our cable systems in the future or how they will do so.
The cable systems that we operate are under franchises that may be subject to non-renewal or termination. The failure to renew a franchise could adversely affect our business in a key market.
The Systems generally operate pursuant to franchises, permits or licenses granted by a municipality or other state or local government controlling the public rights-of-way. Many franchises establish comprehensive facilities and service requirements, as well as specific customer service standards and monetary penalties for non-compliance. In many cases, franchises are terminable if the franchisee fails to comply with significant provisions set forth in the franchise agreement governing system operations. Franchises are generally granted for fixed terms and must be periodically renewed. Local franchising authorities may resist granting a renewal if either past performance or the prospective operating proposal is considered inadequate. Franchise authorities often demand concessions or other commitments as a condition to renewal. In some instances, franchises have not been renewed at expiration, and we have operated under either temporary operating agreements or without a license while negotiating renewal terms with the local franchising authorities. We may be unable to comply with all significant provisions of our franchise agreements. Additionally, although historically we have renewed our franchises without incurring significant costs, we may be unable to renew, or to renew as favorably, our franchises in the future. A termination of and/or a sustained failure to renew a franchise could adversely affect our business in the affected geographic area.
The cable systems that we operate are under franchises that are non-exclusive and local franchise authorities may grant competing franchises in our markets.
Our cable systems operate under non-exclusive franchises granted by local franchising authorities. Consequently, local franchising authorities can grant additional franchises to competitors in the same geographic area. In some cases municipal utilities may legally compete with us without obtaining a franchise from the local franchising authority. The existence of more than one cable system operating in the same territory is referred to as an overbuild. Additional overbuilds could adversely affect our growth, financial condition and results of operations by increasing competition or creating competition.
Changes in channel carriage regulations could impose significant additional costs on us.
Cable operators face significant regulation of their channel carriage. They currently can be required to devote substantial capacity to the carriage of programming that they would not carry voluntarily, including certain local broadcast signals, local public, educational and government access programming, and unaffiliated commercial leased access programming. This carriage burden could increase in the future, particularly if the Congress or the FCC were to require cable systems to carry both the analog and digital (or high-definition) versions of local broadcast signals, or to carry a broadcaster’s entire digital signal instead of just the primary video signal. The FCC tentatively decided against imposition of dual digital and analog must carry in a January 2001 ruling and
confirmed that ruling in a February 2005 order. The FCC also confirmed its initial ruling that, whenever a digital broadcast signal does become eligible for must carry, a cable operator’s obligation is limited to carriage of a single digital video signal. However, the agency has signaled the industry that it may reconsider its rulings.
Actions by pole owners might subject us to substantially increased pole attachment costs.
Cable system attachments to public utility poles, known as pole attachments, historically have been regulated at the federal or state level generally resulting in favorable pole attachment rates for attachments used to provide cable television service. The FCC has determined that a cable television operator’s favorable pole rates are not endangered by the provision of high-speed data access based on the FCC’s conclusion affirmed by the United States Supreme Court in June 2005, that high-speed data access is an interstate information service and not a “telecommunications service”. Despite the existing regulatory regime, utility pole owners in many areas are attempting to raise pole attachment fees and impose additional costs on cable television operators and others. In addition, the favorable pole attachment rates afforded cable television operators under federal law can be gradually increased by utility companies if the operator provides telecommunications services, as well as cable service, over plant attached to utility poles. Any increase in costs could have a material adverse impact on our profitability and discourage system upgrades and the introduction of new products and services.
Offering telecommunications service will subject us to additional regulatory burdens which could cause us to incur additional costs.
We offer VoIP services to our customers. The FCC has held that for purposes of the Telecom Act such services are interstate in nature and therefore they would not be subject to state PUC regulation; however, this ruling has been appealed. It is unclear whether the FCC will ultimately treat VoIP as a “communications”, “information” or other form of service and it has not issued a comprehensive order clarifying the classification of VoIP services. In the past several years, the FCC has applied certain telecommunications requirements to VoIP services, including Enhanced 911, Universal Service Fund contribution and CALEA requirements. If VoIP services are deemed by regulators to be telecommunications services or state-regulated telephone service, offering such services could require us to obtain federal, state and local licenses or other authorizations. If we are required to obtain such authorizations, we may not be able to do so in a timely manner or at all, and conditions could be imposed upon such licenses or authorizations that may not be favorable to us. Furthermore, telecommunications companies, potentially including Internet protocol telephony companies, could be subject to significant regulation. Changes could increase the regulatory burdens on providers of such services, and cause us to incur additional costs.
In addition, cable television operators who provide telecommunications services and cannot reach agreement with local utilities over pole attachment rates in states that do not regulate pole attachment rates will be subject to a methodology prescribed by the FCC for determining the rates. These rates may be higher than those paid by cable television operators that do not provide telecommunications services. The rate increases are being phased in over a five-year period that began on February 8, 2001. If we become subject to telecommunications regulation or higher pole attachment rates, we may incur additional costs, which might be material to our business.
ITEM 1B.
ITEM 1B.
Unresolved Staff Comments
None.
ITEM 2.
ITEM 2.
Properties
We operate the following facilities, all of which are owned, except as noted. All of our owned facilities are subject to liens in favor of the lenders under our senior secured credit facilities. We believe our facilities are adequate for our current and reasonably anticipated future needs.
ITEM 3.
ITEM 3. Legal Proceedings
We are party to various lawsuits arising from time to time in the normal course of business. We are not currently party to any material legal proceedings. Although the outcome of these matters cannot be predicted with certainty and the impact of the final resolution of these matters on our results of operations in a particular subsequent reporting period is not known, management does not believe that the resolution of these lawsuits will have a material adverse effect on financial position or liquidity of our Company.
ITEM 4.
ITEM 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of our security holders during our fiscal year ended December 31, 2006.
PART II
ITEM 5.
ITEM 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Not applicable.
ITEM 6.
ITEM 6. Selected Historical Financial Data
The following table sets forth the selected historical financial data of the Systems as of the dates and for the periods indicated. We derived the selected historical combined statement of operations data for the years ended December 31, 2002 and 2003 and the period ended February 29, 2004 and the selected combined balance sheet data as of December 31, 2002 and 2003 and February 29, 2004 from the Systems’ historical combined financial statements which have been audited by KPMG LLP, independent registered public accounting firm. We derived the summary historical consolidated statement of operations data for the years ended December 31, 2004, 2005 and 2006 and the summary consolidated balance sheet data as of December 31, 2005 and 2006 from the Company’s financial statements appearing elsewhere in this Annual Report on Form 10-K which have been audited by PricewaterhouseCoopers LLP, independent registered public accounting firm.
The selected historical financial data presented below should be read in conjunction with “Item 7
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion of our financial condition and results of operations should be read in conjunction with the audited consolidated financial statements and the accompanying notes included elsewhere in this document. This discussion contains forward-looking statements about our markets, the demand for our products, and our future results. We based these statements on assumptions that we consider reasonable. Actual results may differ materially from those suggested by our forward-looking statements for various reasons including those discussed in the “Forward Looking Statements” section of this document.
Terms used herein such as “we”, “us”, and “our” are references to Atlantic Broadband Finance, LLC and its subsidiaries (collectively the “Company”), as the context requires.
Our Company is a wholly-owned subsidiary of Atlantic Broadband Group, LLC. On September 3, 2003, we entered into an agreement with affiliates of Charter Communications, Inc. to acquire cable systems in Pennsylvania, Florida, Delaware, Maryland, New York and West Virginia. The sale of all of the cable systems excluding those in New York closed on March 1, 2004, while we operated the New York system under a retained franchise operating agreement commencing in conjunction with the acquisition of the other systems until this remaining sale closed on April 30, 2004.
The following discussion and analysis is based upon our audited consolidated financial statements and our review of the business and operations of each of the systems.
Overview of Operations
Our operating revenue is derived primarily from monthly subscription fees charged to customers for video and data services, equipment rental and ancillary services provided by the systems. In addition, we derive revenue from installation and reconnection fees charged to customers to commence and reinstate service, pay-per-view programming where users are charged a fee for individual programs viewed, advertising revenues and franchise fee revenues, which are collected by the systems and then paid to local franchising authorities.
Expenses consist primarily of operating costs, selling, general and administrative expenses, depreciation and amortization expenses and interest expense. Operating costs primarily include programming costs, the cost of the system’s workforce, cable service related expenses, franchise fees and expenses related to customer billings.
Separation from Charter Communications, Inc.
On September 3, 2003, we entered into a definitive asset purchase agreement with Charter Communications, Inc. to acquire the systems for $738.1 million, subject to customary post-closing adjustments, plus estimated fees and expenses (the “Acquisition”).
As a result of the Acquisition, our assets and liabilities were recorded at their fair value as of the closing date. We have also reflected our aggregate borrowings in connection with new financing arrangements. Prior to the Acquisition, the Systems were allocated interest expense from Charter through the due to parents account based on the ratio of basic customers to Charter’s total basic customers multiplied by Charter’s total consolidated interest expense. Our interest expense is lower in periods following the Acquisition.
During the period that Charter owned the Systems, it provided centralized customer billing services, call center operations, corporate managed marketing campaigns, finance, tax, benefits administration, coordination of insurance coverage and self-insurance programs for medical, dental and workers’ compensation claims, and other services. These costs were allocated to the Systems by Charter. As a result of the Acquisition, we are an independent entity, which has resulted in changes to the Systems’ operating cost structure. Accordingly, the financial results presented for periods prior to the Acquisition are not comparable to the financial results for the periods post-acquisition.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations are based upon financial statements which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates, assumptions and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent liabilities. On an ongoing basis, we evaluate our estimates, including those related to the recoverability of long-term assets such as franchises and intangible assets, the useful lives of property, plant and equipment and other finite-lived assets, commitments and contingencies. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions. We believe that the following critical accounting policies affect our more significant judgments and estimates used in the preparation of the financial statements.
Basis of Presentation
The financial statements presented herein include the consolidated accounts of our Company and its subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation.
Segments
SFAS No. 131, Disclosure about Segments of an Enterprise and Related Information, established standards for reporting information about operating segments in annual financial statements and in interim financial reports issued to shareholders. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated on a regular basis by the chief operating decision maker, or decision making group, in deciding how to allocate resources to an individual segment and in assessing performance of the segment.
We manage the Systems’ operations on the basis of geographic divisional operating segments. We have evaluated the criteria for aggregation of the geographic operating segments under paragraph 17 of SFAS No.131. In light of the Systems’ similar services, means for delivery, similarity in type of customers, the use of a unified network and other considerations across its geographic divisional operating structure, management has determined that the Systems have one reportable segment, broadband services.
Capitalization of Labor and Overhead Costs
The cable industry is capital intensive, and a large portion of our resources are spent on capital activities associated with extending, building and upgrading the cable network. Costs associated with network construction, initial customer installations, installation refurbishments and the addition of network equipment necessary to enable advanced services are capitalized. Costs capitalized as part of initial customer installations include materials, direct labor costs associated with capital projects and certain indirect costs. We capitalize direct labor costs associated with personnel based upon the specific time devoted to construction and customer installation activities. Indirect costs are associated with the activities of personnel who assist in connecting and activating the new service and consist of compensation and overhead costs associated with these support functions. The costs of disconnecting service at a customer’s dwelling or reconnecting service to a previously installed dwelling are charged to operating expense in the period incurred. Costs for repairs and maintenance are charged to operating expense as incurred, while equipment replacement and betterments, including replacement of cable drops from the pole to dwelling, are capitalized.
Judgment is required to determine the extent to which indirect costs, or overhead, are incurred as a result of specific capital activities and, therefore, should be capitalized. We capitalize overhead based upon an allocation of the portion of indirect costs that contribute to capitalizable activities using an overhead rate applied to the amount of direct labor capitalized. We have established overhead rates based on an analysis of the nature of costs incurred in support of capitalizable activities and a determination of the portion of costs which is directly attributable to capitalizable activities. The primary costs that are included in the determination of overhead rates are (i) employee benefits and payroll taxes associated with capitalized direct labor, (ii) direct variable costs associated with capitalizable activities, consisting primarily of installation and construction vehicle costs, (iii) the cost of support personnel, such as dispatch that directly assist with capitalizable installation activities, and (iv) indirect costs directly attributable to capitalizable activities.
Valuation of Franchises and Intangible Assets
We have significant intangible assets on our balance sheet. If the value of these assets was impaired by some factor, such as the loss of a franchise or an adverse change in the marketplace, we may be required to record an impairment charge.
In determining whether our franchises have an indefinite life, we considered the exclusivity of the franchise, the expected costs of franchise renewals, and the technological state of the associated cable systems to determine whether we are in compliance with any technologically required upgrades. We have concluded that our franchise rights qualify for indefinite life treatment under SFAS 142.
We test the impairment of our franchise rights annually (on March 1) or whenever events or changes in circumstances indicate that franchise rights might be impaired. The franchise impairment test compares the fair value of the franchise with its carrying amount. The fair value of a franchise is determined through the use of a discounted cash flow analysis. The valuation assumptions used in the discounted cash flow model reflect anticipated future operating results and cash flows based on the System’s business plans. If the fair value of the franchise exceeds its carrying amount, it is not considered impaired. If the carrying amount of the franchise exceeds its fair value, an impairment loss is recognized in an amount equal to the excess.
We periodically evaluate the net realizable value of long-lived assets, including tangible and intangible assets, relying on a number of factors including operating results, business plans, economic projections and anticipated future cash flows. An impairment in the carrying value of an asset is recognized when the expected future operating cash flow derived from the asset is less than its carrying value.
Historical Performance
Operating Data
Results of Operations
The following tables set forth a summary of the Systems’ operations for the periods indicated and their percentages of total revenue (dollars in thousands):
(1) Our Company was formed on August 26, 2003 with no operating activities conducted other than to complete the acquisition of the Systems (the “Acquisition”). On March 1, 2004, in accordance with an asset purchase agreement entered into on September 3, 2003, we purchased the systems from Charter. Accordingly, no meaningful comparative financial information exists for our Company prior to the Acquisition. We incurred total expenses of $1.2 million for the period ended December 31, 2003.
Year Ended December 31, 2006 Compared to Year Ended December 31, 2005
Revenue for the year ended December 31, 2006 was $212.6 million as compared to $189.9 million for the year ended December 31, 2005, an increase of 12.0%. This increase was the result of (i) 38.4% growth in high speed data revenue across all markets driven by continued customer demand, (ii) an $8.5 million increase in video revenues with increased penetration of digital video recorder and high definition product offerings coupled with relatively stable subscriber levels and (iii) $2.3 million in new revenue generated by the launch of our telephone service to the majority of our markets during 2006. Our video revenue has decreased as a percentage of total revenue to 64.0% in 2006 from 67.1% in 2005 as we continue to grow subscriber levels in our non-video products while maintaining stable video subscriber levels. We expect this trend to continue in 2007 as we increase our internet-ready and telephone-ready homes passed with the expected completion of the Aiken system upgrade and the launch of telephone service in some of our smaller markets in Western Pennsylvania.
Operating expenses for the year ended December 31, 2006 were $97.8 million as compared to $89.4 million for the comparable period in 2005, an increase of $8.4 million or 9.4%. This increase is mainly the result of direct costs and indirect costs such as technical and customer service expense trending with the growth in revenue and revenue generating units, slightly offset by the non-recurrence of approximately $1.3 million in repairs and maintenance costs incurred in 2005 in conjunction with hurricane related damage in Miami Beach. We expect that operating expenses will continue to rise as a result of annual programming contract increases and growth in total revenue generating units which will result in increased direct expenses as we service a larger customer base.
Selling, general and administrative expenses for the year ended December 31, 2006 were $32.9 million as compared to $30.6 million for the year ended December 31, 2005, an increase of $2.3 million or 7.5%. The majority of this increase is the result of staffing and related costs incurred to support our new product offerings and overall growth in our customer base. Total costs decreased as a percentage of revenue to 15.5% in 2006 from 16.1% in 2005 mainly due to the non-recurrence of costs incurred in 2005 totaling $0.6 related to our Senior Subordinated Notes exchange offer and one time due diligence costs. We expect selling, general and administrative expenses to increase at a slower rate than revenue growth due to the more fixed nature of these costs as compared to direct costs.
Depreciation of property and equipment and amortization expense was $49.7 million for the year ended December 31, 2006, compared with $42.4 million for the same period in 2005, an increase of $7.3 million. This increase was the result of an overall increase in capital expenditures due mainly to the launch of our telephone service and additional deployment of customer premise equipment.
Income from operations for the year ended December 31, 2006 was $32.3 million as compared to $27.5 million for the comparable period in 2005, for the reasons described above.
The marking-to-market of Atlantic Broadband’s interest rate swap agreements resulted in the recognition of $3.4 million in other expense for the year ended December 31, 2006 as compared to $0.5 million in other income for the year ended December 31, 2005, due to fluctuations in market interest rates.
Interest expense, including amortization of debt financing costs, for the year ended December 31, 2006 was $39.0 million, as compared to $33.9 million for the year ended December 31, 2005. This increase was mainly the result of additional borrowing to finance the acquisition of G Force LLC and increases in market interest rates, as our overall effective interest rate on our Senior Credit Facility increased to 7.59% in 2006 from 6.20% in 2005.
As a result of the factors described above, our net loss was $10.2 million for the year ended December 31, 2006, as compared to net loss of $5.9 million for the year ended December 31, 2005.
Year Ended December 31, 2005 Compared to Year Ended December 31, 2004.
Revenue for the year ended December 31, 2005 was $189.9 million as compared to $151.0 million for the year ended December 31, 2004. This increase was the result of twelve full months of operations in 2005 as compared to only ten months after the closing of the Acquisition on March 1, 2004. As a percentage of revenue, our video revenue had decreased from 70.2% of total revenue to 67.1% of total revenue. This decrease corresponds with the decrease in EBUs, basic subscribers and digital subscribers from December 31, 2004 to December 31, 2005. The EBU and basic subscriber reductions were mainly the result of increased competition for video services from satellite video providers. The decrease in digital subscribers was mainly the result of increased churn of customers in deeply discounted, non-profitable packages inherited from Charter as we raised the package rates to levels more comparable to our main digital tier offering. These lower subscriber levels were offset by increases in HSD subscribers driven by our marketing focus in this area, coupled with the increase in HSD homes passed in 2005 as we completed the planned Delmar system upgrade.
Operating expenses for the year ended December 31, 2005 were $89.4 million as compared to $71.1 million for the comparable period in 2004. This increase was the result of twelve full months of operations in 2005 as compared to only ten months after the closing of the Acquisition on March 1, 2004. As a percentage of total revenues, operating expenses remained relatively consistent in 2005 as compared to 2004 levels. This is the result of the non-recurrence of approximately $1.5 million in third party call center costs incurred in 2004 resulting from the transition from Charter ownership, offset by approximately $1.3 million in repairs and maintenance costs spent in 2005 in conjunction with hurricane related damage in Miami Beach.
Selling, general and administrative expenses for the year ended December 31, 2005 were $30.6 million as compared to $25.1 million for the year ended December 31, 2004. This increase was the result of twelve full months of operations in 2005 as compared to only ten month after the closing of the Acquisition on March 1, 2004. Total costs decreased as a percentage of total revenue from 16.6% in 2004 to 16.1% in 2005. This decrease was the result of the non-recurrence of approximately $4.1 million in post-closing transition related costs incurred in 2004, partially offset by increased sales and marketing spending levels in 2005, $.6 million in administrative costs incurred in conjunction with our 2005 Senior Subordinated Notes exchange offer and $.6 million in due diligence related costs for potential acquisition reviews.
Depreciation of property and equipment and amortization expense was $42.4 million for the year ended December 31, 2005, compared with $30.5 million for the same period in 2004, an increase of $11.9 million. This increase was the result of twelve full months of operations in 2005 as compared to only ten months after the closing of the Acquisition on March 1, 2004, coupled with an overall increase in capital expenditures due mainly to the system rebuild in Delmar.
Income from operations for the year ended December 31, 2005 was $27.5 million as compared to $24.3 million for the comparable period in 2004, for the reasons described above.
The marking-to-market of Atlantic Broadband’s interest rate swap agreements resulted in the recognition of $0.5 million in other income for the year ended December 31, 2005 as compared to $3.5 million in other income for the year ended December 31, 2004 due to fluctuations in market interest rates.
Interest expense, including amortization of debt financing costs, for the year ended December 31, 2005 was $33.9 million as compared to $27.4 million for the year ended December 31, 2004. This increase was the result of twelve full months of operations in 2005 as compared to only ten months after the closing of the Acquisition on March 1, 2004. The overall effective interest rate on our Senior Credit Facility increased to 6.20% in 2005 from 5.05% in 2004 due to increases in market interest rates.
As a result of the factors described above, the Systems’ net loss was $5.9 million for the year ended December 31, 2005 as compared to net income of $0.4 million for the year ended December 31, 2004.
Liquidity and Capital Resources
The Company’s primary source of liquidity is cash flow from operations. We also have available funds under our revolving credit facility, subject to certain conditions. Our primary liquidity requirements will be for debt service, capital expenditures and working capital.
In connection with the system acquisition we incurred substantial amounts of debt, including amounts outstanding under our senior credit facility and our 9 3/8% Senior Subordinated Notes. Interest payments on this indebtedness will significantly reduce our cash flows from operations. As of December 31, 2006, the Company had total debt outstanding of $536.3 million.
Our senior credit facility is a $395.0 million senior credit facility, consisting of a $90 million revolving credit facility (the “Revolver”), a $30 million term loan A tranche and a $275 million term loan B tranche. At December 31, 2006, $29.9 million of the revolving credit facility was outstanding, with $60.1 million of unused senior credit commitments under the revolving credit facility. The Revolver shall be paid such that the amount outstanding shall not exceed $67,500 from March 1, 2009 until the termination date. The Revolver shall be paid in full on the termination date of March 1, 2010. We will be able to prepay revolving credit loans and reborrow amounts that are repaid, up to the amount of the revolving credit commitment then in effect, subject to customary conditions.
The borrowings under the term loans A and B mature on March 1, 2011 and October 1, 2011, respectively. These term loans are payable in quarterly installments which commenced on June 30, 2006.
We expect to incur capital expenditures in 2007 at a level greater than 2006 as we complete the approximate $7.0 million upgrade of the recently acquired Aiken Cluster, which will include offering high speed Internet and telephone services to the entire market, launch video-on-demand services in the majority of our Western Pennsylvania and Maryland/Delaware clusters as well as other one-time capital items. We then expect subsequent year capital expenditure levels to reduce, reflecting more maintenance and discretionary capital spending.
We believe that the cash generated from operations will be sufficient to meet our debt service, capital expenditures and working capital requirements for the foreseeable future. Subject to restrictions on our senior secured credit facilities and the indenture governing our Senior Subordinated Notes, we may incur more debt for working capital, capital expenditures, acquisitions and for other purposes. In addition, we may require additional financing if our plans materially change in an adverse manner or prove to be materially inaccurate. There can be no assurance that such financing, if permitted under the terms of our debt agreement, will be available on terms acceptable to us or at all.
Contractual Obligations
The following table sets forth our long-term contractual cash obligations as of December 31, 2006 (dollars in thousands):
Recently Issued Accounting Standards
In September 2006, the Financial Accounting Standards Board (FASB) issued SFAS No. 157 (“SFAS 157”) “Fair Value Measurements,” which defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 applies to other accounting pronouncements that require or permit fair value measurements. It is effective for us beginning in fiscal year 2008. We are currently evaluating the impact of adopting SFAS 157.
On February 15, 2007, FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). This Statement is a fair value option for financial assets and financial liabilities and includes an amendment of FAS Statement No. 115 which covers accounting for certain investments in debt and equity securities. It is effective for us beginning in fiscal year 2008. We are currently evaluating the impact of adopting SFAS 159.
In September 2006, the Staff of the SEC issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (SAB 108). SAB 108 provides guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of determining whether the current year’s financial statements are materially misstated. SAB 108 is effective for fiscal years ended December 31, 2006. The adoption of SAB 108 did not have a material impact on our financial positions or results of operations.
Inflation and Changing Prices
Our costs and expenses are subject to inflation and price fluctuations. We do not expect such changes to have a material effect on our results of operations.
Item 7A
Item 7A Quantitative and Qualitative Disclosures About Market Risk
We are exposed to certain market risks as part of our ongoing business operations. Primary exposure include changes in interest rates as borrowings under our senior secured credit facilities bear interest at floating rates based on LIBOR or the base rate, in each case plus an applicable borrowing margin. We manage our interest rate risk by balancing the amount of fixed-rate and floating-rate debt. For fixed-rate debt, interest rate changes do not affect earnings or cash flows. Conversely, for floating-rate debt, interest rate changes generally impact our earnings and cash flows, assuming other factors are held constant.
The following table estimates the changes to cash flow from operations if interest rates were to fluctuate by 100 or 50 basis points, or BPS (where 100 basis points represents one percentage point), for a twelve-month period after giving effect to the interest rate swap agreements described below:
We use derivative instruments to manage our exposure to interest rate risks. Our objective for holding derivatives is to minimize the risks using the most effective methods to eliminate or reduce the impacts of these exposures. We use interest rate swap agreements, not designated as hedging instruments under SFAS No. 133, in connection with our variable rate senior credit facility. We do not use derivative financial instruments for speculative or trading purposes.
At December 31, 2006, we had in effect three interest rate swaps with three separate commercial banks, with a total notional amount of $230.0 million. In September 2006, the Company entered into four additional swap agreements with three separate commercial banks with a forward start date of March 19, 2007 for a total notional value of $225,000 with a term of two years. These interest rate swap agreements require us to pay a fixed rate and receive a floating rate thereby creating fixed rate debt. The difference to be paid or received on the swaps are accrued as an adjustment to interest expense. We are exposed to credit loss in the event of nonperformance by the counterparty. The net fair value of the interest rate swap agreements, which represents the cash we would receive to settle the agreements, was approximately $0.7 million and $4.1 million at December 31, 2006 and 2005, respectively.
Off-Balance Sheet Arrangements
We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
ITEM 8.
ITEM 8. Financial Statements and Supplementary Data
For information required by Item 8, refer to the Index to the Financial Statements on page 48.
ITEM 9.
ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
ITEM 9A.
ITEM 9A. Controls and Procedures
The Company’s management, with the participation of the Company’s chief executive officer and chief financial officer, evaluated the effectiveness of the Company’s disclosure controls and procedures as of September 30, 2006. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of the Company’s disclosure controls and procedures as of December 31, 2006 the Company’s chief executive officer and chief financial officer concluded that, as of such date, the Company’s disclosure controls and procedures were effective at the reasonable assurance level.
Changes in internal control over financial reporting. There was no change in the internal control over financial reporting that occurred during the year ended December 31, 2006 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B.
ITEM 9B. Other Information
None.
PART III
ITEM 10.
ITEM 10. Directors, Executive Officers and Corporate Governance
The following table sets forth the names, ages, and positions for each of our directors and executive officers as of December 31, 2006.
Name
Age
Position
David J. Keefe
Chief Executive Officer and Director
Edward T. Holleran
Chief Operating Officer and Director
Patrick Bratton
Vice President and Chief Financial Officer
Almis Kuolas
Vice President and Chief Technology Officer
Chris Daly
Vice President and Chief Marketing Officer
Blake R. Battaglia
Director
John Hunt
Director
Benjamin Diesbach
Director
Jay M. Grossman
Director
Jack Langer
Director
David J. Keefe joined us on September 5, 2003 as Chief Executive Officer with more than thirty years experience building and managing cable systems in the United States, Asia, Europe and South America. Prior to joining us and since 1999, Mr. Keefe served as Chief Operating Officer of Horizon Telecom International. Prior to that he served as Chief Executive Officer for PTK Poland. From 1995 to 1998, Mr. Keefe served as Chief Executive Officer of Kabelkom Hungary. Additionally, Mr. Keefe spent over twenty years in senior management positions with Wharf Cable, Continental Cablevision and American Cablesystems.
Edward T. Holleran joined us on September 5, 2003 as Chief Operating Officer with more than twenty years of general management experience with major U.S. cable companies. Most recently, in 1999 Mr. Holleran co-founded and served as President and CEO of American Broadband. From 1995 to 1998, Mr. Holleran served as Vice President of Broadband Data Services and Vice President of New Product Development for MediaOne and its predecessor company, Continental Cablevision. Additionally, Mr. Holleran spent thirteen years in senior management positions with Continental Cablevision and American Cablesystems.
Patrick Bratton joined us on October 27, 2003 with over ten years of senior financial management experience. Prior to joining us and since 1998, Mr. Bratton served as Chief Financial Officer for Quorum Broadcast Holdings, LLC. From 1995 to 1998 Mr. Bratton served as Chief Financial Officer for Sullivan Broadcast Holdings, Inc. Additionally, Mr. Bratton spent seven years in various roles with DMC Services, Inc. and Price Waterhouse LLP.
Almis Kuolas joined us in October 16, 2003 as Chief Technology Officer with over 25 years of technical operations experience. Prior to joining us and since 2001, Mr. Kuolas served as Senior Director of Engineering and Development for Philips Electronics wireless products division. From 2000 to 2001, Mr. Kuolas served as Chief Technology Officer of American Broadband. Prior to that, he served as Vice President of Systems and Technology for MCI’s TeleTV operations in California. Additionally, Mr. Kuolas spent fourteen years in management positions with Continental Cablevision and American Cablesystems.
Chris Daly joined us on November 1, 2003 as our Chief Marketing Officer with over twenty years of marketing and operations experience. Prior to joining us and since 2001, Mr. Daly served as Chief Operating Officer for Horizon Telecom International. From 1998 to 2000, Mr. Daly served as Senior Director of Marketing for BellSouth Entertainment. Prior to that, he served as Florida Regional Vice President of Marketing for AT&T Wireless Services, formerly McCaw Cellular Communications. Additionally, Mr. Daly spent twelve years in management positions with Continental Cablevision and American Cablesystems.
Blake R. Battaglia has served as a director since September 5, 2003. Mr. Battaglia is a Vice President at ABRY, which he joined in 1998. Prior to joining ABRY, he was an investment banker at Morgan Stanley & Co. Mr. Battaglia currently serves as a director of WideOpenWest Holdings, LLC and Nexstar Broadcasting Group, Inc.
John Hunt has served as a director since February 14, 2005. Mr. Hunt has been a Partner of ABRY since 2004. Prior to joining ABRY, Mr. Hunt was a General Partner at Boston Ventures Management a media and communications focused private equity fund. Mr. Hunt currently serves as a director of Charleston Newspapers, L.P. and Legend Pictures, LLC.
Benjamin Diesbach has served as a director since September 5, 2003. Since its formation in 1995, Mr. Diesbach has served the President of Midwest Research, Inc. a consulting company. Prior to forming Midwest Research, Mr. Diesbach was Chief Executive Officer of Continental Broadcasting, Ltd. Before joining Continental Broadcasting, Mr. Diesbach served as a Vice President of the Crisler Company. Prior to Crisler, he served as Chief Executive Officer of Taft Cable Partners, Executive Vice President of Wometco Cable and Executive Vice President and General Manager of Fabricon Automotive Products. Mr. Diesbach currently serves as a director of Lattice Communications and WideOpenWest Holdings, LLC.
Jay M. Grossman has served as a director since September 5, 2003. Mr. Grossman has been a Partner of ABRY since 1996. Prior to joining ABRY, Mr. Grossman was an investment banker specializing in media and entertainment at Kidder Peabody and at Prudential Securities. Mr. Grossman currently serves as director (or the equivalent) of several companies including Consolidated Theaters, LLC, Monitronics International, Inc., Country Road Communications, Inc., WideOpenWest Holding, LLC and Nexstar Broadcasting Group, Inc.
Jack Langer has served as a director since March 1, 2004. Mr. Langer has extensive experience in equity, bank, subordinated debt and mergers and acquisitions transactions in the cable and other media industries. From 1997 to 2002, Mr. Langer served as a Managing Director and Global Co-Head of the Media Group at Lehman Brothers, Inc. Mr. Langer currently serves as a director of Spanish Broadcasting Systems, Inc.
There are no family relationships among the foregoing persons.
Audit Committees
Since our equity is not currently listed on or with a national securities exchange or national securities association, we are not required to have an audit committee and therefore have not designated any of our board members as audit committee members.
Code of business Conduct and Ethics
Our Company has adopted a Code of Business Conduct and Ethics (the “Code”) applicable to our Company’s directors, officers (including the Chief Executive Officer and Chief Financial Officer and persons performing similar functions), employees, agents and consultants. Our Code satisfies the requirements of a “code of ethics” within the meaning of Section 406 of the Sarbanes-Oxley Act of 2002 and the rules issued by the Securities and Exchange Commission thereunder. Amendments to, or waivers from, a provision of our Code that apply to our Company’s directors or executive officers, including the Chief Executive Officer and Chief Financial Officer and persons performing similar functions, may be made only by the Company’s board of directors. Our Company has not amended the Code and has filed the Code as an exhibit to this Annual Report on Form 10-K.
ITEM 11.
ITEM 11. Executive Compensation
Compensation Committee Report
Because affiliates of ABRY own more than 50% of the voting common stock of Atlantic Broadband Group, LLC, we would be a “controlled company” within the meaning of Rule4350(c)(5) of the Nasdaq Marketplace rules, which would qualify us for exemptions from certain corporate governance rules of the Nasdaq Stock Market LLC, including the requirement that compensation be determined by a majority of independent directors, or a compensation committee comprised solely of independent directors. As such, we do not have a standing compensation committee. However, decisions regarding compensation of the individuals named in the Summary Compensation Table (the “named executive officers”) and directors are made by certain of our non-employee directors, Jay Grossman and Blake Battaglia, with Jay Grossman acting as the chairperson. These individuals are referred to herein as the Compensation Committee.
The Compensation Committee has reviewed and discussed the Compensation Discussion and Analysis with management and, based on its review and discussions, the Compensation Committee recommended to the board of directors that the Compensation Discussion and Analysis be included in the annual report on Form 10K.
This report has been provided by the Compensation Committee of the Board of Directors of the Company.
Jay Grossman, Director, Chairperson of the Compensation Committee
Blake Battaglia, Director
Compensation Discussion and Analysis
Our Compensation Committee is responsible for reviewing and approving the compensation of our named executive officers as well as reviewing and approving our incentive plans, all presented by our chief executive officer. Review and approval of compensation and incentives by the Compensation Committee is done annually as part of the Company’s budget review as well as on an as-needed basis, with the Board of Directors either approving or rejecting the Compensation Committee recommendations.
Compensation Objectives
We believe that our compensation program must support our strategy, be competitive, and provide significant rewards for outstanding performance and clear financial consequences for underperformance. We also believe that a significant portion of the named executive officers’ compensation should be discretionary in the form of annual bonus awards that are paid, if at all, based on company accomplishment and, to a lesser degree, individual performance. The compensation awarded to our named executive officers for fiscal 2006, as well as prior years, was intended:
•
To encourage and reward strong performance; and
•
To motivate our named executive officers by providing them with a meaningful equity stake in the company.
Accounting and cost implications of compensation programs are considered in program design; however, the main driver of design is alignment without business needs.
Role of the Compensation Committee and Executive Officers
The Compensation Committee of the Board of Directors approves and then recommends that the Board of Directors approve their recommendations for all compensation and awards to named executive officers, which include the chief executive officer, chief financial officer and the president/chief operating officer. For the remaining executive officers, the chief executive officer makes recommendations to the Compensation Committee that generally, with minor adjustments, are approved.
Elements of our Compensation Program
Base Salary
Base salary is intended to provide fixed compensation to the named executive officers for their performance of core duties that contributed to our success as measured by the element of corporate performance mentioned above. The Compensation Committee reviews and approves base salary recommendations as presented by the chief executive officer. Base salary recommendations are intended to approximate the market value of a position, based on analysis of similar positions with essentially the same job responsibilities. Market data is provided to the Company by nationally recognized compensation consulting firms and executive search firms. Annual base salary increases for the chief executive officer and chief operating officer are stipulated within their respective employment agreements.
Annual Incentives
Annual incentives in the form of the Company’s “Bonus Plan” are intended to tie a significant portion of each of the named executive officer’s compensation to our annual performance. Additionally, the annual incentive allows us to recognize and individual’s performance in relation to special or strategic projects. The annual incentives paid in 2007 for 2006 performance were based primarily upon the performance of the Company. The Bonus Plan is tied to both revenue and EBITDA growth over the prior year and, to a lesser degree, to individual performance.
Outside of the Company’s “Bonus Plan”, there is no other non-equity incentive compensation plan.
Equity Compensation
In connection with the consummation of the Acquisition in 2004, stock grants were awarded to the named executive officers. These stock holdings are reflected in Item 12
ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholders Matters
Atlantic Broadband Group, LLC indirectly owns all of the membership units of our Company. The following table sets forth information regarding the beneficial ownership of the equity interests of Atlantic Broadband Group, LLC as of December 31, 2006, by:
•
holders having beneficial ownership of more than 5% of the voting equity interest of Atlantic Broadband Group;
•
each director of Atlantic Broadband Group;
•
each of our executive officers shown in the summary compensation table; and
•
all directors and executive officers as a group.
* Less than 1%
(a) “Beneficial ownership” generally means any person who, directly or indirectly, has or shares voting or investment power with respect to a security or has the right to acquire such power within 60 days. Unless otherwise indicated, we believe that each holder has sole voting and investment power with regard to the equity interests listed as beneficially owned. The total equity interests shown for ABRY Partners IV, L.P., ABRY Mezzanine Partners, L.P. and Oak Hill will equate to approximately 71.8%, 8.5%, and 18.8%, respectively, of the total voting equity interests of Atlantic Broadband Group, LLC.
(b) Royce Yudkoff exercises voting and investment control of the equity interests held by ABRY Partners IV, L.P. and ABRY Mezzanine Partners, L.P. The address of both is 111 Huntington Avenue, 30th Floor, Boston, MA 02199.
(c) Royce Yudkoff is the sole member of ABRY Capital Partners, LLC which is the sole general partner of ABRY Capital Partners, L.P. which is the sole general partner of ABRY Partners IV, L.P.
(d) Royce Yudkoff is the sole member of ABRY Mezzanine Holdings, LLC which is the sole general partner of ABRY Mezzanine Investors, L.P. which is the sole general partner of ABRY Mezzanine Partners, L.P.
(e) Represents 26,364,688 owned by Oak Hill Capital Partners, L.P. and 635,312 owned by Oak Hill Capital Management Partners, L.P. The sole general partner of both entities is OHCP Gen Par, L.P. whose sole general partner is OHCP MGP, LLC.
(f) Mr. Battaglia is a limited partner of ABRY Capital Partners, L.P., the sole general partner of ABRY Partners IV, L.P., and ABRY Mezzanine Investors, L.P., the sole general partner of ABRY Mezzanine Partners, L.P., and disclaims beneficial ownership of any equity interests held by either entity. Mr. Battaglia’s address is c/o ABRY Partners IV, L.P., 111 Huntington Avenue, 30th Floor, Boston, MA 02199.
(g) Mr. Hunt is a limited partner of ABRY Mezzanine Investors, L.P., the sole general partner of ABRY Mezzanine Partners, L.P., and disclaims beneficial ownership of any equity interests held by such entity. Mr. Hunt’s address is c/o ABRY Mezzanine Partners, L.P., 111 Huntington Avenue, 30th Floor, Boston, MA 02199.
(h) Mr. Grossman is a limited partner of ABRY Capital Partners, L.P., the sole general partner of ABRY Partners IV, L.P., and ABRY Mezzanine Investors, L.P., the sole general partner of ABRY Mezzanine Partners, L.P. and disclaims beneficial ownership of any equity interests held by either entity. Mr. Grossman’s address is c/o ABRY Partners IV, L.P., 111 Huntington Avenue, 30th Floor, Boston, MA 02199.
ITEM 13.
ITEM 13. Certain Relationships and Related Transactions and Director Independence
Members Agreement
The members of Atlantic Broadband Group, LLC entered into a Members Agreement on March 1, 2004. Pursuant to the Members Agreement, such members have agreed to vote their equity interests in Atlantic Broadband Group, LLC so that the following directors are elected to the board of managers of Atlantic Broadband Group, LLC: (i) three directors designated by ABRY Partners IV, L.P., (ii) one director designated by Oak Hill Capital Partners, L.P., (iii) the then current chief executive officer of Atlantic Broadband Group, LLC, who shall initially be David Keefe, (iv) the then current chief operating officer of Atlantic Broadband Group, LLC, who shall initially be Edward Holleran and (v) one independent director designated by a majority vote of the other directors on such board. The Members Agreement also contains:
•
“tag-along” sale rights exercisable by non-ABRY investors in the event of sales of equity interests by ABRY to unaffiliated third parties;
•
“drag-along” sale rights exercisable by the board of managers of Atlantic Broadband Group, LLC and holders of a majority of the then outstanding Class A units in the event of an Approved Sale, as defined in the Members Agreement;
•
preemptive rights;
•
restrictions on transfers of membership interests by management and other key employees absent written authorization of the Board of Directors, except in certain circumstances; and
•
right of first offer exercisable by ABRY in the event of proposed transfers of membership interests by non-ABRY investors.
The voting restrictions and tag-along, drag-along, transfer restrictions and right of first offer will terminate upon consummation of the first to occur of a Qualified Public Offering, as defined in the Members Agreement, or an Approved Sale.
Indemnification
The Parent’s Amended and Restated Limited Liability Company Agreement, dated as of March 1, 2004, provides for indemnification of directors and officers, including advancement of reasonable attorney’s fees and other expenses, in connection with all claims, liabilities and expenses arising out of the management of the Parent’s affairs. Such indemnification obligations are limited to the extent that the Parent’s assets are sufficient to cover such obligations. The Parent carries directors and officers insurance that covers such exposure for indemnification up to certain limits. While the Parent may be subject to various proceedings in the ordinary course of business that involve claims against directors and officers, we believe that such claims are routine in nature and incidental to the conduct of the Parent’s business. None of such claims, if determined adversely against such directors and officers, would have a material adverse effect on the Parent’s consolidated financial condition or results of operations. As of the closing of the Acquisition, the Parent had not accrued any amounts to cover indemnification obligations arising from such claims.
Registration Rights Agreement
The members of Atlantic Broadband Group, LLC entered into a Registration Rights Agreement on March 1, 2004. Pursuant to the Registration Rights Agreement, the holders of a majority of the Investor Units have the ability to cause the Company to register securities of the Company held by parties to the Registration Rights Agreement and to participate in registrations by the Company of its equity securities. All holders of equity securities are subject to customary lock-up arrangements in connection with public offerings.
Reimbursement Agreement
We entered into a Reimbursement Agreement on March 1, 2004. Pursuant to the Reimbursement Agreement, we agreed to reimburse ABRY for all out-of-pocket expenses incurred in connection with the offering of the Notes, the Acquisition and related transactions or their ownership of equity interest of the Parent.
Board of Directors
The board is currently composed of 7 directors, none of whom is likely to qualify as an independent director based on the definition of independent director set forth in Rule 4200(a)(15) of the Nasdaq Marketplace rules. Because affiliates of ABRY own more than 50% of the voting common stock of Atlantic Broadband Group, LLC we would be a “controlled company” within the meaning of Rule 4350(c)(5) of the Nasdaq Marketplace rules, which would qualify us for exemptions from certain governance rules of The Nasdaq Stock Market LLC, including the requirements that the board of directors be composed of a majority of independent directors.
ITEM 14.
ITEM 14. Principal Accountant Fees and Services
During the fiscal years ended December 31, 2004, 2005 and 2006, fees for services provided by PricewaterhouseCoopers LLP were as follows (in thousands):
“Audit Fees” consisted of fees billed for services rendered for the audit of the Company’s financial statements, review of financial statements included in the Company’s quarterly reports on Form 10-Q, and other services normally provided in connection with statutory and regulatory filings.
“Audit-Related Fees” consisted of fees billed for due diligence procedures in connection with acquisitions.
“Tax Fees” consisted of fees billed for tax payment planning and property tax consultation services.
PART IV.
ITEM 15.
ITEM 15. Exhibits and Financial Statement Schedules
(a) The following documents are filed as part of this report.
1. The financial statements as indicated in the index set forth on page 50.
2. Financial Statement Schedules:
Schedule II - Valuation and Qualifying accounts set forth on page.
Schedules other than that listed above have been omitted, since they are either not applicable, not required or the information is included elsewhere herein.
3. Exhibits
EXHIBIT
NUMBER
EXHIBIT
1.1
Purchase Agreement dated as of January 27, 2004 by and among Atlantic Broadband Finance, LLC, Atlantic Broadband Finance, Inc., Merrill Lynch & Co., Merrill Lynch, Pierce, Fenner & Smith Incorporated and SG Cowen Securities Corporation.***
2.1
Asset Purchase Agreement dated as of September 3, 2003 by and among Charter Communications VI, LLC, The Helicon Group, L.P., Hornell Television Service, Inc., Interlink Communications Partners, LLC, Charter Communications, LLC, Charter Communications Holdings, LLC and Atlantic Broadband Finance, LLC.***
2.1a
First Amendment to the Asset Purchase Agreement, dated as of October 31, 2003 by and among Charter Communications VI, LLC, The Helicon Group, L.P., Interlink Communications Partners, LLC, Charter Communications, LLC, Hornell Television Service, Inc., Charter Communications Holdings, LLC and Atlantic Broadband Finance, LLC.***
2.1b
Second Amendment to the Asset Purchase Agreement, dated as of December 3, 2003 by and among Charter Communications VI, LLC, The Helicon Group, L.P., Interlink Communications Partners, LLC, Charter Communications, LLC, Hornell Television Service, Inc., Charter Communications Holdings, LLC and Atlantic Broadband Finance, LLC.***
2.1c
Third Amendment to the Asset Purchase Agreement, dated as of February 27, 2004 by and among Charter Communications VI, LLC, The Helicon Group, L.P., Interlink Communications Partners, LLC, Charter Communications, LLC, Hornell Television Service, Inc., Falcon Telecable, Charter Communications Holdings, LLC and Atlantic Broadband Finance, LLC.***
3.1
Certificate of Formation of Atlantic Broadband Finance, LLC.***
3.2
Certificate of Incorporation of Atlantic Broadband Finance, Inc.***
3.3
Certificate of Formation of Atlantic Broadband Management, LLC.***
3.4
Certificate of Formation of Atlantic Broadband (Miami), LLC.***
3.5
Certificate of Formation of Atlantic Broadband (Penn), LLC.***
3.6
Certificate of Formation Atlantic Broadband (Delmar), LLC.***
3.7a
Limited Liability Company Agreement of Atlantic Broadband Finance, LLC.***
3.7b
Amended and Restated Limited Liability Company Agreement of Atlantic Broadband Finance, LLC.***
3.8
By-laws of Atlantic Broadband Finance, Inc.***
3.9a
Limited Liability Company Agreement of Atlantic Broadband Management, LLC.***
3.9b
Amended and Restated Limited Liability Company Agreement of Atlantic Broadband Management, LLC.***
** Incorporated by reference to the corresponding Exhibit to Amendment No. 1 to the Registration Statement on Form S-4/A 333-11504, as filed on July 29, 2005.
*** Incorporated by reference to the corresponding Exhibit to the Registration Statement on Form S-4 333-11504, as filed on May 14, 2004.
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Dated: April 2, 2007.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on April 2, 2007
SIGNATURE
CAPACITY
/s/ David J. Keefe
Chief Executive Officer and Director (Principal Executive Officer)
David J. Keefe
/s/ Patrick Bratton
Chief Financial Officer (Principal Financial and
Accounting Officer)
Patrick Bratton
/s/ Edward T. Holleran
Chief Operating Officer and Director
Edward T. Holleran
/s/ Jay M. Grossman
Director
Jay M. Grossman
/s/ Benjamin Diesbach
Director
Benjamin Diesbach
/s/ Blake Battaglia
Director
Blake Battaglia
/s/ John Hunt
Director
John Hunt
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Members
Atlantic Broadband Finance, LLC:
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of changes in members’ equity and of cash flows present fairly, in all material respects, the financial position of Atlantic Broadband Finance, LLC and its subsidiaries at December 31, 2006 and 2005 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2006 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
Boston, Massachusetts
April 2, 2007
ATLANTIC BROADBAND FINANCE, LLC
Consolidated Balance Sheets
December 31, 2006 and 2005
(in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
ATLANTIC BROADBAND FINANCE, LLC
Consolidated Statements of Operations
(in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
ATLANTIC BROADBAND FINANCE, LLC
Consolidated Statements of Changes in Members’ Equity
Years Ended December 31, 2006, 2005 and 2004
(in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
ATLANTIC BROADBAND FINANCE, LLC
Consolidated Statements of Cash Flows
(in thousands)
The accompanying notes are an integral part of these consolidated financial statements.
ATLANTIC BROADBAND FINANCE, LLC
Notes to Consolidated Financial Statements
(Dollars in thousands, except where indicated)
1. Description of Business
Atlantic Broadband Finance, LLC (the “Company”) was formed in Delaware on August 26, 2003. The Company is a wholly-owned subsidiary of Atlantic Broadband Holdings I, LLC (the “Parent”). The Company and the Parent are wholly-owned indirect subsidiaries of Atlantic Broadband Group, LLC.
On September 3, 2003, the Company entered into a definitive asset purchase agreement with affiliates of Charter Communications, Inc. (“Charter”) to purchase certain cable systems in Pennsylvania, Florida, Maryland, West Virginia, Delaware and New York (the “Systems”) for approximately $738.1 million, subject to closing adjustments. The Company obtained equity and debt financing to fund the acquisition, which was consummated on March 1, 2004.
The Systems offer their customers traditional cable video programming as well as high-speed data services and other advanced video related broadband services such as high definition television. The Systems sell their video programming, high-speed data and advanced broadband cable services on a subscription basis.
The Company was capitalized during 2003 through equity contributions totaling $1,709 to fund general and administrative expenses in advance of the Systems acquisition. These activities were mainly associated with obtaining the required consents from the related cable television franchise authorities and raising debt and equity to fund the Systems acquisition. In 2004, the Company obtained additional funding totaling $260,791.
The Company has 5 subsidiaries which operate the Systems: Atlantic Broadband (Penn), LLC, Atlantic Broadband (Delmar), LLC, Atlantic Broadband (Miami), LLC, Atlantic Broadband (SC), LLC and Atlantic Broadband Management, LLC (collectively, the “Subsidiaries”).
2. Risks and Uncertainties
The Company’s future operations involve a number of risks and uncertainties. Factors that could affect future operating results and cause actual results to vary from historical results include, but are not limited to, growth of its subscriber base and the Company’s ability to service its debt and operations with existing cash flows.
The Company plans to continue the expansion of its existing subscriber base through existing and new services, such as: digital cable, high speed Internet, high-definition television, and telephony services. The Company anticipates additional capital expenditures to facilitate this growth. Under current plans and operations, additional financing in excess of existing facilities is not expected to be required. The Company expects to generate cash flow from operations in excess of capital expenditures in 2007. Operating cash flow is expected to be sufficient to repay current obligations and outstanding debt as they become due through at least the next twelve months. Should the Company fail to meet its expectations, the Company would look to draw down against the existing revolving credit facility, obtain additional financing, refinance existing agreements, and/or reduce capital expenditures.
3. Summary of Significant Accounting Policies
Basis of Presentation
The financial statements presented herein include the consolidated accounts of Atlantic Broadband Finance, LLC and its Subsidiaries. Intercompany accounts and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make assumptions and estimates that affect the reported amounts of assets and liabilities, derivative financial instruments and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The most significant estimates relate to useful lives of property, plant and equipment and finite-lived intangible assets and the recoverability of the carrying values of goodwill, other intangible assets and fixed assets (which include capitalized labor and overhead costs) and commitments and contingencies. Actual results could differ from those estimates.
Segments
Statement of Financial Standards (“SFAS”) No. 131, Disclosure about Segments of an Enterprise and Related Information, established standards for reporting information about operating segments in annual financial statements and in interim financial reports issued to shareholders. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated on a regular basis by the chief operating decision maker, or decision making group, in deciding how to allocate resources to an individual segment and in assessing performance of the segment.
The Company manages the Systems’ operations on the basis of geographic divisional operating segments. The Company has evaluated the criteria for aggregation of the geographic operating segments under paragraph 17 of SFAS No.131. In light of the Systems’ similar services, means for delivery, similarity in type of customers, the use of a unified network and other considerations across its geographic divisional operating structure, management has determined that the Systems have one reportable segment, broadband services.
Cash and Cash Equivalents
The Company considers all short-term investments with a remaining maturity of three months or less at the date of purchase to be cash equivalents. Cash and cash equivalents represent short-term investments consisting of commercial paper and money market funds carried at cost plus accrued interest, which approximates market value.
Bad Debts
Bad debt expense and the allowance for doubtful accounts is based on historical trends and analysis. The Company’s policy to reserve against potential bad debts is based on the aging of the individual receivables. The Company manages credit risk by disconnecting services to customers who are delinquent. The practice to write-off the individual receivables is performed after all resources to collect the funds have been exhausted. Actual bad debt expense may differ from the amounts reserved.
Plant, Property and Equipment
Plant, property and equipment are recorded at cost. Initial customer installation costs are capitalized. Sales and marketing costs, as well as costs of subsequent disconnection and reconnection of a given household are charged to expense. Capitalized costs include materials, labor, and certain indirect costs attributable to the capitalization activity. Maintenance and repairs are charged to expense when incurred. Upon sale or retirement, the cost and related depreciation are removed from the related accounts and resulting gains or losses are reflected in operating results.
Plant and equipment are depreciated over the estimated useful life upon being placed into service. Depreciation of plant and equipment is provided on a straight-line basis, over the following estimated useful lives:
Asset Category
Estimated Useful Life (Years)
Office equipment & other
4-10
Subscriber equipment
Vehicles
Headend equipment
Distribution facilities
5-15
Building and leasehold improvements
5-15
Goodwill and Intangible Assets
Intangible assets consist primarily of acquired franchise operating rights and subscriber relationships. Franchise operating rights represent the value attributable to agreements with local franchising authorities, which allows access to homes in the public right of way acquired through a business combination. Subscriber relationships represent the value to the Company of the benefit of acquiring the existing cable television subscriber base. The Company considers franchise operating rights to have an indefinite life. The
Company reached its conclusion regarding the indefinite useful life of its franchise operating rights principally because (i) there are no legal, regulatory, contractual, competitive, economic, or other factors limiting the period over which these rights will continue to contribute to the Company’s cash flows (ii) as an incumbent franchisee, the Company’s renewal applications are granted by the local franchising authority on their own merits and not as part of a comparative process with competing applications and (iii) under the 1984 Cable Act, a local franchising authority may not unreasonably withhold the renewal of a cable system franchise. The Company will reevaluate the expected life of its cable franchise rights each reporting period to determine whether events and circumstances continue to support an indefinite useful life. The subscriber relationships are being amortized over the estimated useful life of the subscriber base. The useful lives for the subscriber relationships is estimated to be approximately three years and at the end of each reporting period, or earlier if circumstances warrant, the Company reassesses the estimated useful life of the relationships.
The Company tests for impairment of its goodwill and franchise operating rights annually or whenever events or changes in circumstances indicate that these assets might be impaired. The first step of the goodwill impairment test compares the fair value of a system with its carrying amount, including goodwill. If the fair value of the system exceeds its carrying amount, goodwill is not considered impaired. If the carrying amount of the system exceeds its fair value, the second step of the goodwill impairment test is performed to measure the amount of the impairment loss, if any. The second step of the goodwill impairment test compares the implied fair value of goodwill with the carrying amount of that goodwill. The implied fair value of goodwill is determined by performing an assumed purchase price allocation, using the system’s fair value (as determined in the first step) as the purchase price. If the carrying amount of goodwill exceeds the implied fair value, an impairment loss is recognized in an amount equal to that excess. Franchise operating rights are tested for impairment comparing the fair value to the carrying amount of the asset on a system by system basis. The fair value of each system is determined using the discounted cash flow valuation method.
An impairment assessment of goodwill and franchise operating rights could be triggered by a significant reduction in operating results or cash flows at one of more of the Company’s systems, or a forecast of such reductions, a significant adverse change in the locations in which the Company’s systems operate, or by adverse changes to ownership rules, among others. As of December 31, 2006, the Company did not identify any triggering events for an impairment assessment. The Company completed its annual impairment on March 1, 2006 and did not identify any impairment. No significant revisions to the underlying operating results or forecasts which would impact these annual impairment results were noted as of December 31, 2006.
Amortization expense on intangible assets with a definite life for the next five years as of December 31, 2006 is as follows:
Realizability of Long-Lived Assets
The carrying values of long-lived assets, which include construction material, property, plant and equipment, and other intangible assets, are evaluated for impairment whenever events or changes in circumstances indicate the carrying amount may not be recoverable. An impairment loss is recognized if the carrying amount exceeds its fair value. The carrying amount is not recoverable if it exceeds the sum of undiscounted cash flows expected to result from the use and eventual disposition of the assets. Any impairment loss would be measured as the amount by which the carrying amount exceeded the fair value, most likely determined by future discounted cash flows. Management believes that there have been no impairments as of December 31, 2006.
Debt Issuance Costs
Certain costs associated with issuance of the Company’s debt have been capitalized. These debt issuance costs are amortized over the life of the Credit Facility using the effective interest method. Amortization expense related to debt issuance costs charged to interest expense in 2006, 2005 and 2004 was $1,895, $1,895 and $1,571, respectively.
Deferred Credits
Deferred credits consist primarily of deferred launch incentives. The Company receives launch incentive payments from programmers. These incentive payments are deferred and recognized over the life of the related programming agreements as an offset to programming costs in direct expenses. To date, these amounts have not been material.
Revenue Recognition
Revenues are generally recognized when evidence of an arrangement exists, services are rendered, the selling price is determinable and collectibility is reasonably assured. Revenues from video and Internet access services are recognized based upon monthly service fees or fees per event. Revenue for customer fees, equipment rental, advertising and pay-per-view programming is recognized in the period that the services are delivered. Video and non-video installation revenue is recognized in the period the installation services are provided to the extent of direct selling costs. Any remaining amounts are deferred and recognized over the estimated average period that the customers are expected to remain connected to the cable system. Under the terms of the Company’s non-exclusive franchise agreements, the Company is generally required to pay up to 5% of its gross revenues derived from providing cable service to the local franchise authority. The Company normally passes these fees through to its cable subscribers.
Marketing Costs
The cost of marketing, advertising, and selling is expensed as incurred and are included in sales, general and administrative expenses. Marketing, advertising, and selling expense in 2006, 2005 and 2004 was $9,669, $9,332 and $5,007, respectively.
Income Taxes
The Company is a limited liability corporation that is treated as a disregarded entity for income tax purposes. The taxable income and expenses of Atlantic Broadband Finance, LLC are ultimately reported on the partnership return of Atlantic Broadband Holdings II, LLC which is a partnership for income tax purposes. No provision for federal income taxes is required by Atlantic Broadband Finance, LLC as its income and expenses are taxable to or deductible by the members of Atlantic Broadband Holdings II, LLC.
Derivative Financial Instruments
The Company uses derivative financial instruments to manage its exposure to fluctuations in interest rates by entering into interest rate exchange agreements (“Swaps”). Derivative financial instruments are accounted for in accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended (“SFAS 133”).
SFAS 133 requires that all derivative instruments, whether designated in hedging relationships or not, be recorded on the balance sheet at their fair values. At December 31, 2006 and 2005, derivative instruments consist solely of Swaps which are used to reduce the Company’s exposure to interest rate fluctuations on its variable rate debt (see Note 8). At December 31, 2006 and 2005, the Swaps were recorded at fair value as an asset of $690 and $4,083, respectively.
The interest rate swap agreements are not designated as hedging instruments, accordingly, changes in fair values are recognized currently in earnings. The Company recorded a loss of $3,393 for the year ended December 31, 2006 and a gain of $536 and $3,547 for the years ended December 31, 2005 and 2004, respectively, from marking to market these derivative instruments.
Concentrations of Risk
Certain financial instruments potentially subject the Company to concentrations of credit risk. These financial instruments consist primarily of trade receivables and cash and cash equivalents. The Company places its cash and cash equivalents with high credit quality financial institutions and limit the amount of credit exposure to any one financial institution. The Company periodically assesses the creditworthiness of the institutions with which it invests. The Company does, however, maintain invested balances in
excess of federally insured limits. The Company periodically assesses the creditworthiness of its customers. Concentrations of credit risk are limited as no single customer accounts for a significant portion of the balance.
Capitalization of Labor and Overhead Costs
The cable industry is capital intensive, and a large portion of our resources are spent on capital activities associated with extending, building and upgrading the cable network. Costs associated with network construction, initial customer installations, installation refurbishments and the addition of network equipment necessary to enable advanced services are capitalized. Costs capitalized as part of initial customer installations include materials, direct labor costs associated with capital projects and certain indirect costs. The Company capitalizes direct labor costs associated with personnel based upon the specific time devoted to construction and customer installation activities. Indirect costs are associated with the activities of personnel who assist in connecting and activating the new service and consist of compensation and overhead costs associated with these support functions. The costs of disconnecting service at a customer’s dwelling or reconnecting service to a previously installed dwelling are charged to operating expense in the period incurred. Costs for repairs and maintenance are charged to operating expense as incurred, while equipment replacement and betterments, including replacement of cable drops from the pole to dwelling, are capitalized.
Judgment is required to determine the extent to which indirect costs, or overhead, are incurred as a result of specific capital activities and, therefore, should be capitalized. The Company capitalizes overhead based upon an allocation of the portion of indirect costs that contribute to capitalizable activities using an overhead rate applied to the amount of direct labor capitalized. The Company has established overhead rates based on an analysis of the nature of costs incurred in support of capitalizable activities and a determination of the portion of costs which is directly attributable to capitalizable activities. The primary costs that are included in the determination of overhead rates are (i) employee benefits and payroll taxes associated with capitalized direct labor, (ii) direct variable costs associated with capitalizable activities, consisting primarily of installation and construction vehicle costs, (iii) the cost of support personnel, such as dispatch that directly assist with capitalizable installation activities, and (iv) indirect costs directly attributable to capitalizable activities.
Recently Issued Accounting Standards
In September 2006, the Staff of the SEC issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (SAB 108). SAB 108 provides guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of determining whether the current year’s financial statements are materially misstated. SAB 108 is effective for fiscal years ended December 31, 2006. The adoption of SAB 108 did not have a material impact on the Company’s financial positions or results of operations.
In September 2006, FASB issued SFAS No. 157, “Fair Value Measurement” (“SFAS 157”) which defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 applies to other accounting pronouncements that require or permit fair value measurements. It is effective for us beginning in fiscal year 2008. The Company is currently evaluating the impact of adopting SFAS 157.
On February 15, 2007, FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). This Statement is a fair value option for financial assets and financial liabilities and includes an amendment of FAS Statement No. 115 which covers accounting for certain investments in debt and equity securities. It is effective for us beginning in fiscal year 2008. The Company is currently evaluating the impact of adopting SFAS 159.
4. Acquisitions
On September 3, 2003, the Company entered into a purchase agreement with affiliates of Charter to acquire the Systems. On March 1, 2004, the Company purchased substantially all of the assets of the Systems for $724.1 million, exclusive of transaction costs. Under a retained franchise agreement executed in conjunction with the purchase agreement, the Company operated certain franchises not transferred on the initial closing date through the date such franchise agreements were transferred. These remaining assets were acquired upon local franchise approval of the underlying license transfers on April 30, 2004 for $8.5 million, exclusive of transaction costs. Under the terms of the purchase agreement, the final purchase price for the Systems was determined based upon a measurement of ending basic and high speed internet subscribers multiplied by a stated rate per subscriber.
The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of the acquisition. The Company obtained third-party valuations of certain acquired intangible assets from Grant Thornton LLP.
Of the $554,200 of acquired intangibles, $509,100 was assigned to franchise operating rights that are not subject to amortization and $42,900 was assigned to subscriber relationships (estimated useful life of approximately 3 years). The remaining $2,200 of acquired intangible assets have estimated useful lives of approximately 1 to 5 years.
The Systems were acquired for the purpose of acquiring existing franchises and related infrastructure; as such the primary asset acquired was the franchise operating rights. The results of operating the Systems are included from March 1, 2004.
The selected unaudited pro forma consolidated information for the years ended December 31, 2004 and 2003, determined as if the acquisition described above occurred on January 1, would have resulted in the following:
This unaudited pro forma information is presented for illustrative purposes only and is not necessarily indicative of results of operations in future periods or results that would have been achieved had the Company and the acquired Systems been combined during the specified periods.
During 2006, the Company made four acquisitions of three small cable systems and one dial-up internet provider for a total purchase price, excluding liabilities assumed, of $1,472.
G Force LLC
On July 13, 2006, the Company entered into a definitive asset purchase agreement to purchase substantially all of the assets of G Force LLC, owner of certain cable systems in South Carolina. The Company financed the acquisition through an increase in its Senior Credit Facility and the issuance of a $6.9 note payable to the seller of the assets. The transaction was consummated on November 1, 2006. The total purchase price for the assets acquired, excluding liabilities assumed, was $62,610.
The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of the acquisition. The Company obtained third-party valuations of certain acquired intangible assets from Grant Thornton LLP.
Of the $39,364 of acquired intangibles, $38,900 was assigned to franchise operating rights that are not subject to amortization and $464 was assigned to subscriber relationships (estimated useful life of approximately 3 years).
5. Plant, Property and Equipment
Plant, property and equipment consist of the following:
Depreciation expense for the years ended December 31, 2006, 2005 and 2004 was $34,125, $27,341 and $17,967, respectively.
6. Intangible Assets
Intangible assets consist of the following:
Amortization expense for the years ended December 31, 2006, 2005 and 2004 was $15,569, $15,032 and $12,529, respectively.
The change in the carrying value of goodwill for the years ended December 31, 2006 and 2005 was as follows:
7. Accrued Expenses
Accrued expenses consist of the following:
8. Debt
On February 10, 2004, the Company entered into $305,000 of term loans (the “Term Loans”) and a $90,000 revolving credit facility (the “Revolver”) with a group of banks and institutional investors led by Merrill Lynch & Company, General Electric Capital Corporation, Societe Generale and Calyon Corporate and Investment Bank. These two facilities are governed by a single credit agreement dated as of February 10, 2004 (collectively, the “Senior Credit Facility”).
The net proceeds from the Senior Credit Facility were primarily used to acquire and operate the Systems.
The Senior Credit Facility contains certain restrictive financial covenants that, among other things, require the Company to maintain certain debt service coverage, interest coverage, fixed charge coverage, leverage ratios and a certain level of EBITDA and places certain limitations on additional debt and investments. The Senior Credit Facility contains conditions precedent to borrowing, events of default (including change of control) and covenants customary for facilities of this nature. The Senior Credit Facility is collateralized by substantially all of the assets of the Company and its subsidiaries.
At December 31, 2006, there was $348,438 outstanding under the Term Loans and $29,917 under the Revolver. At December 31, 2005, there was $305,000 outstanding under the Term Loans and $26,417 under the Revolver. The interest rate on the Senior Credit Facility will be, at the election of the Company, based on either a Eurodollar or a Base Rate option, each as defined in the credit agreement, plus a spread ranging between 1.0% and 3.25%. Excluding the interest rate swaps, the weighted average interest rate for 2006, 2005 and 2004 on the Term Note and Revolver was 7.59%, 6.20% and 5.05%, respectively. Interest payments on Base Rate Loans shall be payable in arrears on the last day of each calendar quarter and at maturity. Interest payments on Eurodollar Loans shall be payable on the last day of each interest period relating to such loan and at maturity.
As of December 31, 2006, there was approximately $60,083 of unused commitments under the Revolver all of which could be drawn in compliance with the financial covenants under the Senior Credit Facility. In order to maintain the revolving lines of credit, the Company is obligated to pay certain commitment fees at nominal interest rates on the unused portions of the loans.
The Company can make no assurances that it will be able to satisfy and comply with the covenants under the Senior Credit Facility. The Company’s ability to maintain its liquidity and maintain compliance with its covenants under the Senior Credit Facility is dependent upon its ability to successfully execute its current business plan. The Company can make no assurances, however, that its business will generate sufficient cash flow from operations or that existing available cash or future borrowings will be available to it under the Senior Credit Facility in an amount sufficient to enable it to pay its indebtedness or to fund its other liquidity needs. As of December 31, 2006, the Company was in compliance with its covenants under the Senior Credit Facility.
Term Loan installments began on June 30, 2006. The Revolver shall be paid such that the amount outstanding shall not exceed $67,500 from March 1, 2009 until the termination date. The Revolver shall be paid in full on the termination date of March 1, 2010. Principal payments under the Senior Credit Facility for each year ending December 31, 2007 through 2011 are as follows:
On August 23, 2006, the Company amended its Senior Credit Facility to increase the Term Loan commitment by $50.0 million in anticipation of the pending acquisition of G Force LLC. The acquisition closed and the additional Term Loan borrowings occurred on November 1, 2006. The additional borrowings were made under the same conditions as the original Term Loans.
Senior Subordinated Notes
On February 10, 2004, the Company issued $150,000 of 9 3/8% senior subordinated notes (the “Notes”). The Notes mature on January 15, 2014. Interest is payable every six months in arrears on January 15 and July 15. The Notes are general unsecured senior subordinated obligations subordinated to the Senior Credit Facility. The proceeds of the offering were used to finance the acquisition of the Systems.
Debt Issuance Costs
For the year ended December 31, 2004, the Company capitalized $15,019 of debt issuance costs related to the Senior Credit Facility and the Notes. In addition, the Company capitalized $1,200 of debt issuance costs related to the increased borrowings under the Senior Credit Facility to fund the acquisition of the G Force LLC assets. Debt issuance costs are amortized using the effective interest method over the term of the Senior Credit Facility.
Interest Rate Swap Agreements
The Company is exposed to the market risk of adverse changes in interest rates. To manage the volatility related to these changes, the Company entered into interest rate swap agreements. The Company is required by its Senior Credit Facility to maintain fifty percent of its outstanding Term Loans in an interest rate swap agreement for three years. These agreements convert at least one-half of the Company’s Term Loan floating rate debt under the Credit Facility to fixed rate debt. The Company’s swap position as
of December 31, 2006, 2005 and 2004 was satisfied by three agreements entered into on March 17, 2004 for a total notional value of $230,000 with a term of three years at a fixed rate of 1.25% for the first year, 2.25% for the second year and rates ranging from 3.53% to 3.58% for the third year. In September 2006, the Company entered into four additional swap agreements with a forward start date of March 19, 2007 for a total notional value of $225,000 with a term of two years at a fixed rate of 5.08%. The marking-to-market of the interest rate swap agreements resulted in the recognition of $3,393 in other expense for the year ended December 31, 2006 and $536 and $3,547 in other income for the years ended December 31, 2005 and 2004, respectively.
Debt Covenants
The Senior Credit Agreement and the Notes described above contain covenants which require the Company to comply with certain financial ratios, capital expenditures and other limits. On December 22, 2005, the Company amended its Senior Credit Agreement to increase the level of capital expenditures allowed during 2005.
The Company was in compliance with all such covenants at December 31, 2006, 2005 and 2004.
On March 6, 2007, the Company further amended its Senior Credit Agreement to increase capital expenditure limits and to adjust certain financial covenant ratios for periods beginning in 2007. The amended financial covenant ratios are less restrictive that the previously effective ratios.
Seller Note
In conjunction with the November 1, 2006 acquisition of G Force, LLC, the Company issued to the seller a note in the amount of $6.9 million. This note has an interest rate of 6%, payable semi-annually, and is payable on the third anniversary of the acquisition date.
9. Member’s Equity
The Parent owns all 1,000 units issued by the Company. The Parent contributed $1,709 in 2003 to effect its formation. In 2004, the Parent contributed $260,791 which the Company used to acquire the Systems.
10. Employee Benefits
401(k) Savings Plan
During 2004, the Company adopted a defined contribution retirement plan which complies with Section 401(k) of the Internal Revenue Code. Substantially all employees are eligible to participate in the plan. The Company matches 50% of each participant’s voluntary contributions subject to a limit of the first 5% of the participant’s compensation. During 2006, 2005 and 2004, the Company recorded $368, $368 and $240, respectively, of expense related to the 401(k) plan.
11. Commitments and contingencies
The Company currently leases office and warehouse space and equipment under both cancelable and non-cancelable operating leases. Rental expense under operating lease agreements for the years 2006, 2005 and 2004 was $640, $604 and $490, respectively.
The Company has entered into several lease commitments for equipment and facilities. Future minimum lease commitments under non-cancelable leases and service agreements as of December 31, 2006 are as follows:
In addition to the above, in the normal course of business, there are various legal proceedings outstanding. In the opinion of management, these proceedings will not have a material adverse effect on the financial position or results of operations or liquidity of the Company.
12. Related Party Transactions
On September 3, 2003, ABRY Partners IV, LP, the principal equity holder of Atlantic Broadband Group, LLC (“ABRY”), paid $5,000 as a pre-closing escrow deposit on the Systems asset purchase agreement. In November 2003, the funds held in escrow were returned to ABRY in exchange for a $25,000 standby letter of credit issued on behalf of the Company and guaranteed by ABRY. The standby letter of credit was terminated upon consummation of the acquisition on March 1, 2004.
13. Valuation and Qualifying Accounts
Allowance for doubtful accounts roll forward:
14. Subsequent Events
On March 6, 2007, the Company amended its Senior Credit Facility and increased the Term Loan commitment and borrowings by $104.5 million. The proceeds of the additional Term Loans were used to provide a dividend to its members of $77.6 million and to reduce outstanding Revolver borrowings by $23.0 million. The balance of the proceeds were used for working capital purposes. The additional borrowings were made under substantially the same conditions as the original Term Loans. The resulting principal payments under the Senior Credit Facility for each year ended December 31, 2007 through 2011 are as follows: