Item 1. Business This combined Annual Report on Form 10-K is separately filed by Cablevision Systems Corporation (“Cablevision”) and CSC Holdings, Inc. (“CSC Holdings” and collectively with Cablevision, the “Company” or the “Registrants”).
Cablevision Systems Corporation
Cablevision Systems Corporation is a Delaware corporation which was organized in 1997. Cablevision owns all of the outstanding common stock of CSC Holdings and its liabilities consist primarily of $1.5 billion senior notes issued in April 2004. Cablevision has no operations independent of its CSC Holdings subsidiary.
CSC Holdings
CSC Holdings is a Delaware corporation which was organized in 1985 and is one of the largest cable operators in the United States based on the number of basic video subscribers. We also operate cable programming networks, entertainment businesses and telecommunications companies. As of December 31, 2006, we served approximately 3.1 million basic video subscribers in and around the New York City metropolitan area, making us the fifth largest cable operator in the United States based on the number of basic video subscribers. We believe that our cable television systems comprise the largest metropolitan cluster of cable television systems under common ownership in the United States (measured by number of basic video subscribers). Through our wholly-owned subsidiary, Rainbow Media Holdings LLC (“Rainbow Media Holdings”), we own interests in and manage numerous national and regional programming networks, the Madison Square Garden sports and entertainment businesses and cable television advertising sales companies. Through Cablevision Lightpath, Inc. (“Lightpath”), our wholly-owned subsidiary, we provide telephone services and high-speed Internet access to the business market.
We classify our business interests into three segments: Telecommunications Services; Rainbow; and Madison Square Garden.
Our Telecommunications Services segment includes CSC Holdings’ cable television business, including its video, high-speed data, Voice over Internet Protocol (“VoIP”) and residential telephone services operations and the operations of the commercial telephone and high-speed data services provided by Lightpath.
Our Rainbow segment consists principally of our interests in national programming services - AMC, IFC, WE tv (formerly WE: Women’s Entertainment), fuse and VOOM HD Networks and regional programming businesses and investments held by Rainbow Media Holdings including Fox Sports Net Bay Area, Fox Sports Net New England and News 12 Networks, a regional news business in the New York City metropolitan area. Rainbow also includes a local advertising sales representation business.
Our Madison Square Garden segment owns and operates the Madison Square Garden Arena and the adjoining Theater at Madison Square Garden, the New York Knickerbockers professional basketball team, the New York Rangers professional hockey team, the New York Liberty professional women’s basketball team, the Hartford Wolf Pack professional hockey team, the regional sports programming networks Madison Square Garden Network and Fox Sports Net New York (collectively, “MSG Networks”), and MSG Entertainment (which operates Radio City Music Hall and the Beacon Theater in New York City under long-term leases). Additionally, Madison Square Garden manages and operates the Hartford Civic Center and Rentschler Field in Connecticut. Madison Square Garden is a wholly-owned subsidiary of Rainbow Media Holdings.
In addition, we own or have interests in the following businesses and assets:
· the motion picture theater business of Clearview Cinemas, which operates 52 movie theaters containing 258 screens,
· PVI Virtual Media Services LLC, which markets a real time video insertion system that places computer generated electronic images into telecasts of sporting events and other programming, and
· the common stock of the following entities (which we monetized through the execution of prepaid forward contracts, collateralized by an equivalent amount of the respective stock):
o Comcast Corporation,
o General Electric Company,
o Charter Communications, Inc.,
o Leapfrog Enterprises, Inc., a designer, developer and marketer of technology-based educational products.
Telecommunications Services
General
Cable television is a service that delivers multiple channels of television programming to subscribers who pay a monthly fee for the services they receive. Television signals are received over-the-air, by fiber optic transport or via satellite delivery by antennas, microwave relay stations and satellite earth stations and are modulated, amplified and distributed over a network of coaxial and fiber optic cable to the subscribers’ television sets. Cable television systems typically are constructed and operated pursuant to non-exclusive franchises awarded by local and state governmental authorities for specified periods of time.
Our cable television systems offer varying packages of service marketed under the Optimum brand name, which may include, among other programming, local broadcast network affiliates and independent television stations, certain other news, information and entertainment channels such as CNN, CNBC, ESPN, and MTV, and certain premium services such as HBO, Showtime, The Movie Channel, Starz!/Encore and Cinemax. We also offer digital video service, branded “iO, Interactive Optimum,” which enables customers to receive video on demand and subscription video on demand services, as well as additional viewing channels.
Our cable television revenues are derived principally from monthly fees paid by subscribers. In addition to recurring subscriber revenues, we derive revenues from the sales of pay-per-view movies and events, video on demand and subscription video on demand program tiers, from the sale of advertising time on advertiser supported programming and from installation and equipment charges. Certain services and equipment provided by substantially all of our cable television systems are subject to regulation. See “Regulation - Cable Television.”
We also provide residential high-speed data services using our cable television broadband network. High-speed data services are provided to customers through a cable modem device. The high-speed data service, marketed as “Optimum Online”, served approximately 2.0 million subscribers at December 31, 2006 for an overall penetration rate of 44.7% of the homes passed by our cable television network. We believe that our high-speed data service penetration has been driven by superior quality and speed and, in part, by a large number of customers installing the necessary equipment without the need for a service call.
In addition, the Company offers Optimum Voice, VoIP technology services which is offered exclusively to our Optimum Online subscribers. As of December 31, 2006, we provided Optimum Voice services to
approximately 1.2 million customers for an overall penetration rate of 26.5% of the homes passed by our cable television network. As of December 31, 2006, we also provided switched residential telephone services to approximately 5,200 subscribers in Long Island, New York and parts of southern Connecticut.
Through Optimum Lightpath, a business broadband service provider, we provide telecommunications services to the business market in the greater New York City metropolitan area. Lightpath provides converged data, Internet and voice solutions to mid-sized and large businesses, hospital systems, municipalities, and school systems.
Optimum Lightpath has built an advanced fiber optic network extending more than 2,700 route miles (131,000 fiber miles) throughout the New York Metropolitan area. Optimum Lightpath provides scalable advanced Metro Ethernet services that support a variety of business applications. Metro Ethernet enables organizations to replace older phone line technology with a single IP based solution that satisfies their telecommunications needs, including voice, video, data and Internet. Because Optimum Lightpath builds its wholly owned fiber optic network directly into customers’ office locations, it can deliver its Metro Ethernet services at high speeds (from 10 Mbps up to 10 Gbps), while offering cost savings over traditional services.
As of December 31, 2006, Lightpath serviced over 2,000 buildings with approximately 127,000 access lines.
The following table sets forth certain statistical data regarding our video, high-speed data and VoIP operations as of the dates indicated.
(1) Basic video customers represent each customer account (set up and segregated by customer name and address), weighted equally and counted as one subscriber, regardless of size, revenue generated, or number of boxes, units, or outlets. In calculating the number of customers, the Company counts all customers other than inactive/disconnected customers. Free accounts are included in the customer counts along with all active accounts, but they are limited to a prescribed group such as current and retired Company employees, and free status is not granted to regular customers as a promotion. Such accounts are also not entirely free, as they typically generate revenue through pay-per-view or other services for which they must pay. The Company counts a bulk commercial customer, such as a hotel, as one customer, and does not count individual room units at that hotel. In counting bulk residential customers such as an apartment building, the Company counts each subscribing family unit within the building as one customer, but does not count the master account for the entire building as a customer.
(2) Number of customers who receive at least one of the Company’s services, including business modem only customers.
(3) Homes passed represent the estimated number of single residence homes, apartment and condominium units and commercial establishments passed by the cable distribution network in areas serviceable without further extending the transmission lines.
(4) Average monthly revenue per basic video customer is calculated by dividing the GAAP revenues for the Telecommunications Services segment, less the revenue attributable to Lightpath, for the fourth quarter of each year presented by the average monthly number of basic video customers served by the Company’s cable television systems for the same period. For purposes of this calculation, both revenue and average number of basic video customers exclude the Company’s Lightpath operations because Lightpath’s third-party revenues are unrelated to the Company’s cable television system customers.
Subscriber Rates and Services; Marketing and Sales
Basic Cable
Our cable television systems offer a government mandated broadcast basic level of service which includes local over-the-air broadcast stations, such as network affiliates (e.g., ABC, NBC, CBS, FOX), and public, educational or governmental channels.
All of our cable television systems also offer an expanded basic package of services, generally marketed as “Family Cable”, which includes, among other programming, certain news, information, entertainment, and sports channels such as CNN, AMC, CNBC, Discovery, ESPN and MTV. For additional charges our cable television systems provide certain premium services such as HBO, Showtime, The Movie Channel, Starz!/Encore and Cinemax, which may be purchased either individually or in tiers.
iO, Interactive Optimum
iO, Interactive Optimum, our digital video service, is available to Cablevision’s entire service area. We ended 2006 with approximately 2.4 million iO subscribers.
The digital video programming services currently offered to subscribers include:
· over 230 channels of entertainment,
· over 50 additional movie channels including multiple channels (“multiplexes”) of HBO, Showtime, Cinemax, Starz!/Encore and The Movie Channel,
· access to over 1,200 titles each month on demand, featuring hundreds of movies, and subscription video on demand programming including HBO On Demand, Showtime On Demand, Cinemax On Demand, and Disney Channel On Demand, Anime On Demand, Howard TV On Demand, Playboy TV on Demand, and here! TV On Demand,
· over 150 hours of special interest programming on demand featuring Mag Rack, a collection of 17 video magazines, plus free on demand programming from Thirteen on Demand, Nick on Demand, WE on Demand, fuse, TV Guide Spot and sportskool,
· 45 channels of uninterrupted commercial-free digital music from Music Choice,
· iO Sports Pak - 10 sports channels featuring college sports, golf, soccer, extreme sports and recreational activities for $4.95 per month,
· optional sports packages from the National Basketball Association (“NBA”), National Hockey League (“NHL”), and college football and basketball,
· iO en espanol- over 30 Spanish language channels including programming from Latin America, the Caribbean, Mexico, and featuring latino, video on demand content,
· 17 channels of international programming from around the world, with channels from Korea, Russia, China, Portugal, Italy, Poland, Japan and India/Southeast Asia,
· 21 channels available in high definition, including local channels such as WCBS, WABC, WNBC, WNYW (FOX), the CW, My9 and WNET (PBS), as well as local sports channels, Madison Square Garden Network, YES Network, SportsNet NY and Fox Sports Net New York. Offerings also include high definition channels from HBO, Cinemax, Showtime, The Movie Channel, Starz!/Encore, Universal, ESPN and INHD. In addition, high definition movies are available on demand for an additional fee,
· a collection of enhanced television applications including News 12 Traffic and Weather (formerly Metro Traffic and Weather) interactive, iO dashboard, iO Showcase, Optimum Autos, and Optimum Homes,
· iO DVR service, giving subscribers the ability to record, pause and rewind live television, currently priced at $9.95 per month, and
· iO Games, a wide variety of interactive games offered in distinct packages including the Arcade Pak, Casino Pak, Variety Pak, and Logic Pak. Each package is currently priced at $4.95 per month.
Packaging of the iO, Interactive Optimum product includes the iO Gold package currently priced at $87.95 per month. iO Gold features over 230 channels, including more than 50 premium movie channels and 21 high definition (HDTV) channels. iO Silver, currently priced at $67.95 per month, includes everything in iO Gold except for NBA TV, Flix and premium movie channels from Showtime, Cinemax and The Movie Channel. The currently priced $9.95 per month iO package (which is included in iO Gold and iO Silver) can be added to any level of cable service and includes an additional 34 digital video channels, 45 digital music channels from Music Choice, and access to video on demand programming, including ‘free’ on demand programming such as Mag Rack and PBS (Thirteen on Demand) as well as iO’s enhanced television services such as iO Games and interactive news and weather sites. Discount pricing is available when iO is combined with other service offerings.
Since our network serving our existing cable television systems is substantially upgraded to provide advanced digital video services, our sales efforts are primarily directed toward increasing our penetration to homes passed for all of our existing services. We market our cable television services through in-person selling, as well as telemarketing, direct mail advertising, promotional campaigns and local media and newspaper advertising.
Optimum Online Optimum Online is our high-speed Internet access for the home. Optimum Online connects customers to the Internet using the same network that delivers our cable television service. It is significantly faster than digital subscriber line (“DSL”) and traditional dial-up services. Optimum Online is available to Cablevision’s entire service area.
During 2006, we completed the upgrade of our plant to allow a 50% increase in download speeds to a maximum of 15Mbps downstream (2Mbps upstream) and we have made available two additional levels of service: Optimum Online Boost (30Mbps/2Mbps) and Optimum Online Ultra (50Mbps/50Mbps) to a portion of our service area.
Optimum Online is currently priced at $49.95 per month on an a la carte basis with Optimum Online Boost available for an additional charge of $14.95 per month. Discount pricing is available when Optimum Online is combined with other service offerings.
We ended 2006 with approximately 2.0 million Optimum online subscribers.
Optimum Voice Optimum Voice is a VoIP service available exclusively to Optimum Online subscribers that offers unlimited local, regional and long-distance calling within the United States, Puerto Rico and Canada with popular calling features at one low, flat monthly rate.
With Optimum Voice, customers can call anywhere within the United States, Puerto Rico and Canada, any time of the day or night, and talk as long as they like at the current price of $34.95 a month. Discount pricing is available when Optimum Voice is combined with other service offerings.
Optimum Voice includes the following premium calling features, plus “My Optimum Voice”:
· Enhanced Voicemail
· Call Waiting
· Caller ID
· Caller ID Blocking
· Call Return
· Three-Way Calling
· Call Forwarding
· Anonymous call blocker - blocks all calls to a Voice customer where a calling party does not display their name or number
· Anonymous calling - hides the Voice customer’s name and number on all calls they make
· Find me - allows calls to a Voice customer’s phone number to ring up to three additional phone lines, such as a cell phone or work number, simultaneously
· Call waiting with caller ID
· Busy Redial
· VIP Ringing - a Voice customer can designate up to a certain number of telephone numbers to ring with a second, distinct ringtone
My Optimum Voice allows customers to easily manage calling features and receive voicemails via the Internet. Customers can view all their call details at their convenience.
We launched Optimum Voice World Call in the second quarter of 2006, which provides flat-rate international calling to anywhere in the world, for $19.95 per month (250 minutes per month).
Optimum Voice is available to Cablevision’s entire service area. We ended 2006 with approximately 1.2 million Optimum Voice customers.
Bundled Offers
We offer several promotional packages with discounted pricing to customers who subscribe to one or more of our products as compared to the a la carte prices for each individual product. Our “Optimum Triple Play” family package currently offers iO Interactive Optimum, Optimum Online and Optimum Voice for $29.95 per month for each for the first twelve months when purchased together. Our “Optimum Double Play” package currently offers Optimum Online and Optimum Voice for $29.95 per month for each for the first twelve months when purchased together. We also offer other pricing discounts for certain products that are added to existing service.
System Capacity
Our cable plant network uses state of the art technology including fiber optic cable. The network is a minimum of 750 MHz two-way interactive system offering a minimum of 67 analog, various digital channels, high-speed data and voice services.
Programming
Adequate programming is available to the cable television systems from a variety of sources, including from Rainbow Media Holdings. Program suppliers’ compensation is typically a fixed, per subscriber monthly fee (subject to contractual escalations) based, in most cases, either on the total number of basic video subscribers of the cable television systems, or on the number of subscribers subscribing to the particular service. The programming contracts are generally for a fixed period of time and are subject to negotiated renewal. Cable programming costs have increased in recent years and are expected to continue to increase due to additional programming being provided to most subscribers, increased costs to produce or purchase cable programming and other factors.
Franchises
The Company’s cable television systems are operated in New York, New Jersey and Connecticut under non-exclusive franchise agreements with state or municipal franchising authorities. Franchise agreements usually require payment of franchise fees and contain regulatory provisions addressing, among other things, upgrades, service quality, cable service to schools and other public institutions, insurance and indemnity bonds. The terms and conditions of cable franchises vary from jurisdiction to jurisdiction. Franchise authorities generally charge a franchise fee of up to 5% of certain of our revenues that are derived from the operation of the system within such locality. The Company generally passes the franchise fee on to its subscribers, listing it as a separate item on the bill.
Franchise agreements are usually for a term of five to fifteen years from the date of grant; most are ten years. Franchises usually are terminable only if the cable operator fails to comply with material provisions, and then only after complying with substantive and procedural protections afforded by federal
and state law. As of December 31, 2006, one of our ten largest franchises is expired and we are currently operating in this area under temporary authority. Approximately 58,000 of the Company’s basic video customers are in this franchise area. The Company has never lost a franchise for an area in which it operates. Historically, expired franchises have routinely been renewed upon expiration. When a franchise agreement reaches expiration, a franchising authority may seek to impose new requirements, including requirements to upgrade facilities, to increase channel capacity and to provide additional support for local public, education and government access programming. Negotiations can be protracted. Franchise agreements sometimes expire before a renewal is negotiated and finalized. State laws provide that pre-existing franchise terms continue in force during the renewal negotiations until one or both parties seek to pursue “formal” franchise remedies under federal law. Federal law provides significant substantive and procedural protections for cable operators seeking renewal of their franchises. See “Regulation - Cable Television.” Despite the Company’s efforts and the protections of federal law, it is possible that one or more of the Company’s franchises may be subject to termination or non-renewal or we may be required to make significant additional investments in the cable systems in response to requirements imposed in the course of the franchise renewal process.
Rainbow
General
We conduct our programming activities through Rainbow Media Holdings, a wholly-owned subsidiary of CSC Holdings. Rainbow Media Holdings’ businesses include ownership interests in national and regional programming networks.
Rainbow Media Holdings’ national entertainment programming networks include AMC, WE tv, IFC, fuse, VOOM HD Networks, Mag Rack and sportskool.
Rainbow Media Holdings holds a 50% interest in a regional sports network that provides regional sports programming to the New England area and also has a 60% interest in Fox Sports Net Bay Area, a regional sports network that provides regional sports programming to the San Francisco/Oakland Bay area.
Rainbow Media Holdings owns News 12 which operates regional news networks servicing the New York City metropolitan area and also owns and operates Rainbow Advertising Sales Corporation, a cable television advertising company.
The following table sets forth estimated subscriber information as of December 31, 2006, 2005 and 2004 for Rainbow Media Holdings’ programming businesses. These businesses are wholly-owned subsidiaries of Rainbow Media Holdings, except for as noted below.
(a) Represents the number of subscribers to distributors’ systems that receive the referenced programming network.
(b) Rainbow Media Holdings holds an 80% interest in the VOOM HD Networks and EchoStar Communication Corporation holds the remaining 20%.
(c) Rainbow Media Holdings holds a 60% interest in Fox Sports Net Bay Area and News Corporation holds the remaining 40%.
(d) Rainbow Media Holdings holds a 50% interest in Fox Sports Net New England and Comcast holds the remaining 50%.
(e) Madison Square Garden Network and Fox Sports Net New York are part of the Company’s Madison Square Garden segment.
National Entertainment Programming Networks
AMC
With a comprehensive library of popular films, AMC offers movie-based entertainment for movie lovers.
AMC is available on cable television and other distribution platforms such as direct broadcast satellite (DBS) in the United States, and in the fourth quarter of 2006, the AMC service was launched by a cable television operator in Canada. It is principally carried on basic or expanded basic tiers for which subscribers do not have to pay a premium to receive the network. Affiliate revenues, which in 2006 accounted for approximately 60% of AMC’s net revenues, are based on fees paid by the distributors for the right to carry the programming.
AMC’s film library consists of films that are licensed from major studios such as Twentieth Century Fox, Warner Bros., Sony (MGM), NBC Universal, Paramount, and Buena Vista under long-term contracts,
with sufficient films under contract as of December 31, 2006 to meet its minimum film programming needs through midyear 2009. AMC generally structures its contracts for the exclusive cable television right to carry the films during identified windows. AMC’s programming also includes original series such as Sunday Morning Shootout, Movies that Shook the World and Movies 101.
WE tv
WE tv is a 24-hour entertainment service oriented to women. The programming features films and original series and specials of particular interest to women.
WE tv has licensed exclusive films and off-network series from major studios such as Twentieth Century Fox, NBC Universal and Warner Bros., as well as independent studios like Miramax and New Line to supplement its slate of original programming. The library has sufficient films licensed under contract as of December 31, 2006 to meet WE tv’s minimum film programming needs through approximately midyear 2010. WE tv’s acquired series include Hope and Faith, Dharma & Greg and Take This House & Sell It!. Bridezillas, Secret Lives of Women, Platinum Weddings and John Edward Cross Country are WE tv’s most successful original series.
IFC
IFC was the first network dedicated to independent films and related programming. IFC presents feature-length films (domestically and internationally produced), documentaries, shorts, animation, new works, “cult classics” and originally produced programs which chronicle independent film trends.
IFC’s film library includes titles from Rainbow Media Holdings’ film production and distribution businesses, as well as from leading independent film studios like Miramax, MGM/UA, Lions Gate and New Line, with sufficient films under contract as of December 31, 2006 to meet its minimum film programming requirements needs through 2008. IFC also features exclusive live coverage of notable international film events like the Cannes Film Festival and the Independent Spirit Awards as well as original series such as Greg the Bunny, The Henry Rollins Show, The Minor Accomplishments of Jackie Woodman, Gunslinger Girl and Basilisk, and original documentaries such as This Film Is Not Yet Rated and Yo Soy Boricua.
fuse
fuse is the nation’s only viewer-influenced multi-platform, music television network, featuring music videos, artist interviews, live concerts, series and specials. fuse is a destination for established and emerging artists.
VOOM HD Networks
VOOM HD Networks is currently a suite of 15 channels, produced exclusively in high-definition and marketed for distribution to direct broadcast satellite and cable operators. VOOM HD Networks range from extreme sports and fashion to art and movies. VOOM HD Networks offer: concerts on Rave HD, art and museum tours on Gallery HD, exploration and nature on Equator HD, extreme sports on Rush HD and 24/7 news and weather on HDNews. Currently, the VOOM HD Networks are available only on EchoStar Communications Corporation’s (“EchoStar”) DISH Network.
In April 2005, subsidiaries of the Company entered into agreements with EchoStar relating to the launch and operation of the business of Rainbow HD Holdings LLC, the Company’s VOOM HD Networks, subject to the closing of the sale of our satellite (Rainbow 1) to EchoStar, which occurred in November 2005. Under those arrangements, EchoStar initially distributed a portion of the VOOM HD Networks programming service and, beginning in 2006 began carrying all 15 of the channels included in the programming service. In connection with the arrangements, EchoStar was issued a 20% interest in
Rainbow HD Holdings, the Company’s subsidiary owning the VOOM HD Networks, and that 20% interest will not be diluted until $500 million in cash has been invested in Rainbow HD Holdings’ equity by the Company.
Under the terms of the affiliation arrangements with EchoStar covering the VOOM HD Networks for a 15 year term, if Rainbow HD Holdings fails to spend $100 million per year, up to a maximum of $500 million in the aggregate, on its service offerings, EchoStar may terminate the affiliation agreement. The Company has the right to terminate the affiliation agreement if the VOOM HD Networks are discontinued in the future.
Regional Sports Networks
Rainbow Media Holdings holds a 60% indirect interest in Fox Sports Net Bay Area and a 50% indirect interest in Fox Sports Net New England. Rainbow Media Holdings manages each of these regional sports networks, which are distributed in their respective region in the United States through cable television as well as other distribution platforms such as direct broadcast satellite.
In April 2005, the Company and News Corporation restructured their ownership of Regional Programming Partners. Prior to the April 2005 transaction, Regional Programming Partners was owned 60% by the Company and 40% by News Corporation. As a result of the restructuring, the Company now owns 100% of Madison Square Garden, 100% of Fox Sports Net Chicago (which was shut down in June 2006) and 50% of Fox Sports Net New England. In connection with the restructuring, these businesses extended the terms of their long-term affiliation agreements with National Sports Partners and their advertising representation agreements with National Advertising Partners.
National Sports Partners and National Advertising Partners were owned 50% by the Company and 50% by News Corporation prior to the restructuring. As a result of the restructuring, the Company no longer owns an interest in National Sports Partners, National Advertising Partners, Fox Sports Net Ohio or Fox Sports Net Florida.
The Company and News Corporation continue to own 60% and 40%, respectively, of Fox Sports Net Bay Area through a separate partnership. The Company continues to manage that network. In connection with the restructuring, Fox Sports Net Bay Area extended the terms of its long-term affiliation agreement with National Sports Partners and its advertising representation agreement with National Advertising Partners.
Other Services
Video-On-Demand Services
Rainbow Media Holdings’ on-demand services include Mag Rack and sportskool. Mag Rack provides a variety of on-demand special interest television programming on a variety of topics including cars, motorcycles, personal relationships, children’s entertainment and music instruction. sportskool features expert sports instruction, coaching and guidance for a wide range of sports and fitness activities. These services are currently offered to Cablevision’s subscribers and are also carried by other distributors.
Rainbow Network Communications
Rainbow Network Communications, servicing primarily Rainbow Media Holdings’ programming offerings, is a full service network programming origination and distribution company. Its services include origination, transmission, video engineering, uplinking, encryption, affiliate engineering, technology consulting, transponder negotiation, content ordering, quality control and editing. Rainbow Network Communications has a state of the art technology center that consolidates all master
control/playback and uplink facilities in one location. This center is fully digital which enables Rainbow Network Communications to process audio and video signals in both standard and high definition.
Film Production and Distribution Businesses
Rainbow leveraged IFC’s brand name in 1997 to create IFC Productions, a feature film production company that provides financing for select independent film projects, and in 2000 to create IFC Films, a theatrical distribution company. Historically, IFC Productions has provided financing for the production of such films as Boys Don’t Cry and Girlfight. In 2005, IFC Production’s Me and You and Everyone We Know won major awards at the Sundance and Cannes Film Festivals and became one of the top 5 grossing films in IFC Production’s history. In 2004, Fahrenheit 9/11, distributed by IFC Films and Lions Gate, received critical acclaim.
Madison Square Garden
Madison Square Garden is a sports and entertainment company that owns and operates the Madison Square Garden Arena and the adjoining Theater at Madison Square Garden, the New York Knickerbockers professional basketball team, the New York Rangers professional hockey team, the New York Liberty professional women’s basketball team, the Hartford Wolf Pack professional hockey team, the Madison Square Garden Network, Fox Sports Net New York and MSG Entertainment (which operates Radio City Music Hall and the Beacon Theater in New York City under long-term leases). Additionally, Madison Square Garden manages and operates the Hartford Civic Center and Rentschler Field in Connecticut. Madison Square Garden is an indirect wholly-owned subsidiary of the Company.
Other Businesses and Assets
Clearview Cinemas operates 52 motion picture theaters containing 258 screens in the New York metropolitan area. Substantially all of the theaters were acquired in transactions completed in 1998 and 1999. A newly constructed five screen theater was opened in November 2006 in South Orange, New Jersey.
An indirect subsidiary of Rainbow Media Holdings owns a 90% interest in an entity, DTV Norwich LLC that holds FCC licenses in 45 metropolitan areas in the United States, including New York, Miami, Los Angeles, and Cleveland, to provide multichannel video distribution and data service (“MVDDS”), which could be used to distribute video, data or other applications to subscribers via terrestrial transmission facilities and rooftop antennas. The Company is not currently utilizing such spectrum.
CSC Holdings holds a 49.9% interest, and certain preferential distribution rights, in Northcoast Communications. Northcoast Communications is controlled by John Dolan, a nephew of Charles F. Dolan and a cousin of James L. Dolan, the Company’s Chairman and Chief Executive Officer, respectively. The Company’s investment in Northcoast Communications was zero at December 31, 2006 and 2005.
PVI Virtual Media Services LLC is a wholly-owned subsidiary of the Company, which markets a real time video insertion system that through patented technology places computer generated electronic images into telecasts of sporting events and other programming.
We also own 3,724,460 shares of Charter Communications common stock and 14,318,412 shares of Comcast common stock acquired in connection with the sale of certain cable television systems. We also own 12,742,033 shares of General Electric common stock acquired in connection with the sale of our interest in the Bravo programming service and 800,000 shares of Leapfrog Enterprises, Inc. common stock. All of these shares have been monetized pursuant to collateralized prepaid forward contracts.
Competition Cable Television
Our cable television systems operate in an intensely competitive environment, competing with a variety of other television programming delivery systems, including satellite delivered signals, delivery systems of incumbent telephone companies and broadcast television signals available to homes within our market by over-the-air reception.
DBS. A primary competitor to our cable television systems is direct broadcast satellite (DBS). Two major DBS services, EchoStar and DirecTV, are available to the vast majority of our customers. According to the Federal Communications Commission’s most recent (2006) report on video competition, DBS providers serve over 27% of households that subscribe to multichannel video programming services. These services each offer over 300 channels of programming, including programming that is substantially similar to the programming that we offer. Federal laws permit DBS systems to retransmit local broadcast television signals to their customers. This has also enhanced the competitive position of DBS. Our ability to compete with these DBS services is also affected by the quality and quantity of programming available to us and to them. Federal law also generally provides DBS operators with access to all satellite-delivered cable programming services. One of these services, DirecTV, also has exclusive arrangements with the NFL that gives it access to programming that we cannot offer and similar deals for other sporting events have been announced or reported.
Incumbent Telephone Companies. We face intense competition from incumbent telephone companies such as Verizon and AT&T Inc., which have recently begun to offer video programming in addition to their voice and high-speed Internet access services, evidencing their commitment to compete across all of the Company’s telecommunications products. Their competitive position has been improved by recent operational, regulatory and legislative advances that they have made. Verizon and AT&T are constructing fiber-based systems designed to provide video programming as well as voice and data services to residential customers in our service area. The attractive demographics of the Company’s service territory make this region a desirable location for investment in video distribution technologies by these companies. Verizon has constructed fiber to the home network plant that passes a significant number of households in our service area, though currently less than a quarter of the households according to our estimates. Verizon has obtained authority to provide video service (it already has or needs no authority to provide phone and data services) for a majority of these homes passed, on a statewide basis in New Jersey and through numerous local franchises in New York. Verizon has so far not indicated any plans to offer video service in Connecticut. AT&T has announced the commencement of video programming service in several markets in Connecticut, where it is currently permitted to offer such service without any state authorization. See “Regulation” and “Risk Factors - Pending FCC, Congressional and judicial proceedings may affect our businesses” for a discussion of regulatory and legislative issues. Verizon and AT&T also market DBS services in our service area. Each of these companies has greater financial resources than we do.
OVS. In addition, competitive service providers that utilize the public rights-of-way can operate an “open video system” (OVS) subject only to selected portions of the federal regulations applicable to our cable systems, but still subject to certain local municipal franchising powers. RCN Corporation is authorized to operate OVS systems that may compete with us in New York City.
Other Competitors. Other sources of actual or potential video competition to cable television systems include broadcast television stations, private home dish earth stations, multichannel multipoint distribution services (“MMDS”), which deliver television programming over microwave super-high frequency channels received by subscribers with a special antenna, satellite master antenna television (“SMATV”) systems, which like MMDS generally serve large multiple dwelling units under an agreement with the landlord, and new services such as wireless local multipoint distribution service (“LMDS”), and MVDDS. The statutory definition of a cable television system excludes facilities that do not use public rights-of-way. This exempts wireless services from local franchise and other requirements
applicable only to cable television system operators. No MVDDS systems have yet been commercially deployed in the United States. Cable television systems also compete with entities that make videotaped movies and programs available for home rental or sale.
Another potential source of competition is the delivery of video programming over the Internet directly to subscribers. There can be no assurance that the provision of video over the Internet or other existing, proposed, or as yet undeveloped technologies will not become dominant in the future and render our cable television systems less profitable or even obsolete.
High-Speed Data
Our high-speed data offering to consumers, Optimum Online, faces intense competition from other providers of high-speed Internet access including services offered by local telephone companies such as Verizon and AT&T. In addition, DBS providers have tested the use of certain spectrum to offer satellite-based high-speed data services and are offering broadband data services via partnerships and marketing arrangements with other providers such as Verizon, AT&T, and Earthlink. The FCC has allocated spectrum for use by licensed and unlicensed providers of wireless broadband service including LMDS, MVDDS, and WiMax, which, if offered within Cablevision’s service area, could compete with our high-speed data offering.
VoIP
Our VoIP service, Optimum Voice, faces intense competition from other providers of voice services, including local exchange carriers such as Verizon and AT&T and other competitive providers of voice services, as well as VoIP providers like Vonage that do not own networks but can provide service to any person with a broadband connection from a cable company or other network. Traditional wireline local exchange carriers and wireless providers have established customer relationships and existing network interconnection arrangements, which may give them an advantage in providing VoIP services.
Lightpath
Lightpath operates in the most competitive business telecommunications market in the country and competes against the very largest telecommunications companies - incumbent local exchange carriers (“ILECs”), other competitive local exchange companies and long distance companies. More specifically, Lightpath faces substantial competition from Verizon and AT&T, which are the dominant providers of local telephone and broadband services in their respective service areas, smaller independent ILECs such as Frontier/Citizens and Warwick Valley Telephone Company, and VoIP providers such as Vonage. ILECs have significant advantages over Lightpath, including greater capital resources, an existing fully operational local network, and long-standing relationships with customers.
While Lightpath and the ILECs are competitors, Lightpath must enter into interconnection agreements with each ILEC so that Lightpath’s customers can make and receive calls to and from customers served by the ILECs and other telecommunications providers. Federal and state law and regulations require ILECs to enter into such agreements and provide such facilities and services, at prices subject to regulation. The specific price, terms and conditions of each agreement, however, depend on the outcome of negotiations between Lightpath and an ILEC. Agreements are also subject to approval by the state regulatory commissions. Lightpath has entered into interconnection agreements with Verizon for New York, New Jersey and portions of Connecticut and with AT&T for portions of Connecticut, which have been approved by the respective state commissions. Lightpath also entered into interconnection agreements with regional carriers in New York and New Jersey. These agreements, like all interconnection
agreements, are for limited terms and are required to be renegotiated, arbitrated and approved subject to the laws in effect at that time.
Lightpath also faces competition from one or more competitive access providers and other new entrants in the local telecommunications and data marketplace, and competitive local exchange carriers (“CLECs”). In addition to the ILECs and CLECs, other potential competitors capable of offering voice and broadband services include electric utilities, long distance carriers, microwave carriers, wireless telephone system operators (such as cellular, PCS, and specialized mobile radio), and private networks built by large end users. A continuing trend toward business combinations and alliances in the telecommunications industry may create stronger competition for Lightpath.
Programming and Entertainment
Rainbow Media Holdings’ programming networks operate in highly competitive markets. First, our programming networks compete with other programming networks to obtain distribution on cable television systems and other multichannel video programming distribution systems, such as DBS, and ultimately for viewing by each system’s subscribers. Second, our programming networks compete with other video programming distributors, including broadcasters and other programming entities, to secure desired entertainment and sports programming. In each of these markets, some of our competitors are large publicly held companies that have greater financial resources than we do. In addition, Rainbow Media Holdings competes with these entities for advertising revenue.
It is difficult to predict the future effect of technology on many of the factors affecting Rainbow Media Holdings’ competitive position. For example, data compression technology has made it possible for most video programming distributors to increase their channel capacity, which may reduce the competition among programming networks and broadcasters for channel space. On the other hand, the addition of channel space could also increase competition for desired entertainment and sports programming and ultimately, for viewing by subscribers. As more channel space becomes available, the position of our programming networks in the most favorable tiers of these distributors would be an important goal. Additionally, video content delivered directly to viewers over the Internet could compete with our programming networks for viewership.
Distribution of Programming Networks
The business of distributing programming networks to cable television systems and other multichannel video programming distributors is highly competitive. Our programming networks face competition from other programming networks for the right to be carried by a particular cable system or other multichannel video programming distribution system, and for the right to be carried on the service tier that will attract the most subscribers. Once our programming network is selected by a cable or other multichannel video programming distribution system for carriage, that network competes for viewers not only with the other channels available on the system, but also with off-air broadcast television, pay-per-view channels and video-on-demand channels, as well as online services, mobile services, radio, print media, motion picture theaters, DVDs, video cassettes and other sources of information, sporting events and entertainment.
Important to our success in each area of competition Rainbow Media Holdings faces are the prices we charge for our programming networks; the quantity, quality and variety of the programming offered on our networks; and the effectiveness of our networks’ marketing efforts. The competition for viewers in the context of nonpremium programming networks directly correlates with the competition for advertising revenues with each of our competitors.
Our ability to successfully compete with other programming networks for distribution may be hampered because the cable television systems, DBS services or other systems through which distribution is sought may be affiliated with other programming networks. In addition, because such affiliated cable television systems or DBS services may have a substantial number of subscribers, the ability of such programming
networks to obtain distribution on affiliated cable television or DBS services may lead to increased subscriber and advertising revenue for such networks because of their increased penetration compared to our programming networks. Even if such affiliated cable television or DBS operators carry our programming networks, there is no assurance that such cable television or DBS operators would not place their affiliated programming network on a more desirable tier, thereby giving the affiliated programming network a competitive advantage over our own.
New or existing programming networks with affiliations to desired broadcasting networks like NBC, ABC, CBS or FOX may also have a competitive advantage over our networks in obtaining distribution through the “bundling” of agreements to carry those programming networks with the agreements giving the cable system or other distributor the right to carry a broadcast station affiliated with the broadcasting network.
An important part of our strategy involves exploiting identified niches of the viewing audience that are generally well-defined and limited in size. Rainbow Media Holdings has faced and will continue to face increasing competition as other programming networks and online or other services are launched that seek to serve the same or similar niches.
Sources of Programming
We also compete with other programming networks to secure desired programming. Although some of this programming is generated internally through our efforts in original programming, most of our programming is obtained through agreements with other parties that have produced or own the rights to such programming. Competition for this programming will increase as the number of programming networks increases. Other programming networks that are affiliated with programming sources such as movie or television studios, film libraries or sports teams may have a competitive advantage over us in this area.
Competition for Entertainment Programming Sources. With respect to the acquisition of entertainment programming, such as syndicated programs and movies, which are not produced by or specifically for programming networks, our competitors include national commercial broadcast television networks, local commercial broadcast television stations, the Public Broadcasting Service and local public television stations, pay-per-view programs, and other cable programming networks. Some of these competitors have exclusive contracts with motion picture studios or independent motion picture distributors or own film libraries. In the future, Internet-based video content distributors may also emerge as competitors for the acquisition of content or the rights to distribute content.
Competition for Sports Programming Sources. Because the loyalty of the sports viewing audience to a sports programming network is primarily driven by loyalty to a particular team or teams, access to adequate sources of sports programming is particularly critical to our sports networks. Our sports networks compete for local and regional rights for teams or events principally with national or regional cable networks that specialize in or carry sports programming, some of which also own or control, or are owned or controlled by, sports teams or leagues; television “superstations” which distribute sports and other programming by satellite; local and national commercial broadcast television networks; and independent syndicators that acquire and resell such rights nationally, regionally and locally. Some of our competitors may also have ownership interests in, or are owned or controlled by, sports teams, leagues or sports promoters. This gives them an advantage in obtaining broadcast rights for such teams or sports. Owners of distribution outlets such as DBS and cable television systems may also contract directly with the sports teams in their local service areas for the right to distribute games on their systems.
To remain competitive in acquiring rights to sports programming, our sports networks attempt to secure long-term rights agreements with teams, leagues, athletic conferences and other sports program suppliers. Our sports networks, however, are not always successful in doing so, and we cannot be assured that our strategy will enable our sports networks to offer sports programming of the type and in the quantity or
quality necessary for such networks to remain competitive. In addition, the increasing amount of sports programming available on a national basis, including pursuant to national rights arrangements (e.g., NBA on ABC, ESPN and TNT and NHL on NBC and vice versa), as part of league-controlled sports networks (e.g., NBA TV and NFL Network), and out-of-market packages (e.g., NBA’s League Pass), may have an adverse impact on our competitive position as our sports networks compete for distribution and for viewers.
In the New York market, the two local professional baseball teams have each organized their own cable television networks featuring the games of their teams. This adversely affects the competitive position of our regional sports programming networks in New York by denying or limiting our access to those games for our own networks and subjecting our networks to competition from these team-owned services.
Competition for Advertising Revenue. The financial success of our programming businesses also depends in part upon unpredictable and volatile factors beyond our control, such as viewer preferences, the strength of the advertising market, the quality and appeal of the competing programming and the availability of other entertainment activities. A shift in viewer preferences could cause our programming to decline in popularity, which could cause a decline in advertising revenues and could jeopardize renewal of our contracts with distributors. A decline in available advertising expenditures by advertisers could also cause a decline in advertising revenues regardless of a change in viewer preferences, especially from increased competition by other programmers providing similar programming. In addition, our competitors may have more flexible programming arrangements, as well as greater volumes of production, distribution and capital resources, and may be able to react more quickly to shifts in tastes and interests.
Madison Square Garden - Sports and Entertainment Businesses
In addition to the competition faced by Madison Square Garden’s programming networks (as discussed above), Madison Square Garden sports teams’ financial success is dependent on their ability to generate advertising sales, paid attendance, luxury box rentals, and food, beverage and merchandise sales. To a large extent, the ability of the teams to build excitement among fans, and therefore produce higher revenue streams, depends on the teams’ winning performance, which generates regular season and playoff attendance and luxury box rentals, and which also supports increases in prices charged for tickets, luxury box rentals, and advertising placement. Each team’s success is dependent on its ability to acquire highly competitive personnel. The governing bodies of the NBA and the NHL have the power and authority to take certain actions that they deem to be in the best interest of their respective leagues, which may not necessarily be consistent with maximizing the professional sports teams’ results of operations. The venues owned and/or operated by Madison Square Garden compete with other entertainment venues in the New York metropolitan area. Competition is affected primarily by the quality of the sports and entertainment offered to consumers and, to a lesser extent, by factors such as price, arena quality and location.
Clearview Cinemas
Clearview Cinemas as a smaller, regional film exhibitor, competes with a number of large theater chains and independent theaters with respect to acquiring licenses to films and attracting patrons. The principal competitive factors in obtaining films from distributors include licensing terms, seating capacity, location, prestige of the theater chain and of the particular theater, quality of projection and sound equipment and the exhibitor’s ability and willingness to promote the distributor’s films. Most of our competitors are in a stronger competitive position than Clearview Cinemas based upon these factors. We believe that the principal competitive factors in attracting film audiences are the availability of marketable films, the location of theaters, theater comfort and environment, projection and sound quality, level of service and ticket price. The theater exhibition industry also faces competition from other motion picture exhibition delivery systems, such as network, syndicated, pay television, DVD and other home video systems, including the availability of films over the internet.
Regulation
Cable Television
Our cable television systems are subject to extensive federal, state and local regulations. Our systems are regulated under congressionally imposed uniform national guidelines, first set in the Cable Communications Policy Act of 1984 and amended by the Cable Television Consumer Protection and Competition Act of 1992 and the Telecommunications Act of 1996.
The following paragraphs describe the existing legal and regulatory requirements that are most significant to our business today.
Franchising. Regulatory responsibility for local aspects of the cable business such as franchisee selection, system construction, safety, and customer service remains with state and local officials. New York, New Jersey and Connecticut laws provide for comprehensive cable regulation, including approval of transfers of our cable franchises and consumer protection legislation. State and local franchising jurisdiction, however, must be exercised consistently with federal law. Verizon is seeking state legislation in New York that would eliminate the need for, or accelerate, additional local franchises. The Federal Cable Act authorizes states or localities to franchise our cable television systems on a non-exclusive basis but sets limits on their franchising powers. It sets a ceiling on cities and other communities imposing franchise fees of not more than 5% of our gross revenues from our provision of cable television service. It prohibits localities from requiring us to carry specific programming services, and protects us in seeking franchise renewals by limiting the factors a locality may consider and requiring a due process hearing before denial of renewal. Our franchising authorities cannot grant an exclusive cable franchise to us and cannot unreasonably refuse to award an additional franchise to compete with us. The FCC has announced, but not released, a decision that would require municipalities to act more expeditiously on local franchises for competitive providers like Verizon and is intended to limit areas of negotiation that might otherwise slow the franchising process. See “Risk Factors - Pending FCC, Congressional and judicial proceedings may affect our businesses.”
Rate Regulation. In some of our cable television systems, the rates for our basic service package are subject to regulation by local franchising authorities in accordance with FCC rules. Local municipalities or state cable television regulators may also regulate the rates we charge for the installation and lease of the equipment used by subscribers to receive the basic service package, including equipment that may also be used to receive other packages of programming, and the installation and monthly use of connections for additional television sets. However, we are permitted to compute our regulated equipment rates by aggregating our costs of broad categories of equipment at the franchise, system, regional or company level.
Rate regulation is by federal law eliminated if one of our cable systems is subject to “effective competition” from another multichannel video programming distributor. We have been successful in
obtaining from the FCC such an “effective competition” finding in a number of communities in our market and are currently seeking such a finding in other communities.
Must-Carry/Retransmission Consent. We are required by federal law to carry local broadcast stations (“must-carry”), or, at the option of a local broadcaster, to obtain the broadcaster’s prior consent for retransmission of its signal. A substantial number of local broadcast stations currently carried by our cable television systems have elected to negotiate for retransmission consent. Our cable television systems have reached retransmission consent agreements with most broadcast stations they currently carry, but the potential remains for broadcast station carriage to be discontinued if such an agreement is not renewed following its expiration.
Congress has established a “hard” date of February 17, 2009, as the deadline by which broadcasters must relinquish their analog spectrum. No later than February 18, 2009, they must transmit solely in digital format. The FCC has ruled that when a broadcaster completes its transition from analog to digital transmission, only its primary digital video stream will be entitled to must-carry. The FCC has twice found that “dual must carry” rules (requiring cable systems to carry both the analog and digital broadcast signals) would be unconstitutional. The FCC has also ruled that broadcasters may not demand mandatory carriage for other than the primary digital video programming stream. The orders rejecting dual must carry and mandatory “multicasting” are currently subject to petitions for reconsideration pending before the FCC.
Ownership Limitations. Congress has required the FCC to set limits on the number of channels that a cable operator can program with programming services we control, and a national limit on the number of subscribers we can serve. In 2001, a federal appellate court held unconstitutional the FCC’s rules establishing a 40% limit on the number of channels of one of our cable television systems that can be occupied by programming services in which we have an attributable interest and a national limit of 30% on the number of multichannel video households that we can serve. The FCC is reviewing its ownership rules in light of that decision.
Set Top Boxes. The FCC requires cable operators to separate security from non-security functions in digital set-top boxes in order to permit the manufacture and sale of these devices by third parties. By July 2007, cable operators themselves must cease providing new digital set-top boxes that integrate security functions with the other capabilities provided by these boxes. The FCC also requires cable operators to allow consumers to connect televisions and other consumer electronics equipment with a slot for a cable security card directly to digital cable systems to enable receipt of one-way digital programming without need for a set-top box. The FCC has granted our request for a limited waiver of the integration ban for our set-top boxes, which rely on a different type of security card for separated security, and has temporarily grandfathered the use of our separate security solution until July 1, 2009.
Network Blackout/Nonduplication. FCC rules require that we black out certain network and sports programming on imported distant broadcast television signals upon request. The FCC also requires that we delete syndicated programming carried on distant signals upon the request of any local television/broadcast station holding the exclusive right to broadcast the same program within our local television market.
PEG and Leased Access. Localities may require free access to public, educational or governmental channels on our systems. We must make a limited number of commercial leased access channels available to third parties (including parties with potentially competitive video services) at regulated rates.
Tiering/A La Carte. Federal law requires us to establish a “basic service” package consisting, at a minimum, of all local broadcast signals that we carry, as well as, if the locality requests, all public, educational and governmental access programming carried by our systems. All subscribers are required to purchase this tier as a condition of gaining access to any other programming that a cable operator provides. We are also required to carry leased access programming on the most widely purchased tier.
Federal law does not otherwise dictate the number or nature of programming services carried by a cable operator on each service tier.
Pole Attachments. The FCC has authority to regulate utility company rates for cable rental of pole and conduit space unless states establish preemptive regulations in this area. The states in which our cable television systems operate have adopted such regulations. Utilities must provide cable television systems and telecommunications carriers with nondiscriminatory access to any pole, conduit or rights-of-way controlled by the utility.
The FCC has adopted regulations to govern the charges for pole attachments used by companies providing telecommunications services, including cable operators, and for attachments used by cable operators to provide Internet access services. The states in which we operate have, to date, adopted the FCC regulations, with minor exceptions, although they remain free to adopt other pole attachment rules.
Telemarketing. The FCC and the Federal Trade Commission have adopted rules limiting the telemarketing practices of cable operators.
Privacy. Our collection and disclosure of subscribers’ personal information is subject to a variety of Federal and state privacy requirements, including those imposed specifically on cable operators by the Communications Act.
Other FCC Regulation. The FCC regulates us in such areas as technical standards, and emergency alerts. We also are prohibited by the Communications Act from transmitting obscene programming over our cable systems. The FCC is also tasked by Congress to promote compatibility between cable television systems and other consumer electronic equipment. The FCC is currently reviewing proposed standards for compatibility of digital equipment.
The FCC also imposes restrictions on our origination cablecasting channels and imposes rules governing political broadcasts; ownership and control of cable home wiring in single family residences and multiple dwelling units; closed captioning on networks we carry; and limitations on advertising contained in children’s programming that we carry.
The FCC requires us to pay annual “regulatory fees” for its services that we may pass on to subscribers. Other fees are assessed for the FCC licenses we hold for business radio, cable television relay systems and earth stations. These fees may not be collected from our subscribers.
Federal Copyright Regulation. We are required to pay copyright royalty fees to receive a statutory compulsory license to carry broadcast television signals. The U.S. Copyright Office has increased our royalty fees from time to time and has, at times, recommended to Congress changes in the statutory compulsory licenses for cable television carriage of broadcast signals. Such changes, if made, could adversely affect the ability of our cable television systems to obtain such programming, and could increase the cost of such programming.
High-Speed Internet
In March 2002, the FCC determined that broadband Internet access services like Optimum Online should be classified as “information services” for regulatory purposes, and the Supreme Court upheld that determination. The FCC has traditionally subjected information services to a lesser degree of regulation than “telecommunications services,” which are offered to the public for a fee on a common carrier basis. The FCC has asked whether it should nonetheless require cable operators to provide transmission capacity to unaffiliated Internet service providers. The outcome of the FCC’s proceeding could affect the regulatory obligations imposed on Optimum Online, and the extent to which states and local authorities may regulate it or assess fees upon revenues generated by it. The FCC has adopted principles, but not
rules, that similarly state that consumers are entitled to access all lawful Internet content using their broadband connections.
Currently, the Communications Act’s limitations on our collection and disclosure of cable subscribers’ personal information also apply with respect to broadband Internet access service provided by cable operators. Broadband Internet access service is also subject to other federal and state privacy laws applicable to electronic communications. Additionally, the FCC has ruled that providers of broadband Internet access services like Optimum Online must comply with the FCC’s regulations implementing the Communications Assistance for Law Enforcement Act (“CALEA”), which requires providers to make their services and facilities accessible for law enforcement intercept requests. The compliance deadline for these providers is May 14, 2007. Various other federal and state laws apply to providers of services that are accessible through Optimum Online, including copyright laws, prohibitions on obscenity, and a ban on unsolicited commercial e-mail. Online content provided by Cablevision is also subject to these laws.
VoIP
The FCC, Congress, and several state commissions are examining issues surrounding the provision of VoIP services like Optimum Voice. In February 2004, the FCC initiated a generic rulemaking proceeding concerning the legal and regulatory implications of IP-based services, including VoIP services. In November 2004, the FCC determined that VoIP services with certain characteristics, including cable-provided VoIP services, are interstate services subject to federal rather than state jurisdiction. The FCC’s determination has been appealed to a federal court of appeals. Although the FCC has not concluded its generic rulemaking proceeding, it has applied some regulations to VoIP service providers like Optimum Voice that have certain characteristics (these services are known as “interconnected VoIP services”). There are several other proceedings pending in which the FCC is reviewing the application of additional regulations to VoIP services. The outcome of the FCC’s generic proceeding or other pending proceedings could affect the regulatory obligations imposed on Optimum Voice.
Emergency 911 Services. In June 2005, the FCC determined that interconnected VoIP services are required to provide enhanced 911 emergency services to their customers and must obtain affirmative acknowledgements that their customers understand the potential limitations of emergency 911 services offered in connection with interconnected VoIP services. The FCC ruled that interconnected VoIP service providers were not permitted to further market their services unless they could provide 911 services and obtain all necessary acknowledgements from existing and new customers.
CALEA. In May 2006, the FCC determined that interconnected VoIP service providers must comply with CALEA. Interconnected VoIP service providers like Optimum Voice are required to be compliant by May 14, 2007.
Universal Service. The FCC decided in June 2006 that interconnected VoIP services such as Optimum Voice should be required to contribute to the universal service fund on an interim basis. The amount of universal service contribution for interconnected VoIP service providers is based on a percentage of revenues earned from end user interstate services. The FCC developed three alternatives under which an interconnected VoIP service provider may elect to calculate its universal service contribution: (1) an interim safe harbor that assumes 64.9% of the provider’s end user revenues are interstate; (2) a traffic study, which has been pre-approved by the FCC, to determine an allocation for interstate end user revenues; or (3) actual interstate and international end user revenues. If an interconnected VoIP service provider calculates its universal service contributions based on its actual percentage of interstate calls, the interstate classification of the service might no longer apply, in which case the interconnected VoIP service provider could be subject to regulation by each state in which it operates as well as federal regulation.
Other Services
Cablevision provides other services and features over its cable system, such as games and interactive advertising, that may be subject to a range of federal, state, and local laws such as privacy and consumer protection regulations. Cablevision also maintains various websites that provide information and content regarding its businesses and offer merchandise for sale. The operation of these websites is also subject to a similar range of requirements.
Telecommunications Services
The Telecommunications Act of 1996 was enacted to remove barriers to entry in the local telephone market that continues to be monopolized by the Bell Operating Companies (“BOCs”) and other ILECs by preempting state and local laws that restrict competition and by requiring ILECs to provide competitors, such as cable operators and long distance companies, with nondiscriminatory access and interconnection to the BOC and ILEC networks and access to certain portions of their communications networks (known as network elements) at cost-based rates. The 1996 Telecommunications Act entitles our Lightpath subsidiary to certain rights, but as a telecommunications carrier, it also subjects Lightpath to regulation by the FCC and the states. Lightpath’s designation as a telecommunications carrier also results in other regulations that may affect Lightpath and the services it offers.
Interconnection and Intercarrier Compensation. The 1996 Telecommunications Act requires Lightpath to interconnect directly or indirectly with other telecommunications carriers. In some cases, interconnecting carriers must compensate each other for the transport and termination of calls on their network (i.e., intercarrier compensation). Accordingly, Lightpath is entitled, in some cases, to compensation from carriers when it terminates their originating calls on its network and in other cases is required to compensate another carrier for utilizing that carrier’s network to terminate traffic. The FCC has adopted limits on the amounts of compensation that may be charged for certain types of traffic.
Universal Service. Lightpath is required to contribute to federal and state universal service funds. Currently, the FCC assesses Lightpath for payments and other subsidies on the basis of a percentage of interstate revenue it receives from certain customers. The FCC has placed limits on the mark-up carriers may place on the universal service line items on their customer bills. States may also assess such payments and subsidies for state universal service programs.
Other Federal Regulation. Lightpath is also subject to other FCC requirements in connection with the interstate long distance services it provides, including the payment of fees to fund the Telecommunication Relay Services fund, local number portability administration, the North American Numbering Plan, and the payment of regulatory fees to support the FCC.
CPNI and Marketing Restrictions. Lightpath is required to comply with the FCC’s rules restricting use of customer proprietary network information (“CPNI”), which includes obtaining permission in certain cases prior to utilizing a customer’s information to market service. Lightpath’s communications with its customers are subject to FCC, Federal Trade Commission, and state regulations on telemarketing, the sending of commercial e-mail messages, and the sending of commercial fax messages.
State Regulation. Lightpath is also subject to regulation by the state commissions in each state in which it provides service. In order to provide service, Lightpath must seek approval from each such state commission and may at times require local approval to construct facilities. Lightpath is currently authorized and provides service in New York, Connecticut, and New Jersey. Lightpath’s regulatory obligations vary from state to state and include some or all of the following requirements: filing tariffs (rates, terms and conditions); filing operational, financial, and customer service reports; seeking approval to transfer the assets or capital stock of the telephone company; seeking approval to issue stocks, bonds, and other forms of indebtedness of the telephone company; reporting customer service and quality of
service requirements; making contributions to state universal service support programs; geographic build-out; and other matters relating to competition.
Programming and Entertainment
Cable television programming networks, such as those owned by Rainbow Media Holdings, are regulated by the FCC in certain respects if they are affiliated with a cable television system operator like Cablevision. Other FCC regulations, although imposed on cable television operators and satellite operators, affect programming networks indirectly.
Closed Captioning and Advertising Restrictions on Children’s Programming. Certain of Rainbow Media Holdings’ networks must provide closed-captioning of programming for the hearing impaired, and its programming and Internet websites intended primarily for children 12 years of age and under must comply with certain limits on advertising.
Indecency and Obscenity Restrictions. Cable operators and other distributors are prohibited from transmitting obscene programming, and our affiliation agreements generally require us to refrain from including such programming on our networks.
Program Access. The “program access” provisions of the Federal Cable Act generally require us to make Rainbow Media Holdings’ satellite-delivered video programming available to competing multichannel video programming providers, such as DBS providers and telephone companies on nondiscriminatory prices, terms and conditions, subject to certain exceptions specified in the statute and the FCC’s rules. Rainbow Media Holdings cannot have exclusive contracts with cable operators for these services. The program-access rules do not generally cover terrestrially-delivered programming created by cable-system affiliated programmers such as Rainbow Media Holdings.
Effect of “Must-Carry” Requirements. The FCC’s implementation of the statutory “must-carry” obligations requires cable and DBS operators to give broadcasters preferential access to channel space. This reduces the amount of channel space that is available for carriage of Rainbow Media Holdings’ networks by cable television systems and DBS operators.
Satellite Carriage. All satellite carriers must under federal law offer their service to deliver Rainbow Media Holdings and its competitor programming networks on a nondiscriminatory basis (including by means of a lottery). A satellite carrier cannot unreasonably discriminate against any customer in its charges or conditions of carriage. Numerous competing satellite services today provide transponders that Rainbow Media Holdings could use to deliver its programming networks.
MVDDS
An indirect subsidiary of Rainbow Media Holdings owns a 90% interest in an entity that holds MVDDS licenses in 45 metropolitan areas including New York, Miami, Los Angeles, and Cleveland. These licenses are for a 10 year term, with a renewal expectancy based on a showing of “substantial service” within each of these market areas at the end of 5 and 10 years into the license period. The FCC’s rules prohibit the Company from holding more than a 20% interest in the MVDDS license in the New York market because of common ownership with the Company’s cable systems there. Absent a waiver of this restriction by the FCC, the Company would need to divest all or a sufficient portion of its investment in the New York City MVDDS license to comply with the restriction. On October 18, 2006, the FCC granted a one-year extension, until October 18, 2007, for the Company to come into compliance with the FCC’s ownership restrictions. We cannot provide any assurance that the FCC would grant a further waiver necessary for the Company to retain its interest in the New York license.
Employees and Labor Relations
As of December 31, 2006, we had 13,938 full-time, 2,280 part-time and 5,857 temporary employees of which 508, 1,214 and 3,476, respectively, were covered under collective bargaining agreements. We believe that our relations with employees are satisfactory.
Our Internet address is www.cablevision.com and the investor relations section of our web site is located at http://www.cablevision.com/index.jhtml?pageType=investor. We make available free of charge, on or through the investor relations section of our web site, annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as well as proxy statements, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the U.S. Securities and Exchange Commission.
Item 1A.
Item 1A. Risk Factors
Government investigations and litigation relating to stock option matters are pending, the scope and outcome of which could have a negative impact on the price of our securities and our business.
On August 8, 2006 the Company disclosed that, based on a voluntary review of past practices in connection with grants of stock options and stock appreciation rights (“SARs”), we had determined that the grant date and exercise price assigned to a number of our stock option and SAR grants during the 1997-2002 period did not correspond to the actual grant date and the closing price of our common stock on the actual grant date. In such cases, the date assigned to the grant corresponded to the date of a unanimous written consent executed by the members of the compensation committee of the Company’s Board of Directors, but the date of that consent did not correspond to the actual date of the grant. In nearly all such cases, the stock price on the assigned date was lower, sometimes substantially lower, than the price on the date the award was actually granted. At all relevant times, the Company’s stock plan required that the exercise price of options be not less than the fair market value per share of the Company’s common stock on the date of grant. In addition, two awards of options and one option modification were also incorrectly accounted for as having been granted to employees or modified for employees. One of these two awards was to the Company’s former compensation consultant (which was subsequently cancelled in 2003) and the other award related to an executive officer whose death occurred after the stated grant date of the award and before the actual grant date. As a result, the Company restated its consolidated financial statements for 1997 through March 31, 2006 as reported in its amended 2005 Form 10-K and its amended March 31, 2006 Form 10-Q filed with the SEC on September 21, 2006. In addition, the Company notified the Internal Revenue Service of the stock option review and provided the IRS an adjustment to reduce the Company’s net operating loss carry forward by $86.2 million for all tax years through December 31, 2004 and in connection with the Company’s filing of its 2005 tax return, the net operating loss was further reduced by $2.2 million. We have advised the SEC and the U.S. Attorney’s Office for the Eastern District of New York of these matters and each has commenced an investigation. We received a grand jury subpoena from the U.S. Attorney’s Office for the Eastern District of New York seeking documents related to the stock options issues. We received a document request from the SEC relating to its informal investigation into these matters. We are cooperating fully with such investigations and intend to continue to do so. In addition, purported derivative lawsuits (including one purported combined derivative and class action lawsuit) relating to our past stock option and SAR grants have been filed. On October 27, 2006, the Board of Directors established a special litigation committee of the Board, consisting of two newly appointed directors. The special litigation committee was given responsibility to review and analyze the facts and circumstances surrounding claims that have been raised in the options litigation in which the Company has been named as a nominal defendant, and which purport to have been brought derivatively on behalf of the Company. The special litigation committee has full and sole authority to consider and determine whether or not prosecution of such claims is in the best interests of the Company and its shareholders, and what actions the Company should take with respect to the cases. We are unable to predict the outcome of these government investigations and lawsuits but such matters will result in substantial legal and other defense costs, have occupied and will continue to occupy the time and attention of our management team and could have a material adverse impact on us and our stock price, including increased stock price volatility, and could negatively impact our business and our ability to raise additional funds in the future.
We have substantial indebtedness and we are highly leveraged, which reduces our capability to withstand adverse developments or business conditions.
We have incurred substantial amounts of indebtedness to finance operations, to upgrade our cable plant and acquire other cable television systems, programming networks, sources of programming and other businesses. We also have incurred indebtedness in order to offer our new services to our current and potential customers. We have also incurred substantial debt to pursue activities outside our core businesses such as our acquisitions of the Wiz, Clearview Cinemas and our development of Rainbow DBS. In 2006, CSC Holdings incurred $3.5 billion of debt, approximately $3.0 billion of which was distributed to Cablevision to fund a $10 per share dividend on its common stock and approximately $414 million of which was used to repay existing indebtedness, including interest, fees and expenses. We may continue to incur substantial amounts of debt in the future. At December 31, 2006, our total indebtedness aggregated approximately $12.5 billion. Because of our substantial indebtedness, we are highly leveraged and we will continue to be highly leveraged. This means that our payments on our borrowings are significant in relation to our revenues and cash flow. This leverage exposes us to significant risk in the event of downturns in our businesses (whether through competitive pressures or otherwise), in our industries or in the economy generally, because although our cash flows would decrease in this scenario, our required payments in respect of indebtedness will not.
Our financial statements reflect substantial losses from continuing operations and a significant stockholders’ deficiency, and we expect that our net losses, absent one-time gains, may continue and remain substantial for the foreseeable future, which may reduce our ability to raise needed capital.
We reported losses from continuing operations of $133.0 million, $127.5 million and $486.0 million for the years ended December 31, 2006, 2005 and 2004, respectively. Our losses from continuing operations primarily reflect our high interest expense, our preferred stock dividends (through May 2004) and depreciation and amortization charges, which may continue to be significant. Our continuing losses may limit our ability to raise needed financing, or to do so on favorable terms, as those losses are taken into account by the organizations that issue investment ratings on our indebtedness.
A lowering or withdrawal of the ratings assigned to our debt securities by ratings agencies may further increase our future borrowing costs and reduce our access to capital.
Our debt ratings are below the “investment grade” category, which results in higher borrowing costs as well as a reduced pool of potential purchasers of our debt as some investors will not purchase debt securities that are not rated in an investment grade rating category. In addition, there can be no assurance that any rating assigned will remain for any given period of time or that a rating will not be lowered or withdrawn entirely by a rating agency, if in that rating agency’s judgment, future circumstances relating to the basis of the rating, such as adverse changes, so warrant. A lowering or withdrawal of a rating may further increase our future borrowing costs and reduce our access to capital. All of Cablevision’s, CSC Holdings’ and RNS’ ratings were placed on creditwatch with negative implications and review for downgrade by both Standard & Poor’s and Moody’s twice during 2006 as a result of the stock option review and subsequent non-compliance with the financial reporting and other information delivery requirements under the Company’s debt instruments and also following the announcement of the Dolan Family Group proposal. While neither occurrence resulted in any downgrades to our ratings and we are no longer on creditwatch, there can be no assurance that this will not occur again.
Our financial performance may be harmed by the significant and credible risks of competition in our cable television, high-speed data and voice businesses.
Competition in our various business segments could adversely affect our business and financial results and our ability to service our debt. Our cable systems compete with a variety of video programming distribution systems, including broadcast television stations, direct broadcast satellite systems, incumbent telephone companies, multichannel multipoint distribution services, satellite master antenna television
systems, private home dish earth stations, and OVS operators like RCN. We face intense competition from incumbent telephone companies such as Verizon and AT&T, which have recently begun to offer video programming in addition to their voice and high-speed Internet access services, evidencing their commitment to compete across all of the Company’s telecommunications products. Their competitive position has been improved by recent operational, regulatory and legislative advances that they have made. Verizon and AT&T are constructing fiber-based systems designed to provide video programming as well as voice and data services to residential customers in our service area. The attractive demographics of the Company’s service territory make this region a desirable location for investment in video distribution technologies by these companies. This intense competition could lead to pressure upon our pricing of telecommunications services, our ability to add or retain customers and our ability to expand services purchased by our customers. Cable systems also compete with the entities that make videotaped movies and programs available for home rental or sale. Actual or potential video competition to cable systems is also possible from the delivery of video programming over the Internet directly to subscribers, and wireless technologies, including LMDS and MVDDS.
Our high-speed data offering to consumers faces intense competition from other providers of high-speed Internet access including services offered by local telephone providers such as Verizon and AT&T. These lines may also be used to offer video programming in competition with our cable systems. In addition, DBS providers have tested the use of certain spectrum to offer satellite-based high-speed data services and are offering broadband data services via partnerships and marketing arrangements with other providers such as Verizon, AT&T and Earthlink. The FCC has allocated spectrum for use by licensed and unlicensed providers of wireless broadband service, including LMDS, MVDDS, and WiMax, which, if offered within Cablevision’s service area, could compete with our high-speed data offering.
Our voice service offerings to consumers face intense competition from other providers of voice services, including local exchange carriers such as Verizon and AT&T and other competitive providers of voice services, as well as VoIP providers like Vonage.
Our ability to meet our obligations under our indebtedness may be restricted by limitations on our subsidiaries’ ability to send us funds.
Our principal subsidiaries include various entities that own cable television systems or own interests in programming networks. Our ability to pay interest on and repay principal of our outstanding indebtedness is dependent primarily upon the operations of our subsidiaries and the distributions or other payments of the cash they generate to us in the form of dividends, loans or advances. Our subsidiaries are separate and distinct legal entities and have no obligation, contingent or otherwise, to pay any amounts due on our public indebtedness or to make any funds available to us to do so. RNS is a party to a credit agreement and indentures that contain various financial and operating covenants that restrict the payment of dividends or other distributions. In addition, our subsidiaries’ creditors, including trade creditors, in the event of a liquidation or reorganization of any subsidiary, would be entitled to a claim on the assets of such subsidiaries, including any assets transferred to those subsidiaries, prior to any of our claims as a stockholder. Creditors of our subsidiaries are likely to be paid in full before any distribution is made to us. To the extent that we are a creditor of a subsidiary, our claims would be subordinated to any security interest in the assets of that subsidiary and/or any indebtedness of that subsidiary senior to that held by us.
Our ability to incur debt and the use of our funds are limited by significant restrictive covenants in financing agreements.
Our credit facilities and debt instruments contain various financial and operating covenants that, among other things, require the maintenance of financial ratios and restrict the relevant borrower’s ability to incur debt from other sources and to use funds for various purposes, including investments in some subsidiaries. Violation of these covenants could result in a default that would permit the parties who have lent money under such credit facilities and such other debt instruments to:
· restrict the ability to borrow undrawn funds under such credit facilities, and
· require the immediate repayment of the borrowings thereunder.
These events would be likely to have a material adverse effect on the value of our debt and equity securities.
We will need to raise significant amounts of funding over the next several years to fund capital expenditures, repay existing obligations and meet other obligations and the failure to do so successfully could adversely affect our business.
Our business is very capital intensive. Operating and maintaining our cable television plant requires significant amounts of cash payments to third parties. Capital expenditures for our businesses were $886.3 million $769.3 million, and $697.5 million in 2006, 2005 and 2004, respectively, and primarily include payments for consumer premises equipment, such as new digital video cable boxes and modems, as well as infrastructure and maintenance expenditures on our cable and Lightpath telecommunications network, in addition to the capital requirements of our other businesses. We expect these capital expenditures to continue to be significant over the next several years, as we continue to market our video, high-speed data and voice services to our customers. Some of our subsidiaries have substantial future capital commitments in the form of long-term contracts that require substantial payments over a long period of time. For example, rights agreements with sports teams under which their games are carried on the networks of certain of our programming subsidiaries almost always involve multi-year contracts that are difficult and expensive to terminate. In addition, if we fail to spend the requisite amounts under our affiliation agreement with EchoStar, up to a maximum of $500 million during the 2005-2010 period in our VOOM HD Networks programming business, EchoStar may terminate the affiliation agreement. We also face the need to renovate our Madison Square Garden Arena in the next several years or pursue a relocation alternative either of which would require significant funding. We will not be able to generate sufficient cash internally to both meet these obligations and repay our indebtedness at maturity. In that regard, we also have maturing debt obligations (excluding collateralized indebtedness) of approximately $3.0 billion over the 2007-2009 period. Accordingly, we will have to do one or more of the following:
· refinance existing obligations to extend maturities,
· raise additional capital, through debt or equity issuances or both,
· cancel or scale back current and future spending programs, or
· sell assets or interests in one or more of our businesses.
However, you should not assume that we will be able to refinance existing obligations or raise any required additional capital or to do so on favorable terms. If we are unable to pursue our current and future spending programs, we may be forced to cancel or scale back those programs. Our choice of which spending programs to cancel or reduce may be limited. Failure to successfully pursue our capital expenditure and other spending plans could materially and adversely affect our ability to compete effectively.
Government investigations relating to improper expense recognition and the timing of recognition of launch support, marketing and other payments under affiliation agreements are pending, the scope and outcome of which could have a negative impact on the price of our securities and our business.
In June 2003, we reported that we had discovered certain improper expense accruals primarily at the national programming services of our Rainbow segment. Following that announcement, investigations were commenced by the SEC and the U.S. Attorney’s Office for the Eastern District of New York. In addition, in July 2004, in connection with our response to comments of the staff of the Division of Corporation Finance of the SEC with respect to our filings under the Securities Exchange Act of 1934, we
provided the SEC with information with respect to certain of our previous restatements/adjustments relating to the timing of recognition of launch support, marketing and other payments under affiliation agreements. The SEC is continuing to investigate the improper expense recognition matter and the timing of recognition of launch support, marketing and other payments under affiliation agreements. The matter has occupied and will continue to occupy the time and attention of our management team. We are cooperating fully and intend to continue to do so. Any adverse developments in connection with this matter, including a determination that we have acted improperly, could have a material adverse effect on our stock price, including increased stock price volatility and could negatively impact our business and our ability to raise additional funds in the future.
Programming costs of our cable television systems are increasing and we may not have the ability to pass these increases on to our subscribers.
Programming costs paid by our cable television systems are one of our largest categories of expenses. These costs have increased rapidly and are expected to continue to increase, particularly with respect to costs for sports programming. We may not be able to pass programming cost increases on to our subscribers due to the increasingly competitive environment. If we are unable to pass these increased programming costs on to our subscribers, our operating results would be adversely affected.
We face intense competition in obtaining content for our programming businesses.
Rainbow Media Holdings’ programming businesses compete with other programming networks to secure desired programming. Most of Rainbow Media Holdings’ programming is obtained through agreements with other parties that have produced or own the rights to such programming. Competition for and choices of programming will increase as the number of programming networks increases. Other programming networks that are affiliated with programming sources such as movie or television studios, film libraries or sports teams may have a competitive advantage over Rainbow Media Holdings in this area.
The success of our programming businesses depends upon the availability of programming that is adequate in quantity and quality, and our ability to obtain carriage of our programming.
Rainbow Media Holdings’ programming networks compete in two highly competitive markets. First, our programming networks compete with other programming networks to obtain distribution on cable television systems and other multichannel video programming distribution services. Second, the success of our programming businesses depends upon the availability of programming that is adequate in quantity and quality. In particular, the national entertainment networks depend upon the availability of films, television programming and music in their niche markets and the regional sports networks depend upon the availability of local sports programming, especially professional sports programming.
The national entertainment networks are parties to film rights agreements giving the networks the right to carry certain films during certain window periods. The regional sports networks are parties to sports rights agreements giving the networks the right to carry all or a portion of the games of local professional sports teams. These rights agreements expire at varying times, may be terminated by the other party if we are not in compliance with the terms of the agreement and, in the case of all sports rights agreements, are subject to league rules and regulations. In addition, our programming businesses are parties to affiliation agreements with distributors that require those programming businesses to deliver programming that meets certain standards as to quantity, quality or content. For example, certain affiliation agreements require that our regional sports networks deliver a certain minimum number of local professional sports games. We would not be able to satisfy those requirements if we did not have the rights to carry the prerequisite number of games from the local professional sports teams. In 2005, we settled litigation with Time Warner, which attempted to terminate its affiliation agreement with AMC, based on the allegation that AMC had changed its programming. To the extent that we do not or are not able to satisfy the quantity, quality or content standards set forth in our affiliation agreements, distributors may have the
right to terminate those affiliation agreements. We cannot assure you that our programming businesses will ultimately be successful in negotiating renewals of their rights agreements or program supply agreements or in negotiating adequate substitute rights or program supply agreements in the event that their rights or program supply agreements expire or are terminated.
A significant amount of our book value consists of intangible assets that may not generate cash in the event of a voluntary or involuntary sale.
At December 31, 2006, we reported $9.8 billion of consolidated total assets, of which $2.5 billion were intangible. Intangible assets include franchises from city and county governments to operate cable television systems, affiliation agreements, and amounts representing the cost of some acquired assets and businesses in excess of their identifiable tangible and intangible assets. While we believe that the carrying value of our intangible assets are recoverable, you should not assume that we would receive any cash from the voluntary or involuntary sale of these intangible assets, particularly if we were not continuing as an operating business. We urge you to read carefully our consolidated financial statements contained herein, which provide more detailed information about these intangible assets.
We are controlled by the Dolan family. As a result of their control of us, the Dolan family has the ability to prevent or cause a change in control or approve, prevent or influence certain actions by us.
We have two classes of common stock:
· Class B common stock, which is generally entitled to ten votes per share and is entitled collectively to elect 75% of the Cablevision Board of Directors, and
· Class A common stock, which is entitled to one vote per share and is entitled collectively to elect the remaining 25% of the Cablevision Board of Directors.
As of February 22, 2007, the Dolan family, including trusts for the benefit of members of the Dolan family, collectively owned all of Cablevision’s Class B common stock, less than 3% of Cablevision’s Class A common stock and approximately 74% of the total voting power of all the outstanding Cablevision common stock. Of this amount, our Chairman, Charles F. Dolan, owned approximately 41% of Cablevision’s Class B common stock, less than 1% of Cablevision’s Class A common stock and approximately 30% of the total voting power of all the outstanding Cablevision common stock. The members of the Dolan family holding Class B common stock have executed a voting agreement that has the effect of causing the voting power of the Class B stockholders to be cast as a block with respect to the election of the directors elected by the Class B stockholders and any change of control transaction. The Dolan family is able to prevent a change in control of Cablevision and no person interested in acquiring Cablevision will be able to do so without obtaining the consent of the Dolan family. On June 19, 2005, Cablevision received a proposal from the Dolan Family Group to acquire the outstanding, publicly-held interests in Cablevision following a pro-rata distribution to all Cablevision stockholders of Rainbow Media Holdings. On October 24, 2005, Cablevision received a letter from the Dolan Family Group withdrawing the June 19, 2005 proposal. In that letter, the Dolan Family Group also recommended that Cablevision’s Board of Directors consider the declaration of a $3 billion one-time, special dividend payable pro rata to all shareholders. The dividend was paid on April 24, 2006 to holders of Cablevision NY Group Class A common stock and Cablevision NY Group Class B common stock. On October 8, 2006, Cablevision received a proposal from the Dolan family to acquire all of the outstanding publicly-held interests in Cablevision, and the proposal was revised by the Dolan family on January 12, 2007. The Special Transaction Committee of Cablevision’s Board of Directors rejected the revised proposal as inadequate on January 16, 2007. The revised proposal expired on January 17, 2007. This proposed transaction would have resulted in the incurrence by CSC Holdings of very substantial additional indebtedness. In both of their proposals, the Dolan family stated that they were only interested in pursuing their proposed transaction and would not sell their stake in Cablevision. There can be no
assurances that the Dolan family will not propose, undertake or consummate a similar transaction in the future.
As a result of the Dolan family’s ownership of all of the Class B common stock, the Dolan family has the power to elect all the directors of Cablevision subject to election by holders of Class B common stock. In addition, Dolan family members may control stockholder decisions on matters in which holders of all classes of Cablevision common stock vote together as a single class. These matters could include the amendment of some provisions of Cablevision’s certificate of incorporation and the approval of fundamental corporate transactions. In addition, the affirmative vote or consent of the holders of at least 66-2/3% of the outstanding shares of the Class B common stock, voting separately as a class, is required to approve the authorization or issuance of any additional shares of Class B common stock. Furthermore, the Dolan family members also have the power to prevent any amendment, alteration or repeal of any of the provisions of Cablevision’s certificate of incorporation that adversely affects the powers, preferences or rights of the Class B common stock.
One purpose of the voting agreement referred to above is to consolidate Dolan family control of Cablevision. The Dolan family requested Cablevision’s Board of Directors to exercise Cablevision’s right, as a “controlled company”, to opt-out of the New York Stock Exchange listing standards that, among other things, require listed companies to have a majority of independent directors on their board and to have an independent corporate governance and nominating committee. Cablevision’s Board of Directors and the directors elected by holders of Class A common stock each approved this request on March 8, 2004.
Our business is subject to extensive government regulation and changes in current or future laws or regulations could restrict our ability to operate our business as we currently do.
The FCC and state and local governments extensively regulate the basic rates we may charge our customers for certain of our video services. They also regulate us in other ways that affect the daily conduct of our video delivery and video programming businesses, our telephone business and, possibly in the future, our high-speed data services business. Our businesses are dependent upon FCC licenses to carry on their operations. Any action by the FCC, the states of New York, New Jersey or Connecticut, or concerted action by local regulators, the likelihood or extent of which we cannot predict, could have a material adverse financial effect on us.
Pending FCC, Congressional and judicial proceedings may affect our businesses.
Changes in Franchising Requirements. In 2006, Congress considered but did not enact legislation that, for the telephone companies and other wireline video competitors, would relax or eliminate some or all of the local franchising requirements applicable to existing cable operators. New Jersey enacted state franchise legislation in August 2006, but included a provision enabling existing operators to elect regulation under the new franchising scheme. Several other states, including New York and Connecticut, are considering or have considered similar legislation. In June 2006, the Connecticut Department of Public Utility Control issued a decision concluding that AT&T did not need to obtain a cable franchise or comply with other cable regulatory requirements before offering its video services throughout Connecticut. The cable industry is currently challenging this decision in court.
In December 2006, the FCC adopted an order imposing a 90-day deadline on local franchising authority consideration of franchise applications from new video entrants, such as local telephone companies, that have pre-existing authority to occupy public rights-of-way authority. The FCC also preempted local franchising laws, regulations and requirements regarding such matters as fees, the provision of “institutional networks,” and system deployment, as applied to new entrants. The FCC issued a Further Notice of Proposed Rulemaking seeking comment on whether these limitations should also apply with
respect to incumbent cable operators, but tentatively concluded that they should not be applied to incumbent operators until their existing franchises are renewed.
Access Obligations and “Net Neutrality.” Some parties have proposed federal, state and local requirements that would force cable systems to provide access to third-party Internet service providers in addition to services the cable system itself provides, such as our Optimum Online cable modem service. In 2002, the FCC asked whether it should nonetheless require cable operators to provide transmission capacity to unaffiliated Internet service providers. The outcome of the FCC’s proceeding could affect the regulatory obligations imposed on Optimum Online, and the extent to which states and local authorities may regulate it or assess fees upon revenues generated by it. Relatedly, some members of Congress have suggested that cable operators and other broadband service providers should be subject to a “net neutrality” requirement barring them from “interfering” with subscriber access to Internet content or from reaching agreement with certain content providers for preferential access. The FCC has adopted principles, but not rules, that state that consumers are entitled to access all lawful Internet content using their broadband connections. We cannot predict whether the pending bills will become law or whether the FCC will adopt binding rules embodying these principles.
Must-Carry/Retransmission Consent. We are required by federal law to carry all local broadcast stations (“must-carry”), or, at the option of a local broadcaster, to obtain the broadcaster’s prior consent for retransmission of its signal (“retransmission consent”). When a broadcaster completes its transition from analog to digital transmission in February 2009, only its primary digital video stream will be entitled to must-carry. The FCC has twice found that “dual must carry” rules (requiring cable systems to carry both the analog and digital broadcast signals) would be unconstitutional. The FCC has also ruled that broadcasters may not demand mandatory carriage for other than the primary digital video programming stream. The orders rejecting dual must carry and mandatory “multicasting” are currently subject to petitions for reconsideration pending for the FCC. We cannot predict how the FCC will rule on those petitions or whether Congress will enact legislation modifying the FCC’s orders.
In the wake of publicized disputes between several cable operators and broadcasters, several members of Congress have expressed concern that that current retransmission consent requirements and practices have had a negative effect on consumers, and stated that it is time for Congress to reexamine those requirements. Other members of Congress have suggested that binding arbitration may be an appropriate means of resolving such disputes. We cannot predict whether Congress will enact legislation to modify the retransmission consent scheme, or whether the FCC will modify its current rules governing this scheme.
Tiering/A La Carte. Some members of Congress have proposed requiring cable operators to offer programming services on an unbundled basis rather than as part of a tier or to provide a greater array of tiers to give subscribers the option of purchasing a more limited number of programming services. The FCC also has indicated an interest in requiring cable operators to offer programming services in this “a la carte” manner, and in February 2006 released a report finding “substantial benefits” in the a la carte model of delivering video programming. We cannot predict whether Congress or the FCC might adopt such a requirement, what form it would take, or the effect of such a requirement on our cable television business or Rainbow Media Holdings.
Program Access. The “program access” provisions of the Federal Cable Act barring providers of satellite-delivered cable-owned video programming from entering into exclusive distribution arrangements with cable operators are set to expire in October 2007. We cannot predict whether the ban on exclusive arrangements will be extended, or whether Congress will apply all or some of the program access requirements to terrestrially-delivered programming services, or what effect such an extension or other modifications might have on Rainbow Media Holdings or Cablevision.
Indecency and Obscenity Restrictions. Cable operators and broadcasters are prohibited from transmitting obscene programming, but only broadcasters currently are subject to restrictions on the
transmission of indecent material. They may not transmit indecent programming when there is a reasonable risk of children in the audience (6 a.m. to 10 p.m.). Some Members of Congress have proposed expanding the prohibitions on indecent programming to include cable and satellite programs, and to prohibit violent programming, notwithstanding the availability of program blocking devices provided by cable and DBS operators. Penalties for violations of this restriction can be severe. We cannot predict the likelihood that such restrictions on cable programming can or will be imposed or the effect such restrictions would have on our cable television and cable programming businesses. Some members of Congress and the Chairman of the Federal Communications Commission have suggested that indecency restrictions for cable might be unnecessary if cable operators were to offer a separate tier of “family” programming or to offer programming services for purchase on an individual, “a la carte”, basis. We cannot predict whether the FCC or Congress would mandate such a tier or offering, or the effect of either such requirement on our cable television and cable programming businesses.
Diversity Requirements. The FCC has announced that it may open a proceeding to examine whether the so-called “70/70 test” in the Federal Cable Act has been satisfied. Under this provision, when cable systems with 36 or more activated channels are available to 70 percent of households within the United States, and when 70 percent of those households subscribe to them, the FCC may promulgate any additional rules necessary to promote diversity of information sources. We cannot predict whether the FCC will impose any such requirements, the nature of any such requirements, or the effect of such on our cable television or cable programming businesses.
Ownership Limitations. Congress has required the FCC to set a national limit on the number of subscribers a cable company can serve, and a limit (the “channel occupancy” limit) on the number of channels that a cable operator can program on any given cable system with programming services controlled by that operator. In 2001, a federal appellate court invalidated the 30% national multichannel subscriber limit and the 40% channel occupancy limit that the FCC had imposed pursuant to this requirement. The FCC is reviewing the ownership rules in light of that decision. We cannot predict at this time how the FCC will rule on these matters.
Internet Access Service Consumer Protection. The FCC is reviewing whether it should develop consumer protection requirements for all providers of broadband Internet access services like Optimum Online. Congress also is considering proposals that would require all broadband Internet access service providers to comply with various rules, such as customer privacy, consumer service standards, and access for persons with disabilities. We cannot predict what, if any, additional regulations will be imposed on Optimum Online.
VoIP. Our rollout of Optimum Voice, a VoIP service that is offered via our cable modem service as an add-on to our Optimum Online service, could also be affected by additional FCC decisions regulating VoIP, state attempts to regulate VoIP, and Congressional action. We cannot predict what, if any, statutory or regulatory obligations will be imposed on VoIP services like Optimum Voice, including the application of various indirect taxes, and what, if any, role state and local authorities will have in regulating these services.
Universal Service. Lightpath and Optimum Voice are required to contribute to the federal universal service fund. Rather than use the current revenue-based approach, the FCC is considering assessing universal service contributions based on a flat-fee charge, such as a per-line or per-number charge. The FCC also is considering whether to apply universal service requirements to interconnected VoIP service providers on a permanent basis, and how contributions should be assessed in the future. States may also assess such payments and subsidies on Lightpath for state universal service programs, and some states are looking at whether VoIP services like Optimum Voice should be subject to state universal service contribution requirements. We cannot predict how the FCC and states may rule on these matters. Any changes to the assessment and recovery rules for universal service may affect Lightpath’s and Optimum Voice’s financial results.
Intercarrier Compensation. The FCC is currently reviewing whether to adopt a new regime to govern intercarrier compensation, including the adoption of unified compensation rates. In addition, proceedings have been initiated to determine what intercarrier compensation charges should apply to the termination of VoIP traffic. We cannot predict how the FCC might rule on these matters. Any changes to the current intercarrier compensation regime may affect Lightpath’s and Optimum Voice’s revenues.
CPNI. The FCC is considering revising its CPNI rules to place additional restrictions on storage and use of CPNI. The revised rules may also extend the CPNI rules to VoIP services like Optimum Voice. Lightpath and Optimum Voice (if applicable) will be expected to comply with any future changes in CPNI regulations.
Our current franchises are non-exclusive and our franchisors need not renew our franchises.
Our cable television systems are operated primarily under non-exclusive franchise agreements with state or municipal government franchising authorities, in some cases with the approval of state cable television authorities. Consequently, our business is dependent on our ability to obtain and renew our franchises. Although we have never lost a franchise as a result of a failure to obtain a renewal, our franchises are subject to non-renewal or termination under some circumstances. In some cases, franchises have not been renewed at expiration, and we operate under temporary authority from the state while negotiating renewal terms with the franchise authorities. As of December 31, 2006, one of our ten largest franchises is expired and we are currently operating in this area under temporary authority. Approximately 58,000 of the Company’s basic video customers are in this franchise area.
Item 1B.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties We own our headquarters building located in Bethpage, New York with approximately 558,000 square feet of space, and certain other real estate where our earth stations, headend equipment and microwave receiving antennae are located primarily in New York, New Jersey and Connecticut, aggregating approximately 662,000 square feet of space. Through Madison Square Garden, we also own the Madison Square Garden Arena (with a maximum capacity of approximately 21,000 seats) and theater complex (approximately 5,600 seats) in New York City comprising approximately 985,600 square feet and a training center in Greenburgh, New York with approximately 105,000 square feet of space. We generally own all assets (other than real property) related to our cable television operations, including our program production equipment, headend equipment (towers, antennae, electronic equipment and satellite earth stations), cable system plant (distribution equipment, amplifiers, subscriber drops and hardware), converters, test equipment, tools and maintenance equipment. We also generally own our service and other vehicles.
We lease real estate where certain of our business offices, earth stations, transponders, microwave towers, warehouses, headend equipment, hub sites, program production studios, access studios and microwave receiving antennae are located, aggregating approximately 2,024,000 square feet of space primarily in New York, New Jersey and Connecticut. We lease several business offices in Woodbury, New York with an aggregate of approximately 224,000 square feet of space and business offices in Jericho, New York with approximately 621,000 square feet of space. Of the amounts above, we currently sublease approximately 320,000 square feet of space to third party tenants and approximately 58,000 square feet of space is currently vacant. Other significant properties that are leased are in New York City and include approximately 145,000 square feet housing Madison Square Garden’s administrative offices, approximately 577,000 square feet comprising Radio City Music Hall (approximately 5,900 seats) and approximately 57,000 square feet comprising the Beacon Theater (approximately 2,900 seats).
Clearview Cinemas leases 42 theaters (21 in New Jersey, 18 in New York, two in Pennsylvania and one in Connecticut) with approximately 37,000 seats and owns an additional nine theaters (five in New York and four in New Jersey) with approximately 6,100 seats. In addition, Clearview Cinemas manages a 940 seat theater in New York for a third party.
We believe our properties are adequate for our use.
Item 3.
Item 3. Legal Proceedings Refer to Note 18 to Cablevision’s consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K for a discussion of our legal proceedings.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
PART II
Item 5.
Item 5. Market for the Registrants’ Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
The information called for by Item 201(d) of Regulation S-K under Item 5 is hereby incorporated by reference to Cablevision’s definitive proxy statement for its Annual Meeting of Shareholders anticipated to be held in May 2007 or if such definitive proxy statement is not filed with the Commission prior to April 30, 2007, to an amendment to this report on Form 10-K filed under cover of Form 10-K/A.
Cablevision NY Group Class A common stock is traded on the NYSE under the symbol “CVC.”
Price Range of Cablevision NY Group Class A Common Stock
The following tables set forth for the periods indicated the intra-day high and low sales prices per share of the Cablevision NY Group Class A common stock as reported on the NYSE:
As of February 22, 2007, there were 1,084 holders of record of Cablevision NY Group Class A common stock.
There is no public trading market for the Cablevision NY Group Class B common stock, par value $.01 per share. As of February 22, 2007, there were 25 holders of record of Cablevision NY Group Class B common stock.
All outstanding shares of common stock of CSC Holdings are held by Cablevision.
Dividends
On April 7, 2006, the Board of Directors of the Company declared a special cash dividend of $10.00 per share on each outstanding share of its Cablevision NY Group Class A common stock and Cablevision NY Group Class B common stock. The dividend was paid on April 24, 2006 to holders of record at the close of business on April 18, 2006. The dividend payment on all outstanding shares of Cablevision common stock and certain common stock equivalents amounted to approximately $2.8 billion. In addition, up to approximately $126.8 million representing $10.00 for each outstanding restricted share and each stock appreciation right and stock option vested as of December 31, 2004, would be payable when, and if, the restrictions lapse on each restricted share and when, and if, such stock appreciation rights and stock options are exercised.
CSC Holdings paid approximately $60.6 million of cash dividends on the Series H and M Preferred Stock in 2004.
Cablevision and CSC Holdings may pay dividends on their capital stock only from surplus as determined under Delaware law. If dividends are paid on the Cablevision NY Group common stock, holders of the Cablevision NY Group Class A common stock and Cablevision NY Group Class B common stock are entitled to receive dividends, and other distributions in cash, stock or property, equally on a per share basis, except that stock dividends with respect to Cablevision NY Group Class A common stock may be paid only with shares of Cablevision NY Group Class A common stock and stock dividends with respect to Cablevision NY Group Class B common stock may be paid only with shares of Cablevision NY Group Class B common stock. Cablevision’s and CSC Holdings’ senior debentures and CSC Holdings’ senior subordinated debt instruments restrict the amount of dividends and distributions in respect of any shares of capital stock that can be made.
Recent Sales and Use of Proceeds
None.
Cablevision NY Group Stock Performance Graph
The chart below compares the performance of the Company’s Cablevision NY Group Class A common stock with the performance of the Russell 3000 Index and a Peer Group Index by measuring the changes in Cablevision NY Group Class A common stock prices from December 31, 2001 through December 31, 2006. The chart has been adjusted for the distribution of the Rainbow Media Group Class A tracking stock on March 29, 2001 and subsequent exchange of the Rainbow Media Group Class A tracking stock for shares of Cablevision NY Group Class A common stock on August 20, 2002. As required by the SEC, the values shown assume the reinvestment of all dividends. Because no published index of comparable media companies currently reports values on a dividends-reinvested basis, the Company has created a Peer Group Index for purposes of this graph in accordance with the requirements of the SEC. The Peer Group Index is made up of companies that engage in cable television operations as a significant element of their business, although not all of the companies included in the Peer Group Index participate in all of the lines of business in which the Company is engaged and some of the companies included in the Peer Group Index also engage in lines of business in which the Company does not participate. Additionally, the market capitalizations of many of the companies included in the Peer Group are quite different from that of the Company. The common stocks of the following companies have been included in the Peer Group Index for 2006: Charter Communications, Inc., Comcast Corporation, Cox Communications, Inc. (through December 8, 2004 after which date Cox Communications was no longer a public company), Insight Communications Inc. (through December 16, 2005 after which date Insight Communications was no longer a public company) and Mediacom Communications Corporation. The chart assumes $100 was invested on December 31, 2001 in each of the Company’s Cablevision NY Group Class A common stock,
the Russell 3000 Index and in a Peer Group Index and reflects reinvestment of dividends on a quarterly basis and market capitalization weighting.
FIVE YEAR CUMULATIVE TOTAL STOCKHOLDER RETURN
FOR CABLEVISION NY GROUP,
RUSSELL 3000 INDEX AND PEER GROUP
Rainbow Media Group Stock Performance Graph
The chart below compares the performance of the Company’s Rainbow Media Group Class A tracking stock with the performance of the Russell 3000 Index and a Peer Group Index by measuring the changes in Rainbow Media Group Class A tracking stock prices for the period from March 30, 2001 (the date Rainbow Media Group Class A tracking stock commenced trading on the New York Stock Exchange) through August 20, 2002, (the date that Rainbow Media Group Class A tracking stock was exchanged for shares of Cablevision NY Group Class A common stock). The Peer Group Index is made up of companies that engage in cable programming operations as a significant element of their business, although not all of the companies included in the Peer Group Index participate in all of the lines of business in which the Company is engaged and some of the companies included in the Peer Group Index also engage in lines of business in which the Company does not participate. Additionally, the market capitalizations of many of the companies included in the Peer Group are quite different from that of the Company. The common stocks of the following companies have been included in the Peer Group Index: Viacom, Inc., Fox Entertainment Group, Inc., Liberty Media Corporation, The E.W. Scripps Company and The Walt Disney Company. The chart assumes $100 was invested on March 30, 2001 in each of the Company’s Rainbow Media Group Class A tracking stock, the Russell 3000 Index and the Peer Group Index and reflects reinvestment of dividends on a quarterly basis and market capitalization weighting.
2001-2002
CUMULATIVE TOTAL STOCKHOLDER RETURN
FOR RAINBOW MEDIA GROUP,
RUSSELL 3000 INDEX AND PEER GROUP
Item 6.
Item 6. Selected Financial Data
The operating and balance sheet data included in the following selected financial data have been derived from the consolidated financial statements of Cablevision and CSC Holdings. The selected financial data presented below should be read in conjunction with the audited consolidated financial statements of Cablevision and CSC Holdings and the notes thereto included in Item 8 of this Report.
(1) Basic video subscribers represent each customer account (set up and segregated by customer name and address), weighted equally and counted as one subscriber, regardless of size, revenue generated, or number of boxes, units, or outlets. In calculating the number of customers, the Company counts all customers other than inactive/disconnected customers. Free accounts are included in the customer counts along with all active accounts, but they are limited to a prescribed group such as current and retired Company employees, and free status is not granted to regular customers as a promotion. Such accounts are also not entirely free, as they typically generate revenue through pay-per-view or other services for which they must pay. The Company counts a bulk commercial customer, such as a hotel, as one customer, and does not count individual room units at that hotel. In counting bulk residential customers such as an apartment building, the Company counts each subscribing family unit within the building as one customer, but does not count the master account for the entire building as a customer.
(2) Number of customers who receive at least one of the Company’s services, including business modem only customers.
(3) Homes passed represent the estimated number of single residence homes, apartment and condominium units and commercial establishments passed by the cable distribution network in areas serviceable without further extending the transmission lines.
(4) Average monthly revenue per basic subscriber is calculated by dividing the GAAP revenues for the Telecommunications Services segment, less the revenue attributable to Lightpath for the fourth quarter of each year presented by the average monthly number of basic video subscribers served by the Company’s cable television systems for the same period. For purposes of this calculation, both revenue and average number of basic video subscribers exclude the Company’s Lightpath operations because Lightpath’s third-party revenues are unrelated to the Company’s cable television system subscribers.
(1) Basic video subscribers represent each customer account (set up and segregated by customer name and address), weighted equally and counted as one subscriber, regardless of size, revenue generated, or number of boxes, units, or outlets. In calculating the number of customers, the Company counts all customers other than inactive/disconnected customers. Free accounts are included in the customer counts along with all active accounts, but they are limited to a prescribed group such as current and retired Company employees, and free status is not granted to regular customers as a promotion. Such accounts are also not entirely free, as they typically generate revenue through pay-per-view or other services for which they must pay. The Company counts a bulk commercial customer, such as a hotel, as one customer, and does not count individual room units at that hotel. In counting bulk residential customers such as an apartment building, the Company counts each subscribing family unit within the building as one customer, but does not count the master account for the entire building as a customer.
(2) Number of customers who receive at least one of the company’s services, including business modem only customers.
(3) Homes passed represent the estimated number of single residence homes, apartment and condominium units and commercial establishments passed by the cable distribution network in areas serviceable without further extending the transmission lines.
(4) Average monthly revenue per basic subscriber is calculated by dividing the GAAP revenues for the Telecommunications Services segment, less the revenue attributable to Lightpath for the fourth quarter of each year presented by the average monthly number of basic video subscribers served by the Company’s cable television systems for the same period. For purposes of this calculation, both revenue and average number of basic video subscribers exclude the Company’s Lightpath operations because Lightpath’s third-party revenues are unrelated to the Company’s cable television system subscribers.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This Annual Report contains statements that constitute forward looking information within the meaning of the Private Securities Litigation Reform Act of 1995, including restructuring charges, availability under credit facilities, levels of capital expenditures, sources of funds and funding requirements, among others. Investors are cautioned that such forward looking statements are not guarantees of future performance or results and involve risks and uncertainties and that actual results or developments may differ materially from the forward looking statements as a result of various factors. Factors that may cause such differences to occur include, but are not limited to:
· the level of our revenues;
· competition from existing competitors (such as direct broadcast satellite providers) and new competitors (such as telephone companies and high-speed wireless providers) entering our franchise areas;
· demand for and growth of our digital video, high-speed data and voice services, which are impacted by competition from other services and the other factors discussed herein;
· the cost of programming and industry conditions;
· the regulatory environment in which we operate;
· developments in the government investigations and litigation related to past practices of the Company in connection with grants of stock options and stock appreciation rights (“SARs”);
· developments in the government investigations relating to improper expense recognition and the timing of recognition of launch support, marketing and other payments under affiliation agreements;
· the outcome of litigation and other proceedings, including the matters described under “Legal Matters” and “Other Matters” in the notes to our consolidated financial statements;
· general economic conditions in the areas in which we operate;
· demand for advertising inventory;
· our ability to obtain or produce content for our programming businesses;
· the level of our capital expenditures;
· the level of our expenses;
· future acquisitions and dispositions of assets;
· the demand for our programming among other cable television and DBS operators and telephone companies and our ability to maintain and renew affiliation agreements with cable television and DBS operators and telephone companies;
· market demand for new services;
· whether pending uncompleted transactions, if any, are completed on the terms and at the times set forth (if at all);
· other risks and uncertainties inherent in the cable television business, the programming and entertainment businesses and our other businesses;
· financial community and rating agency perceptions of our business, operations, financial condition and the industry in which we operate; and
· the factors described in our filings with the Securities and Exchange Commission, including under the sections entitled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained herein.
We disclaim any obligation to update or revise the forward looking statements contained herein, except as otherwise required by applicable federal securities laws.
CABLEVISION SYSTEMS CORPORATION All dollar amounts, except per subscriber, per unit and per share data, included in the following discussion under this Item 7 are presented in thousands.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Summary
Our future performance is dependent, to a large extent, on general economic conditions including capital market conditions, the impact of direct competition, our ability to manage our businesses effectively, and our relative strength and leverage in the marketplace, both with suppliers and customers.
Telecommunications Services
Our Telecommunications Services segment derives revenues principally through monthly charges to subscribers of our video, high-speed data and voice services. These monthly charges include fees for cable television programming, as well as, in many cases, equipment rental, pay-per-view and video-on-demand, high-speed data and voice services. Revenue increases are derived from rate increases, increases in the number of subscribers to these services, upgrades by video customers in the level of programming package to which they subscribe, and additional services sold to our existing subscribers. We also derive revenues from the sale of advertising time available on the programming carried on our cable television systems. Revenues from advertising vary based upon the number and demographics of our subscribers who view the programming carried on our cable television systems. Because 59% of our basic video customers are already subscribers to our high-speed data services, our ability to grow our high-speed data services may be limited. Programming costs are the most significant part of our operating expenses and are expected to increase as a result of digital subscriber growth, additional service offerings and contractual rate increases.
Our cable television video services, which accounted for 46% of our consolidated revenues for the year ended December 31, 2006, face competition from the direct broadcast satellite business and the delivery systems of incumbent telephone companies. There are two major providers of DBS service in the United States, each with significantly higher numbers of subscribers than we have. We compete with these DBS competitors by “bundling” our service offerings with products that the DBS companies cannot efficiently provide at this time, such as high-speed data service and voice service carried over the cable distribution plant, as well as by providing interactive and “on demand” services that are currently unavailable to a DBS subscriber, such as video-on-demand. As discussed in greater detail below, we face intense competition from incumbent telephone companies such as Verizon and AT&T, which have recently begun to offer video programming in addition to their voice and high-speed Internet access services, evidencing their commitment to compete across all of the Company’s telecommunications products. Their competitive position has been improved by recent operational, regulatory and legislative advances that they have made. Historically, we have made substantial investments in the development of new and innovative programming options for our customers as a way of differentiating ourselves from our competitors. We likely will continue to do so in order to be a more effective competitor.
Our high-speed data services business, which accounted for 15% of our consolidated revenues for the year ended December 31, 2006, faces competition from DSL providers, including Verizon and AT&T, and wireless Internet providers. These providers have become increasingly aggressive in their pricing strategies in recent years, and customers may decide that a reduced price is more important to them than the superior speed that cable modems provide. As discussed in greater detail below, another source of competition is incumbent telephone companies such as Verizon and AT&T. This competition, together with our already high penetration, is expected to slow our growth in cable modem penetration from the growth rates we have experienced in the past.
Our consumer voice offering, which accounted for approximately 6% of our consolidated revenues for the year ended December 31, 2006, is competitive with incumbent offerings primarily on the basis of pricing, where unlimited United States, Canada and Puerto Rico long distance, regional and local calling, together with certain features for which the incumbent providers charge extra, are offered at one low price. To the extent the incumbents, who have financial resources that exceed those of the Company, decide to meet our pricing and/or features or reduce their pricing, future growth and success of this business may be impaired. The regulatory framework for cable modem service and voice service is being developed and changes in how we are regulated, including increased regulation, may affect our competitive position.
The telephone companies continue constructing systems designed to provide video programming as well as voice and data services to residential customers in our service area. AT&T has announced plans to begin offering video services in our service area in Connecticut, where it is currently permitted to offer such service without any state authorization. Verizon has constructed fiber to the home network plant that passes a significant number of households in our service area, though currently less than a quarter of the households according to our estimates. Verizon has obtained authority to provide video service (it already has or needs no authority to provide phone and data services) for a majority of these homes passed, on a statewide basis in New Jersey and through numerous local franchises in New York. Verizon has so far not indicated any plans to offer video service in Connecticut. See “Item 1. Business-Regulation” for a discussion of regulatory and legislative issues and “Item 1A. “Risk Factors - Pending FCC, Congressional and judicial proceedings may affect our businesses.”
Optimum Lightpath, our commercial voice and commercial broadband business, which accounted for approximately 4% of our consolidated revenues for the year ended December 31, 2006, operates in the most competitive business telecommunications market in the country and competes against the very largest telecommunications companies - incumbent local exchange companies such as Verizon and AT&T, other competitive local exchange companies and long distance companies. To the extent that dominant market leaders decide to reduce their prices, future success of our Optimum Lightpath may be impaired. The trend in business communications has been shifting from a wired voice medium to a wireless, data medium. Should this trend accelerate dramatically, future growth of Optimum Lightpath may be negatively impacted.
Rainbow
In our Rainbow segment, which accounted for 15% of our consolidated revenues for the year ended December 31, 2006, we earn revenues in two principal ways. First, we receive affiliate fee payments principally from cable television systems and DBS operators. These revenues are generally on a per subscriber basis and earned under multi-year contracts with those operators referred to as affiliation agreements. The specific affiliate fees we earn vary from operator to operator and also vary among our networks but are generally based upon the number of each operator’s subscribers who receive our programming, referred to as “viewing subscribers.” The second principal source of revenues in this segment is from advertising. Under our agreements with cable television system and DBS operators, we have the right to sell a specific amount of national advertising time on our programming networks. Our advertising revenues are more variable than affiliate fees because most of our advertising is sold on a short-term basis, not under long-term contracts. Also, our advertising revenues vary based upon the popularity of our programming as measured by rating services.
We seek to grow our revenues in the Rainbow segment by increasing the number of distributors that carry our services and the number of viewing subscribers. We refer to this as our “penetration”. AMC, which is widely distributed, has less ability to increase its penetration than our newer, less penetrated services. Our revenues may also increase over time through contractual rate increases stipulated in certain of our affiliation agreements. In negotiating for increased or extended carriage, we may be subject to requests by distributors to make upfront payments in exchange for additional subscribers or extended carriage, which we record as
deferred carriage fees and which are amortized as a reduction to revenue over the period of the related subscriber guarantee, or to waive or accept lower subscriber fees if certain additional subscribers are provided. We also may help fund the distributors’ efforts to market our channels or we may permit distributors to offer limited promotional periods without payment of subscriber fees. As we continue our efforts to add subscribers, our subscriber revenue may be negatively affected by subscriber acquisition fees (deferred carriage), discounted subscriber fees and other payments; however, we believe that these transactions generate a positive return on investment over the contract period. We seek to increase our advertising revenues by increasing the number of minutes of national advertising and by increasing rates for such advertising, but, ultimately, the level of our advertising revenues is directly related to the overall distribution of our programming, penetration of our services, and the popularity (including within desirable demographic groups) of our services as measured by rating services.
The principal goals in this segment are to increase our affiliation fee revenues and our advertising revenues by increasing distribution and penetration of our national services. To do this we must continue to contract for and produce high-quality, attractive programming. Our greatest challenge arises from the increasing concentration of subscribers in the hands of a few cable television systems and DBS operators because of the disparate bargaining power between us and the largest cable television systems and DBS operators. This increased concentration could adversely affect our ability to increase the penetration of our services or even result in decreased penetration. In addition, this concentration gives those operators greater leverage in negotiating the price and other terms of affiliation agreements. Moreover, as a result of this concentration, the potential impact of a loss of any one of our major affiliates would have a significant impact on this segment.
Madison Square Garden
Madison Square Garden which accounted for 14% of our consolidated revenues for the year ended December 31, 2006, consists of professional sports teams (principally the New York Knicks of the National Basketball Association (“NBA”) and the New York Rangers of the National Hockey League (“NHL”), along with the Hartford Wolf Pack of the American Hockey League and the New York Liberty of the Women’s National Basketball Association), the MSG Networks sports programming business, and an entertainment business. It also operates the Madison Square Garden Arena, Radio City Music Hall, the Hartford Civic Center and Rentschler Field (sports and entertainment venues in Connecticut), and effective January 1, 2007, the Beacon Theater in New York City. Madison Square Garden faces competitive challenges unique to these activities. We derive revenues in this segment primarily from the MSG Networks (see below), the sale of tickets, including luxury box rentals, to sporting and entertainment events, from rental rights fees paid to this segment by promoters that present events at our entertainment venues and the sports teams’ share of league-wide distributions of national television rights fees and royalties. We also derive revenue from the sale of advertising at our owned and operated venues, from food, beverage and merchandise sales at these venues and from the licensing of our trademarks. MSG Networks derives its revenues from affiliate fees paid by cable television providers (including our cable television systems), satellite providers that provide video service and sales of advertising. This segment’s financial performance is related to the performance of all the teams presented and the attractiveness of its entertainment events.
Our sports teams’ financial success is dependent on their ability to generate advertising sales, paid attendance, luxury box rentals, and food, beverage and merchandise sales. To a large extent, the ability of the teams to build excitement among fans, and therefore produce higher revenue streams, depends on the teams’ winning performance, which generates regular season and playoff attendance and luxury box rentals, and which also supports increases in prices charged for tickets, luxury box rentals, and advertising placement. Each team’s success is dependent on its ability to acquire highly competitive personnel. The governing bodies of the NBA and the NHL have the power and authority to take certain actions that they deem to be in the best interest of their respective leagues, which may not necessarily be consistent with maximizing our professional sports teams’ results of operations.
MSG Networks sports programming business is affected by our ability to secure desired programming of professional sports teams, in addition to our proprietary programming. The continued carriage and success of the teams that are telecast by us will impact our revenues from distribution and from the rates charged for affiliation and advertising, as well as the ability to attract advertisers. In the second quarter of 2004, the New York Mets gave notice of termination of its broadcast rights agreement with MSG Networks. The termination of the rights agreement was effective after the end of the 2005 baseball season. Although the termination of the rights agreement had a negative impact on Madison Square Garden’s revenue, it did not have a significant impact on Madison Square Garden’s results of operations for the year ended December 31, 2006.
Madison Square Garden’s entertainment business is largely dependent on the continued success of our Radio City Christmas Spectacular and our touring Christmas shows, as well as the availability of, and our venues’ ability to attract concerts, family shows and events.
The dependence of this segment’s revenues on its sports teams and Christmas shows generally make it seasonal with a disproportionate share of its revenues and operating income being derived in the fourth quarter of each year.
Stock Option Related Matters
We incurred substantial expenses in 2006 for legal, accounting, tax and other professional services in connection with the Company’s voluntary review of past practices in connection with grants of stock options and SARs, the preparation of restated financial statements, stock option related litigation, and the investigations by the Securities and Exchange Commission (“SEC”) and the U.S. Attorney’s Office for the Eastern District of New York. We expect to continue to incur substantial expenses in connection with these matters. Refer to Note 18 of our consolidated financial statements.
Critical Accounting Policies
In preparing its financial statements, the Company is required to make certain estimates, judgments and assumptions that it believes are reasonable based upon the information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. The significant accounting policies which we believe are the most critical to aid in fully understanding and evaluating our reported financial results include the following:
Impairment of Long-Lived and Indefinite-Lived Assets:
The Company’s long-lived and indefinite lived assets at December 31, 2006 include excess costs over fair value of net assets acquired (“goodwill”) of approximately $1,032,117, approximately $1,510,034 of other intangible assets ($893,879 of which are indefinite-lived intangibles) and approximately $3,714,842 of property, plant and equipment. Such assets accounted for approximately 64% of the Company’s consolidated total assets.
In accordance with Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, the Company is required to determine goodwill impairment using a two-step process. The first step of the goodwill impairment test is used to identify potential impairment by comparing the fair value of a reporting unit with its carrying amount, including goodwill. If the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment test is performed to measure the amount of impairment loss, if any. The second step of the goodwill impairment test compares the implied fair value of the reporting unit’s goodwill with the carrying amount of that goodwill. If the carrying amount of the reporting unit’s goodwill exceeds the implied fair value of that goodwill, an impairment
loss is recognized in an amount equal to that excess. The implied fair value of goodwill is determined in the same manner as the amount of goodwill that would be recognized in a business combination.
The impairment test for other indefinite-lived intangible assets consists of a comparison of the fair value of the intangible asset with its carrying value. If the carrying value of the intangible asset exceeds its fair value, an impairment loss is recognized in an amount equal to that excess. For other long-lived assets, including intangibles that are amortized, the Company evaluates assets for recoverability when there is an indicator of potential impairment. If the undiscounted cash flows from a group of assets being evaluated is less than the carrying value of that group of assets, the fair value of the asset group is determined and the carrying value of the asset group is written down to fair value.
In assessing the recoverability of the Company’s goodwill and other long-lived assets, the Company must make assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. These estimates and assumptions could have a significant impact on whether an impairment charge is recognized and also the magnitude of any such charge. Estimates of fair value are primarily determined using discounted cash flows and comparable market transactions. These valuations are based on estimates and assumptions including projected future cash flows, discount rate, determination of appropriate market comparables and the determination of whether a premium or discount should be applied to comparables. For the Telecommunications Services segment, these valuations also include assumptions for average annual revenue per customer, number of homes passed, operating margin and market penetration as a percentage of homes passed, among other assumptions. For the Madison Square Garden and Rainbow segments, these valuations also include assumptions for projected average rates per basic and viewing subscribers, number of events (MSG segment only), access to sports programming and film rights and the cost of such programming and film rights, amount of programming time that is advertiser supported, number of advertising spots available and the sell through rates for those spots, average fee per advertising spot, and operating margins, among other assumptions. If these estimates or material related assumptions change in the future, we may be required to record additional impairment charges related to our long-lived assets.
In order to evaluate the sensitivity of the fair value calculations of the Company’s reporting units on the impairment calculation for indefinite-lived intangibles, the Company applied a hypothetical 10% decrease to the fair values of each reporting unit. This hypothetical decrease would have no impact on the impairment analysis for any of the Company’s reporting units.
Rights to feature film inventory acquired under license agreements along with the related obligations are recorded at the contract value when a license agreement is executed or the license period has begun, unless there is uncertainty with respect to either cost, acceptability or availability, then when the uncertainty is resolved. Costs are amortized to technical and operating expense on the straight-line basis over the respective license periods. We periodically review the programming usefulness of our feature film inventory based on a series of factors, including ratings, type and quality of program material, standards and practices, and fitness for exhibition based on the programming of the individual programming service. If we determine that substantially all of the films in a film license agreement have no future programming usefulness and will no longer be exploited, we would record a write-off for the portion of the unamortized cost of the film license agreement that was attributed to those films.
In 2004, the Company recorded impairment losses totaling $354,812 related to its decision to seek strategic alternatives for the Rainbow DBS segment of its operations. The Company recorded impairment charges of $90,540 included in depreciation and amortization expense relating to long-lived assets and other indefinite-lived intangible assets and $75,805 included in technical and operating expenses representing the write down of certain film and programming contracts relating to its VOOM HD Networks programming service. In addition, the Company recorded an impairment charge relating to the Rainbow DBS satellite distribution business of $155,415 reflecting the excess of the carrying value over the estimated fair value of long-lived assets and goodwill and other indefinite-lived intangible assets and a charge of approximately $33,052 representing the write off of equipment inventory and deposits which
have been recorded in discontinued operations. In addition to the Rainbow DBS segment impairment losses, we recorded impairment losses of approximately $1,640, $663 and $297 in the years ended December 31, 2006, 2005 and 2004, respectively, included in technical and operating expense, representing the impairment of certain film and programming contracts and $2,104 and $7,697 in 2006 and 2005, respectively, included in depreciation and amortization related to certain other long-lived assets and intangibles primarily within our theater operations and PVI Virtual Media business in 2006 and within our theater operations and Rainbow segment in 2005.
Useful Lives of Finite-Lived Intangible Assets:
The Company has recognized intangible assets for affiliation relationships, affiliation agreements, advertiser relationships, season ticket holder relationships and suite holder contracts and relationships as a result of the Regional Programming Partners restructuring transaction with News Corporation in April 2005. In addition, the Company has also recognized intangible assets for affiliation agreements and advertiser relationships as a result of the July 2003 repurchase of Metro-Goldwyn-Mayer, Inc.’s (“MGM”) 20% interest in each of American Movie Classics Company LLC, WE: Women’s Entertainment and The Independent Film Channel LLC and the repurchase of NBC’s interests in Rainbow Media Holdings in various transactions in 2001 and 2002. The Company has determined that such intangible assets have finite lives and has estimated those lives to be 4 to 11 years for affiliation agreements, 24 years for affiliation relationships, 7 to 10 years for advertiser relationships, 10 to 15 years for season ticket holder relationships and 3 to 11 years for suite holder contracts and relationships. At December 31, 2006, the carrying values, net of accumulated amortization, were $416,886 for affiliation agreements and affiliation relationships, $36,002 for broadcast rights and other agreements, $61,257 for advertiser relationships, $64,978 for season ticket holder relationships, $15,352 for suite holder contracts and relationships and $21,680 for other intangibles.
The amount we originally allocated in purchase accounting to the affiliation agreements and affiliation relationships finite-lived intangibles in our consolidated financial statements is the estimated aggregate fair value of those affiliation agreements, affiliation relationships and the related customer relationships. The useful lives for the affiliation agreements were determined based upon an analysis of the weighted average lives of existing agreements the Company had in place with its major customers at the time that purchase accounting was applied, plus an estimate for renewals of such agreements. The Company has been successful in renewing its affiliation agreements and maintaining customer relationships in the past and believes it will be able to renew its major affiliation agreements and maintain those customer relationships in the future. However, it is possible that the Company will not successfully renew such agreements as they expire or that if it does, the net revenue earned may not equal or exceed the net revenue currently being earned, which could have a significant adverse impact on our business. In light of these facts and circumstances, the Company has determined that an estimated useful life of 4 to 11 years for affiliation agreements and 24 years for affiliation relationships is appropriate depending on the nature of the underlying intangible asset.
There have been periods when an existing affiliate agreement has expired and the parties have not finalized negotiations of either a renewal of that agreement or a new agreement for certain periods of time. In substantially all these instances, the affiliates continued to carry and pay for the service under oral or written interim agreements until execution of definitive replacement agreements or renewal. In one case during 2004, there was a 10 day period in which an affiliate was restricted from carrying certain of the Company’s sports and entertainment networks because the parties had not reached agreement on contract renewal terms. We reached a short-term agreement with the affiliate at the end of the 10 day period and that affiliate continuously carried the networks pursuant to successive subsequent short-term agreements through March 7, 2005. However, we were unable to reach an agreement with this affiliate at expiration on March 7, 2005, and this affiliate discontinued carriage of certain of the Company’s sports networks. On May 9, 2005, we reached a multi-year agreement on key rate and positioning terms for carriage of these sports networks and the parties subsequently entered into definitive documentation
reflecting such agreement. See “Impairment of Long-Lived and Indefinite-Lived Assets” discussion above.
If an affiliate were to cease carrying the service on an other than temporary basis, the Company would record an impairment charge for the then remaining carrying value of that affiliate agreement intangible asset. If the Company were to renew an affiliate agreement at rates that produced materially less net revenue compared to the net revenue produced under the previous agreement, the Company would evaluate the impact on its cash flows and, if necessary, would further evaluate such indication of potential impairment by following the policy described above under “Impairment of Long-Lived and Indefinite-Lived Assets” for the asset group containing that intangible. The Company also would evaluate whether the remaining useful life of the affiliate agreement remained appropriate. Based on December 31, 2006 carrying values, if the estimated life of all affiliate agreements and affiliation relationships were shortened by 10%, the effect on amortization in the year ending December 31, 2007 would be to increase our annual amortization expense by approximately $6,683.
Valuation of Deferred Tax Assets:
Deferred tax assets have resulted primarily from the Company’s future deductible temporary differences and NOLs. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax asset will not be realized. The Company’s ability to realize its deferred tax assets depends upon the generation of sufficient future taxable income and tax planning strategies to allow for the utilization of its NOLs and deductible temporary differences. If such estimates and related assumptions change in the future, the Company may be required to record additional valuation allowances against its deferred tax assets, resulting in additional income tax expense in the Company’s consolidated statement of operations. Management evaluates the realizability of the deferred tax assets and the need for additional valuation allowances quarterly. At this time, based on current facts and circumstances, management believes that it is more likely than not that the Company will realize benefit for its gross deferred tax assets, except those deferred tax assets against which a valuation allowance has been recorded which relate to certain state net operating loss carry forwards. In 2006, the Company recorded a decrease in the valuation allowance of $10,404 relating to certain state net operating loss carry forwards. In 2005 and 2004, the Company recorded increases in the valuation allowance of $6,459 and $14,036, respectively, relating to certain state net operating loss carry forwards. During 2006 and 2005, certain state net operating loss carry forwards expired prior to utilization. The deferred tax asset corresponding to the expired net operating loss carry forwards had been fully offset by a valuation allowance. The associated deferred tax asset and valuation allowance were both reduced by $2,638 and $6,953 in 2006 and 2005, respectively.
Plant and Equipment:
Costs incurred in the construction of the Company’s cable television system, including line extensions to, and upgrade of, the Company’s hybrid fiber-coaxial infrastructure and headend facilities are capitalized. These costs consist of materials, subcontractor labor, direct consulting fees, and internal labor and related costs associated with the construction activities. The internal costs that are capitalized consist of salaries and benefits of Company employees and the portion of facility costs, including rent, taxes, insurance and utilities, that supports the construction activities. These costs are depreciated over the estimated life of the plant and headend facilities. Costs of operating the plant and the technical facilities, including repairs and maintenance and call completion fees, are expensed as incurred.
Costs incurred to connect businesses or residences that have not been previously connected to the infrastructure or digital platform are also capitalized. These costs include materials, subcontractor labor, internal labor to connect, provision and provide on-site and remote technical assistance and other related costs associated with the connection activities. In addition, on-site and remote technical assistance during the provisioning process for new digital product offerings are capitalized. The departmental activities supporting the connection process are tracked through specific metrics, and the portion of departmental
costs that is capitalized is determined through a time weighted activity allocation of costs incurred based on time studies used to estimate the average time spent on each activity. New connections are amortized over 5 years or 12 years for residence wiring and feeder cable to the home, respectively. The portion of departmental costs related to reconnection, programming service up- and down- grade, repair and maintenance, and disconnection activities are expensed as incurred.
Defined Benefit Pension Plans:
The Company sponsors both funded and unfunded defined benefit pension plans in various forms covering employees who meet the applicable eligibility requirements. The Company’s company-wide plans include a non-contributory cash balance retirement plan, an unfunded non-qualified excess cash balance plan and an unfunded supplemental defined benefit plan (collectively, the “Cablevision Qualified and Non-qualified Defined Benefit Plans”). In addition, Madison Square Garden sponsors a non-contributory pension plan covering its non-union employees (hired prior to January 1, 2001), an unfunded non-qualified defined benefit pension plan and two non-contributory pension plans covering certain of its union employees (collectively, the “Madison Square Garden Qualified and Non-qualified Defined Benefit Plans”).
The Company utilizes actuarial methods required by Statement of Financial Accounting Standards (“SFAS”) No. 87, Employers’ Accounting for Pensions (“Statement No. 87”), in calculating the liability and expense related to these plans. These actuarial methods require numerous assumptions in an attempt to estimate future events, including the discount rate, expected long-term rate of return on plan assets and the rate of future compensation increases, as determined annually by the Company. Material changes in the pension costs of the plans may occur in the future due to changes in these assumptions, changes in the number of the plan participants, changes in the level of benefits provided, changes in asset levels and changes in legislation. Our assumptions reflect our historical experience and management’s best judgment regarding future expectations.
Since liabilities under defined benefit plans are measured on a discounted basis, the discount rate is a significant assumption. The discount rate is subject to change each year, consistent with changes in applicable high-quality, long-term corporate bond indices. Based on the expected duration of the benefit payments for the plans, we refer to applicable bond yields (such as Moody’s Aaa Corporate Bonds) and the Buck Consultants’ Discount Rate Model (which is developed by examining the yields on selected highly rated corporate bonds), to select a rate at which we believe the plans’ benefits could be effectively settled. Based on the published rates and the results from the Buck Consultants’ Discount Rate Model as of December 31, 2006 and 2005, we used the following weighted average discount rates for the Cablevision Qualified and Non-qualified Defined Benefit Plans and the Madison Square Garden Qualified and Non-qualified Defined Benefit Plans:
For the year ended December 31, 2006, these discount rates had an aggregate effect of decreasing the Madison Square Garden Qualified and Non-qualified Plans’ benefit obligation by approximately
$6,797. There was no effect on the benefit obligation for the Cablevision Qualified and Non-qualified Defined Benefit Plans.
The expected long-term return on plan assets is based on a periodic review and modeling of the plan’s asset allocation structure over a long-term horizon. Expectations of returns for each asset class are the most important of the assumptions used in the review and modeling and are based on comprehensive reviews of historical data and economic/financial market theory. The expected long-term rate of return was selected from within the reasonable range of rates determined by (a) historical real returns, net of inflation, for the asset classes covered by the investment policy, and (b) projections of inflation over the long-term period during which benefits are payable to plan participants. The expected rate of return for the Cablevision Qualified and the Madison Square Garden Qualified Defined Benefit Plans was 8.00% for 2006 and 2005, respectively.
The following table reflects the Company’s estimates of the possible effects of changes in the discount rates and expected rates of return on its 2007 net periodic benefit cost and its benefit obligation at December 31, 2006 for the Cablevision Qualified and Non-qualified Defined Benefit Plans and the Madison Square Garden Qualified and Non-qualified Defined Benefit Plans:
Generally accepted accounting principles include mechanisms that serve to limit the volatility in our earnings which otherwise would result from recording changes in the value of plan assets and benefit obligations in our consolidated financial statements in the periods in which those changes occur. For example, while the expected long-term rate of return on the Plans’ assets should, over time, approximate the actual long-term returns, differences between the expected and actual returns could occur in any given year. These differences contribute to the deferred actuarial gains or losses, which are then amortized over time.
The rate of future compensation increases is another assumption used by the Company’s third party actuary. The weighted average rate of future compensation increases used in 2006 and in 2005 for the Cablevision Qualified Defined Benefit and Non-qualified Defined Benefit Plans and the Madison Square Garden Qualified and Non-qualified Defined Benefit Plans are as follows:
In addition, the Company’s actuary also uses other assumptions such as termination and mortality rates. The actuarial assumptions used by the Company may differ materially from actual results due to changing economic and market conditions, higher or lower benefit payments or longer or shorter life spans of participants, among other things. Differences between actual and expected occurrences could significantly impact the actual amount of net periodic cost and the benefit obligation recorded by the Company.
Certain Transactions The following transactions occurred during the periods covered by this Management’s Discussion and Analysis of Financial Condition and Results of Operations.
2005 Transactions. In April 2005, the Company and News Corporation restructured Regional Programming Partners. As a result, the Company now owns 100% of Madison Square Garden and no longer owns interests in Fox Sports Net Ohio, Fox Sports Net Florida, National Sports Partners or National Advertising Partners. The Company also owns 100% of Fox Sports Net Chicago, which was shut down in June 2006, as well as 50% of Fox Sports Net New England and continues to own 60% of Fox Sports Net Bay Area.
In April 2005, subsidiaries of the Company entered into agreements with EchoStar relating to the launch and operation of the business of Rainbow HD Holdings, the Company’s VOOM HD Networks high definition television programming service, subject to the closing of the sale of our satellite (Rainbow 1) to EchoStar which occurred in November 2005. Under those arrangements, EchoStar was initially distributed a portion of the VOOM HD Networks programming service and, beginning in 2006 began carrying all 15 of the channels included in the programming service. In connection with the arrangements, EchoStar was issued a 20% interest in Rainbow HD Holdings, the Company’s subsidiary owning the VOOM HD Networks, and that 20% interest will not be diluted until $500,000 in cash has been invested in Rainbow HD Holdings’ equity by the Company.
Under the terms of the affiliation arrangements with EchoStar covering the VOOM HD Networks for a 15 year term, if Rainbow HD Holdings fails to spend $100,000 per year, up to a maximum of $500,000 in the aggregate, on its service offerings, EchoStar may terminate the affiliation agreement. The Company has the right to terminate the affiliation agreement if the VOOM HD Networks are discontinued in the future.
2004 Transactions. In 2004, Rainbow DBS invested approximately $84,600 in exchange for a substantial interest in an entity that had acquired licenses from the FCC to provide multichannel video distribution and data service in 46 metropolitan areas in the United States.
In July 2004, Northcoast Communications, a 49.9% owned subsidiary of the Company, completed its sale of its wholly-owned subsidiary, Cleveland PCS, to an unaffiliated entity. The Company did not record any gain or loss in connection with the sale.
Results of Operations - Cablevision Systems Corporation
The following table sets forth on a historical basis certain items related to operations as a percentage of net revenues for the periods indicated:
STATEMENT OF OPERATIONS DATA
Comparison of Consolidated Year Ended December 31, 2006 Versus Year Ended December 31, 2005
Consolidated Results - Cablevision Systems Corporation
The Company classifies its business interests into three reportable segments:
· Telecommunications Services, consisting principally of our video, high-speed data, and Voice over Internet Protocol services and our commercial data and voice services operations of Lightpath;
· Rainbow, consisting principally of interests in national and regional cable television programming networks, including AMC, IFC, WE tv (formerly WE: Women’s Entertainment), fuse and VOOM HD Networks; and
· Madison Square Garden, which owns and operates professional sports teams, regional cable television sports programming networks and an entertainment business.
The Company allocates certain costs to each segment based upon their proportionate estimated usage of services. The segment financial information set forth below, including the discussion related to individual line items, does not reflect intersegment eliminations unless specifically indicated.
See “Business Segments Results” for a more detailed discussion relating to the operating results of our segments.
Revenues, net for the year ended December 31, 2006 increased $754,984 (15%) as compared to revenues for the prior year. The net increase is attributable to the following:
Technical and operating expenses (excluding depreciation, amortization and impairments) include primarily:
· cable programming costs which are costs paid to programmers, net of amortization of any launch support received, for cable content and are generally paid on a per-subscriber basis;
· network management and field service costs which represent costs associated with the maintenance of our broadband network, including costs of certain customer connections;
· contractual rights payments to broadcast certain live sporting events and contractual payments pursuant to employment agreements with professional sports teams’ personnel;
· amortization of costs to license programming, including feature films, and programming and production costs of our Rainbow businesses; and
· interconnection, call completion and circuit fees relating to our telephone and VoIP businesses which represent the transport and termination of calls with other telecommunications carriers.
Technical and operating expenses (excluding depreciation and amortization and impairments) in 2006 increased $411,062 (18%) as compared to 2005. The net increase is attributable to the following:
As a percentage of revenues, technical and operating expenses increased 2% during 2006 as compared to 2005. This increased percentage is primarily attributable to increases in technical and operating expenses of the Madison Square Garden segment and to a lesser extent the Rainbow segment.
Selling, general and administrative expenses include primarily sales, marketing and advertising expenses, administrative costs, and costs of customer call centers. Selling, general and administrative expenses increased $188,342 (15%) for 2006 as compared to 2005. The net increase is attributable to the following:
On January 1, 2006, the Company adopted SFAS No. 123R, Share-Based Payment (“Statement No. 123R”). Statement No. 123R eliminates the ability to account for share-based compensation transactions, as the Company formerly did, using the intrinsic value method as prescribed by Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and generally requires that share-based payments be accounted for using a fair-value-based method. As a result of the adoption of Statement No. 123R, the Company’s stock plan expense for 2006 for all segments has increased as compared to 2005.
As a percentage of revenues, selling, general and administrative expenses remained constant in 2006 compared to 2005.
Restructuring credits amounted to $3,484 in 2006 and $537 in 2005. The 2006 amount related primarily to adjustments to facility realignment provisions recorded in connection with the 2001 and 2002 restructuring plans of $3,996, partially offset by a charge of $512 relating to facility realignment and severance costs associated with the 2006 restructuring plans. The 2005 amount is comprised of a $2,060 credit resulting from changes in estimates of facility realignment costs relating to the 2001 and 2002 restructuring plans, partially offset by $1,025 of severance costs in 2005 and $498 of additional provisions for severance costs associated with the 2004 and 2003 restructuring plans.
Depreciation and amortization (including impairments) increased $45,170 (4%) for 2006 as compared to 2005. The net increase consisted of an increase in depreciation expense of $53,571 primarily from depreciation of new fixed assets in our telecommunication services segment, partially offset by a decrease in amortization expense of $8,401 primarily resulting from an impairment of certain intangibles recorded in 2005 attributable to the shutdown of two of three MetroChannels and a net decrease of $741 relating to the impairment of certain long-lived assets within our theater operations.
Net interest expense increased $142,937 (19%) during 2006 compared to 2005. The net increase is attributable to the following:
Equity in net income of affiliates amounted to $6,698 in 2006 compared to $3,219 in 2005. Such amounts consist of the Company’s share of the net income or loss of certain businesses in which the Company does not have a majority ownership interest.
Gain on sale of affiliate interests of $64,968 for the year ended December 31, 2005 resulted primarily from the Company and News Corporation restructuring their ownership of National Sports Partners and National Advertising Partners.
Gain (loss) on investments, net for the years ended December 31, 2006 and 2005 of $290,052 and $(138,312) respectively, consists primarily of the net increase or decrease in the fair value of Comcast, General Electric, AT&T, Charter Communications, Leapfrog, and Adelphia Communications common stock owned by the Company. The effects of these gains and losses are largely offset by the losses and gains on related derivative contracts described below.
Write-off of deferred financing costs for the year ended December 31, 2006 of $14,083 includes $6,084 of costs written off in connection with the refinancing of the Rainbow National Services LLC credit agreement in July 2006, $3,412 of costs written off in connection with the early redemption of CSC Holdings’ $250,000 principal amount of 10-1/2% Senior Subordinated Debentures due 2016 in May 2006, and $4,587 of costs written off in connection with the refinancing of the CSC Holdings credit agreement.
Gain (loss) on derivative contracts, net for the years ended December 31, 2006 and 2005 consisted of the following:
The effects of these gains and losses are largely offset by the losses and gains on investment securities pledged as collateral which are included in gain (loss) on investments, net discussed above.
Loss on extinguishment of debt of $13,125 for the year ended December 31, 2006 represents the premium paid on the early redemption of CSC Holdings’ $250,000 principal amount of 10-1/2% Senior Subordinated Debentures due 2016 in May 2006.
Minority interests represent other parties’ share of the net income (losses) of entities which are not entirely owned by us but which are consolidated in our financial statements. For the years ended December 31, 2006 and 2005 minority interests consisted of the following:
Net miscellaneous income of $2,837 and $651 for the years ended December 31, 2006 and 2005, respectively, resulted primarily from dividends received on certain of the Company’s investment securities, partially offset by other miscellaneous expenses.
Income tax benefit attributable to continuing operations of $134,217 for the year ended December 31, 2006 resulted primarily from the Company’s pretax loss, state income tax benefit of $24,315, increased by a $10,404 decrease in the valuation allowance relating to certain state net operating loss carry forwards, a tax benefit of $16,356 resulting from the reduction in a tax contingency liability pursuant to a change in judgment, a tax benefit of $5,013 resulting from the favorable settlement of an issue with a taxing authority, partially offset by the impact of non-deductible officers’ compensation of $4,443 and other non-deducible expenses of $6,768.
Income tax benefit attributable to continuing operations of $75,691 for the year ended December 31, 2005 resulted primarily from the pretax loss, state income tax benefit of $12,211, increased by a tax benefit of $6,701 resulting from an adjustment to a state tax rate, partially offset by an increase in the valuation allowance of $6,459 relating to certain state net operating loss carry forwards and the impact of non-deductible officers’ compensation of $6,226 and other non-deducible expenses of $10,637.
The Company is currently being audited by the state of Ohio for the tax year ended December 31, 2000. The primary audit issue is the amount of gain that should be subject to tax in Ohio pursuant to the 2000 sale of certain cable television systems. Ohio has asserted that more of the gain should be taxed in Ohio. Ohio has issued a proposed assessment of additional tax due of approximately $55,000 plus interest of approximately $12,000. As of December 31, 2006, the Company has recorded a liability with respect to such matter of approximately $11,000, including interest, which represents management’s current estimate of the additional amount that may be owed.
Income (loss) from discontinued operations
In April 2005, the operations of the Rainbow DBS satellite distribution business were shut down. In connection with the shut down, certain assets of the business, including the Rainbow 1 direct broadcast satellite and certain other related assets were sold to a subsidiary of EchoStar for $200,000 in cash. This transaction closed in November 2005.
In September 2005, Loral Space & Communications Holding Corporation (“Loral”) filed an action against Cablevision and Rainbow DBS Holdings, Inc. (“Rainbow DBS”) for breach of contract based on a letter agreement dated March 23, 2001 (“the Letter Agreement”) between Loral and Rainbow DBS. Loral alleges that the sale of the Rainbow-1 satellite and related assets to EchoStar constituted a sale of “substantially all of the assets of Rainbow DBS” triggering a “Make Whole Payment” under the Letter Agreement of $33,000 plus interest. A trial in this matter took place in January 2007 in New York Supreme Court for New York County. On January 24, 2007, the jury returned a verdict finding that the EchoStar sale had triggered a Make Whole Payment under the Letter
Agreement, requiring a payment to Loral of $50,898, including interest, which has been accrued for as of December 31, 2006 and reflected as an expense in discontinued operations. Cablevision and Rainbow DBS have filed a motion for judgment as a matter of law, or in the alternative for a new trial, which is pending.
In April 2005, the Company and News Corporation restructured Regional Programming Partners. As a result, the Company now owns 100% of Madison Square Garden, 50% of Fox Sports Net New England and continues to own 60% of Fox Sports Net Bay Area and no longer owns interests in Fox Sports Net Ohio, Fox Sports Net Florida, National Sports Partners or National Advertising Partners. The Company also owned 100% of Fox Sports Net Chicago which was shut down in June 2006.
The operating results of the Fox Sports Net Chicago, Fox Sports Net Ohio and Fox Sports Net Florida businesses and those of the Rainbow DBS distribution business, which was shut down in April 2005, have been reported in discontinued operations in the Company’s consolidated statements of operations for all periods presented.
Income (loss) from discontinued operations, net of taxes for the years ended December 31, 2006 and 2005 reflects the following items, net of related income taxes and minority interests:
* The 2006 amount includes $30,025, net of taxes, representing the Make Whole Payment due to Loral. See Note 18 to the consolidated financial statements.
** The 2006 amount includes approximately $46,100, net of taxes, representing the collection in June 2006 of affiliate revenue from a cable affiliate, including approximately $42,200, net of taxes, relating to periods prior to 2006, that had not been previously recognized due to a contractual dispute. The underlying contract was terminated in June 2006 and no further payments will be received under this contract.
Business Segments Results - Cablevision Systems Corporation
Telecommunications Services
The table below sets forth, for the periods presented, certain historical financial information and the percentage that those items bear to revenue for the Company’s Telecommunications Services segment:
Revenues, net for the year ended December 31, 2006 increased $630,942 (17%) as compared to revenues for the prior year. The following table presents the increases by major components of revenues for the years ended December 31, 2006 and 2005 for the Company’s Telecommunications Services segment:
Revenue increases reflected above are primarily derived from increases in the number of subscribers to these services (set forth in the table below), upgrades by video customers from the level of the programming package to which they subscribe, additional services sold to our existing subscribers and general increases in rates, offset in part by offer discounts and other rate changes. As a result, our average monthly revenue per basic video subscriber for the fourth quarter of December 2006 was $115.30 as compared with $100.46 for the fourth quarter of December 2005. The increase in Optimum Lightpath net revenues is primarily attributable to growth in Ethernet data services and Optimum Voice call completion activity, partially offset by a decline in traditional circuit switched services. The following table presents certain subscriber information for the years ended December 31, 2006 and 2005 for the Company’s cable television systems (excluding Lightpath):
The Company added basic video customers and revenue generating units ("RGUs") in each quarter of 2006 aggregating approximately 100,000 and 1,404,000, respectively, for the year. However, fewer basic video customers and RGUs were added during the fourth quarter of 2006 as compared to the fourth quarter of 2005. Because of our relatively high digital video penetration rates and, to a lesser extent, the increasing competition in our service territory, we expect our basic video customer and RGU growth in 2007 to be lower than what we experienced in 2006.
Technical and operating expenses (excluding depreciation and amortization) for 2006 increased $269,941 (18%) compared to 2005. The net increase is attributable to the following:
* Represents the collection of $26,500 in June 2006 related to the resolution of a contractual programming dispute, $19,476 of which was due in periods prior to 2006 but not recognized as a reduction to programming costs because it was being disputed and was not being paid by the affiliate. The underlying contract was terminated in June 2006 and no further payments will be received under the contract. Payments received under the contract are accounted for as a reduction to programming costs.
As a percentage of revenues, technical and operating expenses remained constant, during 2006 as compared to 2005.
Selling, general and administrative expenses increased $129,474 (18%) for 2006 as compared to 2005. The net increase is attributable to the following:
As a percentage of revenues, selling, general and administrative expenses remained constant in 2006 as compared to 2005.
Restructuring charges amounted to $295 in 2005. This amount is comprised primarily of $894 of severance costs associated with the 2005 restructuring plans and $263 of additional provisions for severance associated with the 2004 restructuring plans, partially offset by a credit of $896 resulting from changes in estimates of facility realignment costs relating to the 2002 restructuring plans.
Depreciation and amortization increased $72,547 (9%) for 2006 as compared to 2005. The increase resulted primarily from depreciation of new fixed assets, primarily subscriber devices.
Rainbow
The table below sets forth, for the periods presented, certain historical financial information and the percentage that those items bear to revenues for the Company’s Rainbow segment:
Included in the Rainbow segment’s results of operations is operating income from AMC, IFC and WE tv aggregating $197,294 and $185,703, and operating losses from Rainbow’s other programming services aggregating $168,547 and $147,132 for the years ended December 31, 2006 and 2005, respectively. These other programming services consist of Fox Sports Net Bay Area, fuse, Mag Rack, sportskool, News 12 Networks, IFC Entertainment, VOOM HD Networks, Rainbow Network Communications, Rainbow Advertising Sales Corp. and other Rainbow ventures. The operating loss was attributable primarily to VOOM HD Networks, as well as the News 12 Networks and fuse, which more than offset
operating income generated by Fox Sports Net Bay Area. The VOOM HD Networks business has been incurring substantial operating losses and these losses are expected to continue for at least the next several years.
Revenues, net for the year ended December 31, 2006 increased $60,425 (7%) as compared to revenues for the prior year. The net increase is attributable to the following:
Advertising revenue as a percentage of total revenue increased in 2006 as compared to 2005 and we expect this trend to continue.
Revenue increases discussed above are primarily derived from increases in the level of advertising on our networks, increases in the number of subscribers to our programming services, and increases in fees charged for our services. The following table presents certain viewing subscriber information for the years ended December 31, 2006 and 2005:
Technical and operating expenses (excluding depreciation and amortization and impairments) for the year ended December 31, 2006 increased $37,128 (11%) compared to 2005. The net increase is attributable to the following:
As a percentage of revenues, technical and operating increased 1% during 2006 as compared to 2005 resulting primarily from higher programming costs associated with the VOOM HD Networks.
Selling, general and administrative expenses increased $39,851 (12%) for 2006 compared to 2005. The net increase is attributable to the following:
As a percentage of revenues, selling, general and administrative expenses increased 2% in 2006 compared to 2005.
Depreciation and amortization (including impairments) decreased $6,873 (6%) for 2006 as compared to 2005. The net decrease was comprised of approximately $4,963 resulting from the impairment of certain intangibles during the second quarter of 2005, a decrease of approximately $3,585 attributable to the MetroChannel business, which shut down two of its three channels in the second quarter of 2005, and a decrease of approximately $1,237 due to the transfer of certain intangibles to another operating segment in the second quarter of 2005. Partially offsetting these decreases was an increase of approximately $2,912 resulting primarily from depreciation of new fixed assets.
Madison Square Garden The table below sets forth, for the periods presented, certain historical financial information and the percentage that those items bear to net revenues for Madison Square Garden.
The dependence of this segment’s revenues on its sports teams and Christmas shows generally make it seasonal with a disproportionate share of its revenues and operating income being derived in the fourth quarter of each year.
Revenues, net for the year ended December 31, 2006 increased $49,645 (6%) as compared to revenues for the prior year. This net increase is attributable to the following:
* The retroactive MSG Networks affiliate rate adjustments discussed above resulted from the signing of certain affiliate contracts in 2005 that increased rates for periods prior to January 1, 2005. Therefore the results for the year ended December 31, 2005 reflect positive retroactive rate adjustments related to the periods prior to January 1, 2005 that did not recur in 2006.
Technical and operating expenses for the year ended December 31, 2006 increased $87,793 (17%) as compared to the prior year. This increase is attributable to the following:
* The change in the provisions for certain team personnel transactions includes the settlement in 2006 of the dispute with the Knicks ex-head coach, Larry Brown, under which the Knicks agreed to pay Mr. Brown $18,500 of the disputed amount in connection with his employment agreement.
The purchase accounting liabilities discussed above were established in April 2005 as a result of the Company’s acquisition of the minority interest in Madison Square Garden. Following this transaction the Company began to amortize these purchase accounting liabilities over the period of the respective player contracts. During 2006 and 2005, the majority of these players were subsequently waived or traded and the unamortized purchase accounting liabilities associated with these players were immediately written off. As a result, the amount of amortization associated with these team personnel transactions declined from $25,358 in 2005 to $3,381 in 2006.
As a percentage of revenues, technical and operating expenses increased 7% during the year ended December 31, 2006 as compared to the prior year.
Selling, general, and administrative expenses for the year ended December 31, 2006 increased $20,292 (12%) as compared to the prior year. This increase is attributable to the following:
As a percentage of revenues, selling, general and administrative expenses increased 1% during the year ended December 31, 2006 as compared to the prior year.
Restructuring charges of $366 for the year ended December 31, 2005 primarily represent charges recorded as a result of the final cost determination for benefits associated with the elimination of certain staff positions.
Depreciation and amortization expense for the year ended December 31, 2006 decreased $2,674 (4%) as compared to the prior year resulting primarily from lower depreciation expense due to assets which became fully depreciated. The lower depreciation expense was partly offset by higher amortization due primarily to the amortization of certain intangible assets recorded as a result of the Company’s acquisition of the minority interest in Madison Square Garden in April 2005 and the transfer of certain intangibles from another operating segment in 2005. This increase in amortization expense was partly offset by a decrease in the amortization of certain other intangibles that became fully amortized in 2005.
Comparison of Consolidated Year Ended December 31, 2005 Versus Year Ended December 31, 2004
Revenues, net for the year ended December 31, 2005 increased $539,941 (12%) as compared to revenues for the prior year. The net increase is attributable to the following:
Technical and operating expenses (excluding depreciation and amortization, and impairments) include primarily:
· cable programming costs which are costs paid to programmers, net of amortization of any launch support received, for cable content and are generally paid on a per-subscriber basis;
· network management and field service costs which represent costs associated with the maintenance of our broadband network, including costs of certain customer connections;
· contractual rights payments to broadcast certain live sporting events and contractual payments pursuant to employment agreements with professional sports teams’ personnel;
· amortization of costs to license programming, including feature films, and programming and production costs of our Rainbow businesses; and
· interconnection, call completion and circuit fees relating to our telephone and VoIP businesses which represent the transport and termination of calls with other telecommunications carriers.
Technical and operating expenses (excluding depreciation and amortization and impairments) for 2005 increased $105,661 (5%) compared to 2004. The net increase is attributable to the following:
As a percentage of revenues, technical and operating expenses decreased 3% during 2005 as compared to 2004. The decrease resulted primarily from impairment charges in 2004 amounting to 2% of revenues.
Selling, general and administrative expenses include primarily sales, marketing and advertising expenses, administrative costs and costs of customer call centers. Selling, general and administrative expenses increased $107,163 (9%) for 2005 as compared to 2004. The net increase is attributable to the following:
As a percentage of revenues, selling, general and administrative expenses decreased 1% during 2005 compared to 2004.
Other operating income, net of $95,758 for the year ended December 31, 2004 includes primarily a $54,052 cash payment received in connection with the New York Mets’ notice of termination of the broadcast rights agreement with Madison Square Garden which was effective at the end of the 2005 baseball season and a $41,788 reversal of a purchase accounting liability related to this broadcast rights agreement.
Restructuring credits amounted to $537 in 2005 and $835 in 2004. The 2005 amount is comprised of a $2,060 credit resulting from changes in estimates of facility realignment costs relating to the 2001 and 2002 restructuring plans, partially offset by $1,025 of current severance costs in 2005 and $498 of additional provisions for severance costs associated with the 2004 and 2003 restructuring plans. The 2004 amount is comprised of a $5,761 credit resulting from changes in estimates of facility realignment and other costs relating to the 2001, 2002 and 2003 restructuring plans, partially offset by $4,926 of severance costs.
Depreciation and amortization (including impairments) decreased $55,032 (5%) for 2005 as compared to 2004. The decrease resulted primarily from impairment charges in 2004 of $78,497 relating to certain Rainbow DBS assets that were not held for sale and $12,043 related to certain assets of the VOOM HD Networks and lower write-off and disposal costs of certain fixed assets in 2005. These decreases were partially offset by an increase of $35,508 resulting primarily from depreciation of new fixed assets, impairment charges of $7,697 recorded in 2005 relating primarily to certain long-lived assets and intangibles within our theater operations and Rainbow segment and an increase in amortization expense as a result of an increase in amortizable intangibles resulting from the Regional Programming Partners transaction.
Net interest expense increased $35,370 (5%) during 2005 compared to 2004. The net increase is attributable to the following:
Equity in net income of affiliates amounted to $3,219 in 2005 compared to equity in net loss of affiliates of $12,997 in 2004. Such amounts consist of the Company’s share of the net income or loss of certain businesses in which the Company does not have majority ownership interest.
Gain on sale of programming and affiliate interests amounted to $64,968 for the year ended December 31, 2005 compared to $2,232 for the year ended December 31, 2004. The 2005 gain resulted primarily from the Company and News Corporation restructuring their ownership of National Sports Partners and National Advertising Partners. The 2004 gain resulted from the sale of a minority-owned affiliate interest.
Gain (loss) on investments, net for the years ended December 31, 2005 and 2004 consisted of the following:
The effects of these gains and losses are largely offset by the losses and gains on related derivative contracts described below.
Write-off of deferred financing costs of $18,961 in 2004 consisted of costs written off in connection with the redemption of CSC Holdings’ Series H and Series M Redeemable Exchangeable Preferred Stock and CSC Holdings’ 9-7/8% senior subordinated debentures aggregating $5,080 and termination of certain of the Company’s credit agreements aggregating $13,881.
Gain (loss) on derivative contracts, net for the years ended December 31, 2005 and 2004 consisted of the following:
The effects of these gains and losses are largely offset by the losses and gains on investment securities pledged as collateral which are included in gain (loss) on investments, net discussed above.
Loss on extinguishment of debt of $78,571 for the year ended December 31, 2004 represents premiums of $58,170 on the early redemption of CSC Holdings’ Series H and Series M Redeemable Preferred Stock, $14,325 on the early redemption of CSC Holdings’ 9-7/8% senior subordinated debentures, and $6,076 on the termination of the AT&T Wireless stock monetization contracts.
Minority interests represent other parties’ share of the net income (losses) of entities which are not entirely owned by us but which are consolidated in our financial statements. For the years ended December 31, 2005 and 2004 minority interests consisted of the following:
Net miscellaneous income of $651 for the year ended December 31, 2005 resulted primarily from dividends received on certain of the Company’s investment securities, partially offset by other miscellaneous expenses.
Income tax benefit attributable to continuing operations of $75,691 for the year ended December 31, 2005 resulted primarily from the pretax loss, state income tax benefit of $12,211, increased by a tax benefit of $6,701 resulting from an adjustment to the state tax rate, partially offset by an increase in the valuation allowance of $6,459 relating to certain state net operating loss carry forwards and the impact of non-deductible officers’ compensation and other non-deducible expenses of $6,226 and $10,637, respectively. Income tax benefit attributable to continuing operations of $201,397 in 2004 resulted primarily from the pretax loss, offset by an increase in the valuation allowance of $14,036, non-deductible preferred stock dividends of $21,208, a non-deductible adjustment related to the exchange right and put option related to the Series A Preferred Stock of CSC Holdings of $11,098, a non-deductible redemption premium related to the Series H and M Preferred Stock of CSC Holdings of $20,360, state income tax benefit of $25,692, a tax benefit of $21,615 resulting from an adjustment to the deferred tax rate, and the impact of non-deductible officers’ compensation and other non-deductible expenses of $8,303 and $4,776, respectively.
Income (loss) from discontinued operations
In April 2005, the operations of the Rainbow DBS satellite distribution business were shut down. In connection with the shut down, certain assets of the business, including the Rainbow 1 direct broadcast satellite and certain other related assets were sold to a subsidiary of EchoStar for $200,000 in cash. This transaction closed in November 2005.
In April 2005, the Company and News Corporation restructured Regional Programming Partners. As a result, the Company now owns 100% of Madison Square Garden, 50% of Fox Sports Net New England and continues to own 60% of Fox Sports Net Bay Area and no longer owns interests in Fox Sports Net Ohio, Fox Sports Net Florida, National Sports Partners or National Advertising Partners. The Company also owned 100% of Fox Sports Net Chicago which was shut down in June 2006.
The operating results of the Fox Sports Net Chicago (which was shut down in June 2006), Fox Sports Net Ohio and Fox Sports Net Florida businesses and those of the Rainbow DBS distribution business, which was shut down in April 2005, have been reported in discontinued operations in the Company’s consolidated statements of operations for all periods presented.
Income (loss) from discontinued operations, net of taxes for the years ended December 31, 2005 and 2004 reflects the following items, net of related income taxes and minority interests:
Extraordinary loss, net of taxes of $7,436 for the year ended December 31, 2004 resulted from Rainbow DBS’ investment in DTV Norwich, LLC and represents the excess of the purchase price over fair value of the acquired assets.
Business Segments Results - Cablevision Systems Corporation Telecommunications Services
The table below sets forth, for the periods presented, certain historical financial information and the percentage that those items bear to revenue for the Company’s Telecommunications Services segment:
Revenues, net for the year ended December 31, 2005 increased $482,809 (15%) as compared to revenues for the prior year. The following table presents the increases by major components of revenues for the years ended December 31, 2005 and 2004:
Revenue increases reflected above are primarily derived from increases in the number of subscribers to these services (set forth in the table below), upgrades by video customers in the level of the programming package to which they subscribe, additional services sold to our existing subscribers and general increases in rates, offset in part by offer discounts and other rate changes. The increase in Lightpath net revenues is attributable primarily to growth in Ethernet data services over Lightpath’s fiber infrastructure and to growth in traditional data services. As a result, our average monthly revenue per basic video subscriber for the fourth quarter of December 2005 was $100.46 as compared to $88.33 for the fourth quarter of December 2004. The following table presents certain subscriber information for the years ended December 31, 2005 and 2004 for the Company’s cable television systems:
Technical and operating expenses (excluding depreciation and amortization) for 2005 increased $228,137 (18%) compared to 2004. The net increase is attributable to the following:
As a percentage of revenues, technical and operating expenses increased 1% during 2005 as compared to 2004.
Selling, general and administrative expenses increased $67,602 (11%) for 2005 as compared to 2004. The net increase is attributable to the following:
As a percentage of revenues, selling, general and administrative expenses remained constant in 2005 as compared to 2004.
Restructuring charges amounted to $295 in 2005 and $736 in 2004. The 2005 amount is comprised of $894 of current severance costs and $297 of additional provisions for severance associated with the 2004 restructuring plans, partially offset by a $896 credit resulting from changes in estimates of facility realignment costs relating to the 2002 restructuring plans. The 2004 amount is comprised of $882 of new provisions associated with the elimination of positions, including severance and outplacement costs, partially offset by a credit of $146 in facility realignment costs relating to the 2001 and 2002 restructuring.
Depreciation and amortization increased $56,692 (7%) for 2005 as compared to 2004. The increase resulted primarily from depreciation of new fixed assets, primarily subscriber devices and increases in amortization expense relating to other amortizable intangibles.
Rainbow
The table below sets forth, for the periods presented, certain historical financial information and the percentage that those items bear to revenues for the Company’s Rainbow segment:
Included in the Rainbow segment’s results of operations is operating income from AMC, IFC and WE tv aggregating $185,703 and $159,815 and operating losses from Rainbow’s other programming services aggregating $147,132 and $321,432 for the years ended December 31, 2005 and 2004, respectively. These other programming services consist of Fox Sports Net Bay Area, fuse, Mag Rack, sportskool,
News 12 Networks, IFC Entertainment, VOOM HD Networks, Rainbow Network Communications, Rainbow Advertising Sales Corp. and other Rainbow ventures. The operating loss was attributable primarily to the VOOM HD Networks, as well as the News 12 Networks and fuse which more than offset operating income generated by Fox Sports Net Bay Area. The 2004 operating loss included impairment charges relating to the VOOM HD Networks and certain Rainbow DBS assets that were not held for sale.
Revenues, net for the year ended December 31, 2005 increased $19,167 (2%) as compared to revenues for the prior year. The net increase is attributable to the following:
Revenue increases discussed above are primarily derived from increases in the level of advertising on our networks, increases in the number of subscribers to our programming services, and increases in fees charged for our services. The following table presents certain viewing subscriber information for the years ended December 31, 2005 and 2004:
Technical and operating expenses (excluding depreciation and amortization and impairments) for the year ended December 31, 2005 decreased $84,607 (20%) compared to 2004. The net decrease is attributable to the following:
As a percentage of revenues, technical and operating expenses decreased 11% during 2005 as compared 2004. The decrease resulted primarily from impairment charges in 2004 amounting to approximately 9% of revenues.
Selling, general and administrative expenses increased $3,976 (1%) for 2005 compared to 2004. The net increase is attributable to the following:
As a percentage of revenues, selling, general and administrative expenses remained constant in 2005 compared to 2004.
Depreciation and amortization (including impairments) decreased $100,467 (47%) for 2005 as compared to 2004. The decrease resulted primarily from impairment charges in 2004 of $78,497 relating to certain Rainbow DBS assets that were not held for sale and $12,043 related to certain assets of the VOOM HD Networks. A decrease of approximately $11,970 resulted primarily from certain intangibles becoming fully amortized in 2004 and a decrease of $3,720 resulted from certain fixed assets becoming fully depreciated. These decreases were partially offset by increases of $4,963 resulting from the impairment in 2005 of certain intangibles and $800 from the impairment of fixed assets.
Madison Square Garden
The table below sets forth, for the periods presented, certain historical financial information and the percentage that those items bear to net revenues for Madison Square Garden:
Revenues, net for the year ended December 31, 2005 increased $25,641 (3%) as compared to revenues for the prior year. This net increase is attributable to the following:
Technical and operating expenses (excluding depreciation and amortization) for the year ended December 31, 2005 decreased $42,553 (8%) as compared to the prior year. This net decrease is attributable to the following:
The purchase accounting liabilities discussed above were established in April 2005 as a result of the Company’s acquisition of the minority interest in Madison Square Garden. Following this transaction the Company began to amortize these purchase accounting liabilities over the period of the respective player contracts. Some of these players were subsequently waived or traded before December 31, 2005 resulting in the complete amortization of the associated purchase accounting liabilities. The higher net luxury tax provision of $2,908 resulted primarily from luxury tax associated with a player who was waived prior to the new NBA Collective Bargaining Agreement and whose contractual obligations are now subject to luxury tax. This was substantially offset by lower luxury tax for the current calendar year’s portion of the tax for the 2005-2006 season as compared to the prior year’s portion of the 2003-2004 season. There was no luxury tax attributable to the 2004-2005 season.
Selling, general, and administrative expenses for the year ended December 31, 2005 increased $22,038 (15%) as compared to the prior year primarily driven by an increase in expenses related to employee salaries and related benefits, including stock and long-term incentive plans, higher professional fees and other costs relating primarily to the Company’s efforts to acquire the development rights over the New York Metropolitan Transportation Authority’s Hudson Rail Yards, and higher charitable contributions.
Other operating income of $95,840 in 2004 results from the notice of termination of Madison Square Garden’s broadcast rights agreement with the New York Mets. In the second quarter of 2004, the New York Mets gave notice of termination of their rights agreement with Madison Square Garden, and with the notice paid Madison Square Garden a contractually obligated termination fee of $54,052. The termination of the rights agreement was effective at the end of the 2005 baseball season. In addition, Madison Square Garden recorded a $41,788 credit reflecting the reversal of a purchase accounting liability related to this rights agreement.
Restructuring charges of $366 in 2005 primarily represent charges recorded as a result of the final cost determination for benefits associated with the elimination of certain staff positions. Restructuring charges of $4,146 for 2004 primarily represent severance costs associated with the elimination of certain staff positions in 2004.
Depreciation and amortization for the year ended December 31, 2005 increased $17,389 (38%), as compared to the prior year. An increase of $10,668 resulted from higher amortization of intangibles primarily due to certain intangible assets recorded as a result of the Company’s acquisition of the minority interest in Madison Square Garden. An increase of $6,721 resulted from higher depreciation expense primarily due to the acceleration of depreciation of certain Madison Square Garden Arena assets due to its planned renovation.
CSC HOLDINGS, INC.
The statement of operations results of CSC Holdings are identical to the statement of operations results of Cablevision, except for the following:
· Interest expense of $132,784, $124,498 and $85,048 for the years ended December 31, 2006, 2005 and 2004, respectively, relating to $1,500,000 of Cablevision senior notes issued in April 2004 included in Cablevision’s consolidated statements of operations,
· Interest income of $3,958 and $89 for the years ended December 31, 2006 and 2005, respectively, related to cash held at Cablevision,
· Miscellaneous expenses of $177 included in Cablevision’s consolidated statement of operations for the year ended December 31, 2005, and
· Income tax benefit of $52,831, $50,993 and $35,125 for the years ended December 31, 2006, 2005 and 2004, respectively, included in Cablevision’s consolidated statements of operations related to the items listed above.
Refer to Cablevision’s Management’s Discussion and Analysis of Financial Condition and Results of Operations herein.
LIQUIDITY AND CAPITAL RESOURCES
Overview
Cablevision has no operations independent of its subsidiaries. Cablevision’s outstanding securities consist of Cablevision NY Group Class A and Cablevision NY Group Class B common stock and $1,500,000 of debt securities. Funding for the debt service requirements of our debt securities is provided by our subsidiaries operations, principally CSC Holdings, as permitted by the covenants governing CSC Holdings’ credit agreements and public debt securities. Funding for our subsidiaries is generally provided by cash flow from operations, cash on hand, and borrowings under bank credit facilities made available to the Restricted Group (as later defined) and to Rainbow National Services LLC (“RNS”) and the proceeds from the issuance of notes and debentures in the capital markets. The Company has accessed the debt markets for significant amounts of capital in the past and may do so in the future. For the year ended December 31, 2006, Cablevision had cash flow from operating activities in excess of capital expenditures.
The following table summarizes our outstanding debt and present value of capital leases as well as interest expense and capital expenditures as of and for the year ended December 31, 2006:
Total amounts payable by the Company and its subsidiaries in connection with its outstanding obligations during the five years subsequent to December 31, 2006 and thereafter, including capital leases and related interest, the value deliverable at maturity under monetization contracts and the $4,992,500 of outstanding bank debt as of December 31, 2006 are as follows:
* Cablevision has the option, at maturity, to deliver the shares of common stock underlying the monetization contracts along with proceeds from the related derivative contracts in full satisfaction of the maturing collateralized indebtedness or obtain the required cash equivalent of the common stock through new monetization and derivative contracts. The amounts included in the table are $102,469 in 2007, $222,624 in 2008 and $667,455 in 2009.
Restricted Group As of December 31, 2006, CSC Holdings and those of its subsidiaries which conduct our cable television video operations (including approximately 3.1 million basic video customers and 2.4 million digital video customers) and high-speed data service (which encompasses approximately 2.0 million customers) and our residential voice services operations (which encompasses approximately 1.2 million customers), as well as Optimum Lightpath, our commercial data and voice service business comprise the “Restricted Group” since they are subject to the covenants and restrictions of the credit facility and the indentures governing the notes and debentures securities issued by CSC Holdings. In addition, the Restricted Group is also subject to the covenants of the debt issued by Cablevision.
Sources of cash for the Restricted Group include primarily cash flow from the operations of the businesses in the Restricted Group, borrowings under its bank credit agreement and issuance of notes and
debentures in the capital markets and, from time to time, distributions or loans from its subsidiaries. The Restricted Group’s principal uses of cash (excluding the cash used to pay the special dividend discussed below) include capital spending, in particular the capital requirements associated with the growth of its services such as digital video, high-speed data and voice; debt service, including distributions made to Cablevision to service interest expense on its debt securities; other corporate expenses and changes in working capital; and investments that it may fund from time to time. We currently expect that the net funding and investment requirements of the Restricted Group will be met with cash generated by its operating activities and borrowings under the Restricted Group’s bank credit facility and that the Restricted Group’s available borrowing capacity under that facility will be sufficient to meet these requirements for the next 12 months.
On February 24, 2006, the Restricted Group entered into a $2,400,000 credit facility with a group of banks consisting of three components: a $1,000,000 revolver, a $1,000,000 term A-1 loan facility and a $400,000 term A-2 loan facility that has since been refinanced and repaid in full, as described below. Of the $1,400,000 proceeds received from the term loans under the credit facility, $1,265,648 was used to repay the outstanding borrowings and accrued interest under the prior Restricted Group credit facility that was scheduled to mature in June 2006, and $26,059 for fees and expenses. On March 29, 2006, the Restricted Group entered into a $3,500,000 term B loan facility, of which $414,077 of the proceeds was used to prepay the outstanding borrowings of the term A-2 loan facility, including accrued interest, fees and expenses. The balance of the outstanding term B loan facility borrowings was invested in short-term AAA rated funds until approval of the special dividend by the Company’s Board of Directors, and was then distributed to Cablevision on April 24, 2006 after the special dividend was approved by the Board of Directors.
The three components of the new Restricted Group credit facility, the $1,000,000 revolver, the $1,000,000 term A-1 loan facility and the $3,500,000 term B loan facility, are direct obligations of CSC Holdings, guaranteed by most Restricted Group subsidiaries and secured by the pledge of the stock of most Restricted Group subsidiaries. As of February 23, 2007, $51,994 of the $1,000,000 revolving credit facility was restricted for certain letters of credit issued on behalf of CSC Holdings and $948,006 of the revolver was undrawn. The revolving credit facility and the term A-1 loan facility mature in six years in February 2012 and the term B loan facility matures in seven years in March 2013. The revolver has no required interim repayments, the $1,000,000 term A-1 loan facility requires quarterly repayments aggregating 0% in year one, 5% in each of years two and three, 25% in each of years four and five, and 40% in the final year and the $3,500,000 term B loan facility is subject to quarterly repayments totaling 1% ($8,750 per quarter) in each of years one through six and 94% ($822,500 per quarter) in the final year. The interest rate on the term A-1 loan facility varies, depending on the Restricted Group’s cash flow ratio (as defined) from .75% to 1.75% over the Eurodollar Rate for Eurodollar-based borrowings and from zero to .75% over the Base Rate for Base Rate Borrowings (as defined). The interest rate on the borrowings under the term B loan facility is the Eurodollar Rate (as defined) plus 1.75% or prime rate plus .75%, at the Company’s election. The weighted average interest rates as of December 31, 2006 on borrowings under the term A-1 loan facility and term B loan facility were 6.62% and 7.12%, respectively.
The principal financial covenants, which are not identical for the revolving credit facility and the term A-1 loan facility, on the one hand, and the term B loan facility, on the other, include (i) under the revolving credit facility and the term A-1 loan facility, maximum total leverage of 7.50 to 1 with subsequent stepdowns over the life of the revolving credit facility and the term A-1 loan facility until reaching 4.50 to 1 for periods beginning on and after January 1, 2010, (ii) under the revolving credit facility and the term A-1 loan facility, maximum senior secured leverage of 4.00 times cash flow through December 31, 2006 with annual stepdowns thereafter over the life of the revolving credit facility and the term A-1 loan facility until reaching 3.00 to 1 for periods beginning on and after January 1, 2010, (iii) under the revolving credit facility and the term A-1 loan facility, minimum ratios for cash flow to interest expense of 1.75 to 1 initially, increasing to 2.00 to 1 on and after July 1, 2007, and (iv) under the revolving credit facility and the term A-1 loan facility, a minimum ratio of cash flow less cash taxes to total debt expense (defined to include interest expense, certain payments of principal and dividends paid
by CSC Holdings to Cablevision to permit Cablevision to pay interest and certain principal payments on its debt) of 1.50 to 1. These covenants and restrictions on the permitted use of borrowed funds in the revolving credit facility may limit our ability to utilize all of the undrawn revolver funds. Additional covenants include limitations on liens and the issuance of additional debt. Under the term B loan facility, we are limited in our ability to incur additional indebtedness based on a maximum ratio of total indebtedness to cash flow (as defined in the term B loan facility) of 7.50 to 1 with subsequent stepdowns over the life of the term B loan facility until reaching 5.00 to 1 for periods beginning on and after January 1, 2010 and a maximum senior secured leverage ratio of 4.50 times cash flow (as defined in the term B loan facility).
Under the revolving credit facility and the term A-1 loan facility, there are generally no restrictions on investments that the Restricted Group may make, provided it is not in default. The Restricted Group can make distributions or other restricted payments so long as CSC Holdings is not in default but there is a limitation (initially $200,000, subject to increase to reflect capital contributions or issuance of equity interests) on restricted payments during any period when the cash flow leverage ratio is greater than 6.00 to 1. The $200,000 limitation does not apply to restricted payments by CSC Holdings to Cablevision to be used by Cablevision to make scheduled payments of principal or interest on its indebtedness. Under the term B loan facility, there also are generally no restrictions on investments that the Restricted Group may make provided it is not in default; however, CSC Holdings must also remain in compliance with the maximum ratio of total indebtedness to cash flow and the maximum senior secured leverage ratio. Our ability to make restricted payments is also limited by provisions in the term B loan facility and the indentures covering our notes and debentures.
CSC Holdings, a member of the Restricted Group, has issued senior and senior subordinated notes and debentures, which also contain financial and other covenants, though they are generally less restrictive than the covenants contained in the Restricted Group’s bank credit facility. Principal covenants include a limitation on the incurrence of additional indebtedness based upon a maximum ratio of total indebtedness to cash flow (as defined in the indentures) of 9.00 to 1 and limitations on dividends and distributions. The indentures governing the Cablevision note and debenture issuances contain similar covenants and restrictions, including a limitation on additional debt incurrence based on a 9.00 to 1 debt to cash flow ratio. There are no covenants, events of default, borrowing conditions or other terms in the Restricted Group’s credit facility or in any of CSC Holdings’ or Cablevision’s other debt securities that are based on changes in the credit ratings assigned by any rating agency. The Restricted Group was in compliance with all of its financial covenants under its various credit agreements as of December 31, 2006.
Cablevision’s and CSC Holdings’ future access to the debt markets and the cost of any future debt issuances are also influenced by their credit ratings, which are provided by Moody’s Investors Service and Standard & Poor’s. Key factors in the assessment of Cablevision’s and CSC Holdings’ credit ratings include Cablevision and CSC Holdings’ financial strength and flexibility, operating capabilities, management risk tolerance and ability to respond to changes in the competitive landscape. The corporate credit rating for Cablevision and CSC Holdings is B1 with a stable outlook by Moody’s and BB with a negative outlook by Standard & Poor’s. Any future downgrade to the Cablevision and/or CSC Holdings credit ratings by either rating agency could increase the interest rate on future debt issuances and could adversely impact our ability to raise additional funds. See discussion under Item 1A - Risk Factors, “A lowering or withdrawal of the ratings assigned to our debt securities by ratings agencies may further increase our future borrowing costs and reduce our access to capital.”
Rainbow and Rainbow National Services
RNS, our wholly-owned subsidiary which owns the common equity interests in the Company’s AMC, WE tv and IFC programming operations, generated positive cash from operating activities in 2006. Its cash on hand, plus cash flow from operations and proceeds from borrowings available to it, provides the capital required for net funding and investment requirements of other Rainbow programming entities including the VOOM HD Networks, News 12 Networks and fuse subject to the applicable covenants and limitations contained in RNS’ financing agreements.
On July 5, 2006, RNS entered into an $800,000 senior secured credit facility (the “New RNS Credit Facility”) which consists of a $500,000 term A loan facility and a $300,000 revolving credit facility. The term A loan facility matures June 30, 2013 and the revolving credit facility matures June 30, 2012. The New RNS Credit Facility allows RNS to utilize up to $50,000 of the revolving credit facility for letters of credit and up to $5,000 for a swing loan. Further, the New RNS Credit Facility provides for an incremental facility of up to $925,000, provided that it be for a minimum amount of $100,000. If an incremental facility is established, RNS and the lenders will enter into a supplement to the New RNS Credit Facility with terms and conditions that are no more restrictive than those of the New RNS Credit Facility. There are no commitments from the lenders to fund an incremental facility.
On July 5, 2006, RNS borrowed the entire $500,000 term A loan facility and $10,000 under the revolving credit facility. RNS used the $510,000 borrowed under the New RNS Credit Facility and $88,048 of additional available cash to repay all of its outstanding borrowings, accrued interest and fees due under its August 2004 $950,000 senior secured credit facility of which $592,500 was outstanding under a term loan at July 5, 2006 (scheduled to mature March 31, 2012) and to pay certain fees and expenses incurred in connection with the New RNS Credit Facility. RNS may use future borrowings under the New RNS Credit Facility to make investments, distributions, and other payments permitted under the New RNS Credit Facility and for general corporate purposes. The borrowings under the New RNS Credit Facility may be repaid without penalty at any time. Outstanding borrowings under the term loan and revolving credit facility at February 23, 2007 were $500,000 and $10,000, respectively. RNS had $290,000 in undrawn revolver commitments at February 23, 2007.
Borrowings under the New RNS Credit Facility are direct obligations of RNS which are guaranteed jointly and severally by substantially all of its subsidiaries and by Rainbow Programming Holdings LLC, the direct parent of RNS, and are secured by the pledge of the stock of RNS and substantially all of its subsidiaries, and all of the other assets of RNS and substantially all of its subsidiaries (subject to certain limited exceptions). Borrowings under the New RNS Credit Facility bear interest based on either the Base Rate (the greater of the Federal Funds Rate plus 0.5% and the prime rate (as defined in the New RNS Credit Facility)) or the Eurodollar Rate (as defined in the New RNS Credit Facility). The interest rate under the New RNS Credit Facility varies, depending on RNS’ cash flow ratio (as defined in the New RNS Credit Facility), from 1.0% to 1.5% over the Eurodollar Rate for Eurodollar-based borrowings and from zero to 0.5% over the Base Rate for Base Rate borrowings. At December 31, 2006, the interest rate on the term A loan facility and the revolving credit facility was 6.62% and 6.60%, respectively. The term A loan is to be repaid in quarterly installments of 1.25% of the original outstanding balance ($6,250) from March 31, 2008 until December 31, 2010, 2.5% of the original outstanding balance ($12,500) from March 31, 2011 until December 31, 2012, and 32.5% of the original outstanding balance ($162,500) on March 31, 2013 and June 30, 2013, the maturity of the term A loan. Any amounts outstanding under the revolving credit facility are due at maturity on June 30, 2012.
The financial covenants consist of (i) a minimum ratio of operating cash flow to total interest expense for each quarter (all as defined in the New RNS Credit Facility) of 1.75 to 1, (ii) a maximum cash flow ratio of total indebtedness to annualized operating cash flow (as defined in the New RNS Credit Facility) of 6.75 to 1 through June 30, 2008, decreasing thereafter to 6.25 to 1, and (iii) a maximum senior secured leverage ratio of senior secured debt to annualized operating cash flow (all as defined in the New RNS
Credit Facility) of 5.50 to 1. Additional covenants include restrictions on indebtedness, guarantees, liens, investments, dividends and distributions and transactions with affiliates.
RNS is obligated to pay fees of 0.375% per annum on any undrawn revolver commitment.
RNS also has notes outstanding consisting of $300,000 principal amount of 8-3/4% senior notes due September 1, 2012 and $500,000 principal amount of 10-3/8% senior subordinated notes due September 1, 2014. These notes are guaranteed by substantially all of RNS’ subsidiaries.
RNS was in compliance with all of its financial covenants under its various credit agreements as of December 31, 2006.
In April 2005, subsidiaries of the Company entered into agreements with EchoStar relating to the launch and operation of the business of Rainbow HD Holdings LLC, the Company’s VOOM HD Networks high definition television programming service, subject to the closing of the sale of our satellite (Rainbow 1) to EchoStar which occurred in November 2005. Under those arrangements, EchoStar was initially distributed a portion of the VOOM HD Networks programming service and, beginning in 2006 began carrying all 15 of the channels included in the programming service. In connection with the arrangements, EchoStar was issued a 20% interest in Rainbow HD Holdings, the Company’s subsidiary owning the VOOM HD Networks, and that 20% interest will not be diluted until $500,000 in cash has been invested in Rainbow HD Holdings’ equity by the Company.
Under the terms of the affiliation arrangements with EchoStar covering the VOOM HD Networks for a 15 year term, if Rainbow HD Holdings fails to spend $100,000 per year, up to a maximum of $500,000 in the aggregate, on its service offerings, EchoStar may terminate the affiliation agreement. The Company has the right to terminate the affiliation agreement if the VOOM HD Networks are discontinued in the future.
RNS’ future access to the debt markets and the cost of any future debt issuances are also influenced by its credit ratings, which are provided by Moody’s Investors Service and Standard & Poor’s. Key factors in the assessment of RNS’ credit ratings include its free cash flow generating capacity, fiscal strategy, enterprise value and industry risk. The corporate credit rating for RNS is B1 with a stable outlook by Moody’s and BB with a negative outlook by Standard & Poor’s. Any future downgrade to the RNS credit ratings by either rating agency could increase the interest rate on future debt issuances and could adversely impact its ability to raise additional funds. See discussion under Item 1A - Risk Factors, “A lowering or withdrawal of the ratings assigned to our debt securities by ratings agencies may further increase our future borrowing costs and reduce our access to capital.”
Madison Square Garden We currently expect Madison Square Garden’s funding requirements for the next twelve months to be met by its cash on hand and cash from operations.
During the fourth quarter of 2004, the Company announced its intent to renovate the MSG Arena. Although management of the Company is committed to this renovation project, another alternative, which would involve construction of a new arena on the site of the Farley post office, is also being pursued. A substantial renovation or relocation of the Arena would require significant funding.
Debt Covenants Compliance
CSC Holdings and RNS Credit Agreements:
On August 29, 2006, CSC Holdings advised the agent bank and the lenders under the new Restricted Group credit facility that due to the expected restatement of its financial statements resulting from the stock option review, it was unable to comply with its covenant to deliver financial information, due on that date, with respect to the periods ended June 30, 2005 and 2006.
On August 29, 2006, the lenders under the new Restricted Group credit facility, other than the term B lenders, agreed to waive until September 22, 2006 any default resulting from this covenant noncompliance. CSC Holdings delivered all required information under the new Restricted Group credit facility on September 21, 2006 and the information delivery covenant noncompliance was cured by that delivery.
The Restricted Group did not obtain a waiver of the default resulting from this covenant noncompliance from the lenders holding term B loans under the new Restricted Group credit facility and the bank serving as administrative agent under the new Restricted Group credit facility gave a notice of default to CSC Holdings with respect to such term B covenant noncompliance. CSC Holdings delivered all required information under the new Restricted Group credit facility on September 21, 2006, which cured the information delivery covenant noncompliance within the applicable cure period.
In December 2005, the Company determined that there were certain technical covenant violations under the prior Restricted Group credit facility and the prior RNS credit facility. CSC Holdings and RNS received waivers from the lenders under the credit facilities and RNS entered into a related amendment of its credit agreement. In addition, the Company obtained waivers under the agreements governing its monetizations and interest rate swaps. On January 31, 2006, the Company announced that it had cured these covenant violations and was in compliance with all of the covenants of its debt instruments.
Cablevision and CSC Holdings Indentures:
As a result of not filing their Quarterly Report on Form 10-Q for the quarter ended June 30, 2006 by September 8, 2006, Cablevision and CSC Holdings were not in compliance with the information delivery and filing requirements under the indentures relating to their notes and debentures. An entity stating that it represented holders of more than 25% of the outstanding securities of a series under one of Cablevision’s indentures notified Cablevision that it is serving a notice of default under the applicable indenture and demanded that the covenant noncompliance be remedied. Cablevision and CSC Holdings delivered all required information under the indentures on September 21, 2006, which cured any potential default within the applicable cure period, upon which time the Company was in compliance with all of the covenants of its debt instruments.
Monetization Contract Maturities
During the year ended December 31, 2006, monetization contracts covering 5,586,687 shares of our Charter Communications stock, 3,449,785 shares of our AT&T stock, 12,742,033 shares of our General Electric stock and 7,159,206 shares of our Comcast Communications stock matured. We settled our obligations under the related Charter Communications and AT&T collateralized indebtedness by delivering an equivalent number of Charter Communications and AT&T shares and the cash proceeds from the related equity derivative contracts.
We settled our obligations under the related Comcast and General Electric collateralized indebtedness by delivering cash equal to the collateralized loan value, net of the value of the related equity derivative contracts. The cash was obtained from the proceeds of new monetization contracts covering an
equivalent number of Comcast and General Electric shares, proceeds from a prepaid interest rate swap executed in conjunction with the equity derivative contract related to the Comcast shares and, in certain instances, cash from CSC Holdings. The terms of the new contracts allow the Company to retain upside participation in both Comcast and General Electric shares up to each respective contract’s upside appreciation limit with downside exposure limited below the respective hedge price.
During the next twelve months, monetization contracts covering 3,724,460 shares of Charter Communications stock and 800,000 shares of Leapfrog stock also mature. The Company intends to settle such transactions by either delivering shares of the applicable stock and proceeds of the equity derivative contracts or delivering cash from the proceeds of a new monetization transaction.
CASH FLOW DISCUSSION
Operating Activities
Net cash provided by operating activities amounted to $961,642 for the year ended December 31, 2006 compared to $923,044 for the year ended December 31, 2005. The 2006 cash provided by operating activities resulted from $995,764 of income before depreciation and amortization, $129,496 of non-cash items, a $54,075 increase in accrued and other liabilities and $41,170 from an increase in accounts payable. Partially offsetting these increases were decreases in cash resulting from a $137,196 increase in feature film inventory resulting primarily from new film licensing and original programming agreements, a $59,616 increase in current and other assets, a $29,784 decrease in feature film and contract obligations, a $17,336 decrease in deferred carriage fees payable, and a $14,931 increase in other deferred costs, including an $11,469 increase in deferred carriage fees.
Net cash provided by operating activities amounted to $923,044 for the year ended December 31, 2005 compared to $685,836 for the year ended December 31, 2004. The 2005 cash provided by operating activities resulted from $956,110 of income before depreciation and amortization, $97,282 of non-cash items, $88,716 from an increase in accrued and other liabilities, and $45,371 from a net increase in deferred carriage fees payable, $30,606 from an increase in accounts payable and $25,671 from an increase in deferred revenue. Partially offsetting these increases were decreases in cash resulting from a $142,703 increase in feature film inventory resulting from new film licensing agreements, a $96,752 increase in current and other assets and an $81,257 increase in deferred carriage fees. The increase of $81,257 in deferred carriage fees and an offsetting increase in current and non-current liabilities of $52,527 arose as one part of a series of multiple agreements entered into simultaneously with the settlement of the litigation between AMC and Time Warner Entertainment, L.P.
Net cash provided by operating activities amounted to $685,836 for the year ended December 31, 2004. The 2004 cash provided by operating activities resulted primarily from $652,642 of income before depreciation and amortization, $218,479 of non-cash items, a $52,033 increase in accrued interest, a $129,777 increase in feature film rights payable and a $11,915 increase in accounts payable. Partially offsetting these increases were decreases in cash resulting from a $258,371 increase in feature film inventory resulting from new film licensing agreements, a $89,283 increase in current and other assets and a $31,356 decrease in accrued and other liabilities.
Investing Activities
Net cash used in investing activities for the year ended December 31, 2006 was $873,173 compared to $763,600 for the year ended December 31, 2005. The 2006 investing activities consisted primarily of $886,297 of capital expenditures ($819,747 of which relate to our Telecommunications Services segment), partially offset by other net cash receipts aggregating $13,124.
Net cash used in investing activities for the year ended December 31, 2005 was $763,600 compared to $792,315 for the year ended December 31, 2004. The 2005 investing activities consisted of $769,292 of
capital expenditures ($695,327 of which relate to our Telecommunication Services Segment), $12,886 in additions to other intangible assets and $9,520 in increases to investment securities and other investments, partially offset by a decrease of $27,342 in restricted cash and other net cash receipts of $756.
Net cash used in investing activities for the year ended December 31, 2004 was $792,315. The 2004 investing activities consisted of $697,514 of capital expenditures ($621,480 of which relate to our Telecommunication Services Segment), an $84,738 payment for the acquisition of our interest in DTV Norwich and its acquisition of FCC licenses to provide multichannel video distribution and data service, a $35,797 increase in restricted cash and other net cash payments of $4,341, partially offset by $30,075 received in connection with Northcoast Communications’ sale of PCS licenses, representing the release of funds held in escrow.
Financing Activities
Net cash used in financing activities amounted to $16,759 for the year ended December 31, 2006 compared to $644,594 for the year ended December 31, 2005. In 2006, the Company’s financing activities consisted primarily of a $2,840,780 dividend distribution to common stockholders, $263,125 used for the redemption of CSC Holdings’ senior subordinated debentures, $47,540 in deferred financing costs and other net cash payments of $6,314, partially offset by net proceeds from bank debt of $3,141,000.
Net cash used in financing activities amounted to $644,594 for the year ended December 31, 2005 compared to net cash provided by financing activities of $805,200 for the year ended December 31, 2004. In 2005, the Company’s financing activities consisted of net repayments of bank debt of $638,000 and other net cash payments of $6,594.
Net cash provided by financing activities amounted to $805,200 for the year ended December 31, 2004. In 2004, the Company’s financing activities consisted primarily of $2,793,922 of proceeds from the issuance of senior notes, net bank debt proceeds of $132,848 and $7,270 from the issuance of common stock, partially offset by payments of $1,694,622 for the redemption of CSC Holdings’ Series H and Series M Redeemable Preferred Stock and its Series A Exchangeable Participating Preferred Stock, $350,000 to redeem CSC Holdings’ 9-7/8% senior subordinated debentures, $70,086 of deferred financing costs and other net cash payments of $14,132.
Discontinued Operations
The net effect of discontinued operations on cash and cash equivalents amounted to a cash inflow of $79,656 and $110,976 for the years ended December 31, 2006 and 2005, respectively, and a cash outflow of $157,052 for the year ended December 31, 2004, respectively.
Operating Activities Net cash provided by operating activities of discontinued operations amounted to $75,189 for the year ended December 31, 2006 compared to net cash used by operating activities of $64,535 for the year ended December 31, 2005. The 2006 cash provided by operating activities resulted primarily from the collection of $77,996 of affiliate revenue in June 2006 from a cable affiliate that had not been previously collected due to a contractual dispute.
Net cash used by operating activities of discontinued operations amounted to $64,535 for the year ended December 31, 2005 compared to $73,860 for the year ended December 31, 2004. The 2005 cash used by operating activities resulted primarily from a loss of $67,691 before depreciation and amortization and non-cash items, partially offset by net changes in assets and liabilities of $3,156.
Net cash used by operating activities of discontinued operations amounted to $73,860 for the year ended December 31, 2004. The 2004 operating activities resulted primarily from a loss of $72,184 before depreciation and amortization and non-cash items and net changes in assets and liabilities of $1,676.
Investing Activities
Net cash provided by investing activities of discontinued operations for the year ended December 31, 2006 was $4,467 compared to net cash provided by investing activities of $80,174 for the year ended December 31, 2005. The 2006 investing activities consisted of a $3,912 refund from a supplier and $555 of other net cash receipts.
Net cash provided by investing activities of discontinued operations for the year ended December 31, 2005 was $80,174 compared to net cash used by investing activities of $84,816 for the year ended December 31, 2004. The 2005 investing activities consisted of $200,801 of proceeds primarily from the sale of the Rainbow DBS satellite, partially offset by $108,947 of net cash transferred to News Corporation as part of the Regional Programming Partners restructuring, $11,504 of capital expenditures and other net cash payments of $176.
Net cash used in investing activities of discontinued operations for the year ended December 31, 2004 was $84,816. The 2004 investing activities consisted of $78,121 of capital expenditures and $6,695 of additions to intangible assets.
The net increase in cash classified in assets held for sale was $95,337 and $1,624 for the years ended December 31, 2005 and 2004, respectively.
Contractual Obligations and Off Balance Sheet Commitments
The Company’s contractual obligations as of December 31, 2006, which consist primarily of our debt obligations, and the effect such obligations are expected to have on our liquidity and cash flow in future periods, are summarized in the following table:
See “Liquidity and Capital Resources” section for a discussion on payment options the Company has on its monetization contracts and notices of default received under various debt obligations. See Notes 9 and 10 to our consolidated financial statements for a discussion of our long-term debt. See Note 13 to our consolidated financial statements for a discussion of our operating leases. See Note 1 to our consolidated financial statements for a discussion of our feature film obligations.
(1) Programming obligations represent contractual commitments with various programming vendors to provide video services to the Company’s subscribers. Future fees under such contracts are based on numerous factors, including the number of subscribers receiving the programming. Amounts reflected above are based on the number of subscribers receiving the programming as of December 2006 multiplied by the per subscriber rates contained in the executed agreements in effect as of December 31, 2006.
(2) Purchase obligation amounts not reflected on the balance sheet consist primarily of (i) long-term rights agreements which provide Madison Square Garden and other regional sports networks with exclusive broadcast rights to certain live sporting events in exchange for minimum contractual payments, (ii) payments under employment agreements that we have with our professional sports teams’ personnel that are generally guaranteed regardless of employee injury or termination, and (iii) minimum purchase requirements incurred in the normal course of the Company’s operations.
(3) Operating lease commitments represent primarily future minimum payment obligations on various long-term, noncancelable leases for office and storage space, lease commitments for Radio City Music Hall, the Beacon Theater and Clearview Cinemas, and rental space on utility poles used for the Company’s Telecommunications Segment. (4) Includes outstanding guarantees primarily by CSC Holdings in favor of certain financial institutions in respect of ongoing interest expense obligations and potential early termination events in connection with the monetization of the Company’s holdings of Charter Communications. Amounts payable under such monetization guarantees are estimated as of a particular point in time by the financial institution counterparty and are based upon the current price of the underlying common stock and various other assumptions, including stock market volatility and prevailing interest rates. Such guaranteed amounts approximate the fair value of the monetization indebtedness less the sum of the fair values of the underlying stock and the equity collar as reflected in the Company’s accompanying consolidated balance sheet.
(5) Consist primarily of letters of credit obtained by CSC Holdings in favor of insurance providers and certain governmental authorities for the Telecommunications Services segment.
(6) Excludes interest payments and includes future payments due on the Company’s (i) bank debt, (ii) senior notes and debentures, (iii) senior subordinated notes and debentures, (iv) collateralized indebtedness, and (v) notes payable.
(7) Reflects the face amount of capital lease obligations, including related interest.
(8) Consist principally of amounts earned under employment agreements that we have with our professional sports teams’ personnel. Other long-term obligations also include deferred carriage payments.
The future cash payments reflected above do not include the impact of potential insurance recoveries or amounts which may be due to the NBA for luxury tax payments.
In addition, the future cash payments reflected above do not include the payments required under the Company’s agreements with EchoStar relating to the launch and operation of the business of Rainbow HD Holdings, the Company’s VOOM HD Networks high-definition television programming service. EchoStar was issued a 20% interest in Rainbow HD Holdings, the Company’s subsidiary owning the VOOM HD Networks programming service, and that 20% interest will not be diluted until $500,000 in cash has been invested in Rainbow HD Holdings by the Company. Under the terms of the affiliation arrangements with EchoStar covering the VOOM HD Networks for a 15 year term, if Rainbow HD Holdings fails to spend $100,000 per year, up to a maximum of $500,000 in the aggregate, on its service offerings, EchoStar may terminate the affiliation agreement. The Company has the right to terminate the affiliation agreement if the VOOM HD Networks are discontinued in the future. On the fifth or eighth anniversary of the effective date of the agreement, the termination of the affiliation agreement by EchoStar, or other specified events, EchoStar has a put right to require a wholly-owned subsidiary of Rainbow Media Holdings to purchase all of its equity interests in Rainbow HD Holdings at fair value. On the seventh or tenth anniversary of the effective date of the agreement, or the second anniversary date of the termination of the Affiliation Agreement by EchoStar, a wholly-owned subsidiary of Rainbow Media Holdings has a call right to purchase all of EchoStar’s ownership in Rainbow HD Holdings at fair value.
Managing our Interest Rate and Equity Price Risk Interest Rate Risk
To manage interest rate risk, we have entered into interest rate swap contracts to adjust the proportion of total debt that is subject to variable and fixed interest rates. Such contracts effectively fix the borrowing rates on floating rate debt to provide an economic hedge against the risk of rising rates and/or effectively convert fixed rate borrowings to variable rates to permit the Company to realize lower interest expense in a declining interest rate environment. We do not enter into interest rate swap contracts for speculative or trading purposes and have only entered into transactions with counterparties that are rated investment grade.
All of our interest rate derivative contracts are entered into by CSC Holdings and are thus attributable to the Restricted Group; all such contracts are carried at their fair market values on our consolidated balance sheets, with changes in value reflected in the consolidated statements of operations.
Equity Price Risk
We have entered into derivative contracts to hedge our equity price risk and monetize the value of our shares of Comcast, Charter Communications, General Electric, and Leapfrog. These contracts, at maturity, are expected to offset declines in the fair value of these securities below the hedge price per share, while allowing us to retain upside appreciation from the hedge price per share to the relevant cap price. If any one of these contracts is terminated prior to its scheduled maturity date due to the occurrence of an event specified in the contract, we would be obligated to repay the fair value of the collateralized indebtedness less the sum of the fair values of the underlying stock and equity collar, calculated at the termination date. The underlying stock and the equity collars are carried at fair market value on our consolidated balance sheets and the collateralized indebtedness is carried at its accreted value. Please refer to Note 10 to our consolidated financial statements for additional information on these transactions.
See “Item 7A
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
All dollar amounts, except per subscriber, per unit and per share data, included in the following discussion under this Item 7A are presented in thousands.
Equity Price Risk
The Company is exposed to market risks from changes in certain equity security prices. Our exposure to changes in equity security prices stems primarily from the shares of Comcast, Charter Communications, General Electric and Leapfrog common stock held by us. We have entered into prepaid forward contracts consisting of a collateralized loan and an equity collar to hedge our equity price risk and to monetize the value of these securities. These contracts, at maturity, are expected to offset declines in the fair value of these securities below the hedge price per share, while allowing us to retain upside appreciation from the hedge price per share to the relevant cap price. The contracts’ actual hedge prices per share vary depending on average stock prices in effect at the time the contracts were executed. The contracts’ actual cap prices vary depending on the maturity and terms of each contract, among other factors. If any one of these contracts is terminated prior to its scheduled maturity date due to the occurrence of an event specified in the contract, we would be obligated to repay the fair value of the collateralized indebtedness less the sum of the fair values of the underlying stock and equity collar, calculated at the termination date. The following table details our estimated early termination exposure as of December 31, 2006:
The underlying stock and equity collars are carried at fair value on our consolidated balance sheet and the collateralized indebtedness is carried at its accreted value. The carrying value of our collateralized indebtedness amounted to $921,574 at December 31, 2006. At maturity, the contracts provide for the option to deliver cash or shares of General Electric, Charter Communications, Comcast, or Leapfrog stock (as the case may be), with a value determined by reference to the applicable stock price at maturity.
As of December 31, 2006, the fair value and the carrying value of our holdings of Comcast, Charter Communications, General Electric and Leapfrog common stock aggregated $1,099,210. Assuming a 10% change in price, the potential change in the fair value of these investments would be approximately $109,921. As of December 31, 2006, the net fair value and the carrying value of the equity collar component of the prepaid forward contracts entered into to hedge the equity price risk of certain of these securities aggregated $82,009, a net payable position. For the year ended December 31, 2006, we recorded a net loss on all outstanding equity derivative contracts of $214,352. We also recorded an unrealized and realized gain on our holdings of the underlying stocks of $284,096 for the year ended December 31, 2006, as shown in the following table:
In addition, at December 31, 2006, the Company had other investment securities with a carrying value of approximately $10,715. Assuming a 10% change in the price of the securities, the potential change in the fair value of these investments would be approximately $1,072.
The maturity, number of shares deliverable at the relevant maturity, hedge price per share, and the lowest and highest cap prices received for each security monetized via a prepaid forward contract are summarized in the following table:
* Represents the price below which we are provided with downside protection and above which we retain upside appreciation. Also represents the price used in determining the cash proceeds payable to us at inception of the contracts.
** Represents the price up to which we receive the benefit of stock price appreciation.
Fair Value of Debt: Based on the level of interest rates prevailing at December 31, 2006, the fair value of our fixed rate debt of $6,886,074 exceeded its carrying value of $6,812,986 by $73,088. The fair value of these financial instruments is estimated based on reference to quoted market prices for these or comparable securities. Our floating rate borrowings bear interest in reference to current LIBOR-based market rates and thus approximate fair value. The effect of a hypothetical 100 basis point decrease in interest rates prevailing at December 31, 2006 would increase the estimated fair value of our fixed rate debt by $236,505 to $7,122,579. This estimate is based on the assumption of an immediate and parallel shift in interest rates across all maturities.
Interest Rate Derivative Contracts: Our exposure to interest rate movements results from our use of floating rate debt, including $3,500,000 of debt incurred in 2006 to fund the approximately $3,000,000 special dividend described herein and to repay existing indebtedness of approximately $414,000, including accrued interest, fees and expenses. To manage interest rate risk, from time to time we have entered into interest rate swap contracts to adjust the proportion of total debt that is subject to variable and fixed interest rates. Such contracts effectively fix the borrowing rates on floating rate debt to provide an economic hedge against the risk of rising rates and/or effectively convert fixed rate borrowings to variable rates to permit the Company to realize lower interest expense in a declining interest rate environment. In addition, from time to time we may utilize short-term interest rate lock agreements to hedge the risk that the cost of a future issuance of fixed rate debt may be adversely affected by changes in interest rates. We do not enter into interest rate swap contracts for speculative or trading purposes. All of our interest rate derivative contracts are entered into by CSC Holdings and are thus attributable to the Restricted Group; all such contracts are carried at their fair market values on our consolidated balance sheets, with changes in value reflected in the consolidated statements of operations.
As of December 31, 2006, we had outstanding interest rate swap contracts to convert fixed rate debt to floating rate debt covering a total notional principal amount of $450,000. As of December 31, 2006, the fair market value and carrying value of these interest rate swap contracts was $6,568, a net liability position, reflected as liabilities under derivative contracts in our consolidated balance sheet. Assuming an immediate and parallel shift in interest rates across the yield curve, a 100 basis point increase in interest rates from December 31, 2006 prevailing levels would increase the fair value of these contracts to a net liability of $10,963.
As of December 31, 2006, we also had outstanding interest rate swap contracts in the notional amount of $3,700,000 to effectively fix borrowing rates on floating rate debt. As of December 31, 2006, these interest rate swap contracts had a fair market value and carrying value of $31,398, a net liability position, as reflected under derivative contracts in our consolidated balance sheet. Assuming an immediate and parallel shift in interest rates across the yield curve, a 100 basis point decrease in interest rates prevailing at December 31, 2006 would increase our liability under these derivative contracts by $98,663 to a liability of $130,061.
For the year ended December 31, 2006, we recorded a net loss on interest swap contracts of $36,473, as detailed in the table below:
In addition, we had outstanding at December 31, 2006 prepaid interest rate swap contracts with a notional value of $105,061 entered into in connection with our monetization transactions. As of December 31, 2006, the fair value of our prepaid interest rate derivative contracts was $10,340, a net liability position. Assuming an immediate and parallel shift in interest rates across the yield curve, a 100 basis point increase in interest rates from December 31, 2006 prevailing levels would increase our liability under these derivative contracts by $697 to a liability of $11,037.
For the year ended December 31, 2006, we recorded a net loss on such derivative contracts of $2,887 as detailed below:
Item 8.
Item 8. Financial Statements and Supplementary Data.
For information required by Item 8, refer to the Index to Financial Statements on page 110.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A.
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
An evaluation was carried out under the supervision and with the participation of the Company’s management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined under SEC rules). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the design and operation of these disclosure controls and procedures were effective as of December 31, 2006.
Management’s Annual Report on Internal Control Over Financial Reporting
The Company’s management is responsible for establishing and maintaining effective internal control over financial reporting as defined in Rules 13a-15(f) under the Securities Exchange Act of 1934, as amended. The Company’s internal control over financial reporting is a process designed under the supervision of the Company’s Chief Executive Officer and Chief Financial Officer to provide reasonable assurance to the Company’s management and Board of Directors regarding the reliability of financial reporting and the preparation of the Company’s external financial statements, including estimates and judgments, in accordance with accounting principles generally accepted in the United States of America.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those internal controls determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
The Company’s management conducted an assessment of the effectiveness of the Company’s internal control over financial reporting based on the framework established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this assessment, management concluded that the Company’s internal control over financial reporting was effective as of December 31, 2006.
Attestation Report of the Registered Public Accounting Firm
Management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2006 has been audited by KPMG LLP, an independent registered public accounting firm, as stated in their attestation reports appearing on pages I-1, I-2, II-1 and II-2.
Changes in Internal Control
None.
Item 9B.