Attached files
file | filename |
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EX-2.1 - ASSET PURCHASE AGREEMENT - KNOLOGY INC | dex21.htm |
EX-31.1 - SECTION 302 CEO CERTIFICATION - KNOLOGY INC | dex311.htm |
EX-31.2 - SECTION 302 CFO CERTIFICATION - KNOLOGY INC | dex312.htm |
EX-32.2 - SECTION 906 CFO CERTIFICATION - KNOLOGY INC | dex322.htm |
EX-32.1 - SECTION 906 CEO CERTIFICATION - KNOLOGY INC | dex321.htm |
Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2010
COMMISSION FILE NUMBER: 000-32647
KNOLOGY, INC.
(Exact name of registrant as specified in its charter)
DELAWARE | 58-2424258 | |
(State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) | |
KNOLOGY, INC. 1241 O.G. SKINNER DRIVE WEST POINT, GEORGIA |
31833 | |
(Address of principal executive offices) | (Zip Code) |
Registrants telephone number, including area code: (706) 645-8553
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check One)
Large accelerated filer | ¨ | Accelerated filer | x | |||
Non-accelerated filer | ¨ (Do not check if smaller reporting company) | Smaller reporting company | ¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): Yes ¨ No x
As of October 31, 2010, Knology, Inc. had 37,102,302 shares of common stock outstanding.
Table of Contents
KNOLOGY, INC. AND SUBSIDIARIES
QUARTER ENDED SEPTEMBER 30, 2010
INDEX
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ITEM 1. | FINANCIAL STATEMENTS |
KNOLOGY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
December 31, 2009 |
September 30, 2010 (Unaudited) |
|||||||
ASSETS | ||||||||
CURRENT ASSETS: |
||||||||
Cash and cash equivalents |
$ | 44,016 | $ | 61,366 | ||||
Restricted cash |
725 | 1,401 | ||||||
Certificates of deposit and other short term investments |
35,050 | 30,150 | ||||||
Accounts receivable, net of allowance for doubtful accounts of $1,218 and $1,269 as of December 31, 2009 and September 30, 2010, respectively |
32,668 | 35,745 | ||||||
Prepaid expenses and other |
2,986 | 4,441 | ||||||
Total current assets |
115,445 | 133,103 | ||||||
PROPERTY, PLANT AND EQUIPMENT, NET |
357,880 | 355,992 | ||||||
GOODWILL |
149,741 | 149,741 | ||||||
CUSTOMER BASE, NET |
8,661 | 7,057 | ||||||
DEFERRED DEBT ISSUANCE AND DEBT MODIFICATION COSTS, NET |
7,544 | 5,368 | ||||||
INVESTMENTS |
3,683 | 4,011 | ||||||
OTHER INTANGIBLES AND OTHER ASSETS, NET |
3,947 | 3,406 | ||||||
Total assets |
$ | 646,901 | $ | 658,678 | ||||
LIABILITIES AND STOCKHOLDERS EQUITY | ||||||||
CURRENT LIABILITIES: |
||||||||
Current portion of long term debt |
$ | 9,841 | $ | 10,593 | ||||
Accounts payable |
25,768 | 32,676 | ||||||
Accrued liabilities |
22,349 | 19,739 | ||||||
Unearned revenue |
14,795 | 16,558 | ||||||
Interest rate swaps |
16,526 | 0 | ||||||
Total current liabilities |
89,279 | 79,566 | ||||||
NONCURRENT LIABILITIES: |
||||||||
Long term debt, net of current portion |
591,514 | 576,019 | ||||||
Interest rate swaps |
0 | 8,382 | ||||||
Total noncurrent liabilities |
591,514 | 584,401 | ||||||
Total liabilities |
680,793 | 663,967 | ||||||
COMMITMENTS AND CONTINGENCIES |
||||||||
STOCKHOLDERS EQUITY: |
||||||||
Preferred stock, $.01 par value per share; 199,000,000 shares authorized, none outstanding |
0 | 0 | ||||||
Non-voting common stock, $.01 par value per share; 25,000,000 shares authorized, none outstanding |
0 | 0 | ||||||
Common stock, $.01 par value per share; 200,000,000 shares authorized, 36,561,405 and 37,076,450 shares issued and outstanding at December 31, 2009 and September 30, 2010, respectively |
366 | 371 | ||||||
Additional paid-in capital |
602,508 | 608,020 | ||||||
Accumulated other comprehensive loss |
(10,324 | ) | 6 | |||||
Accumulated deficit |
(626,442 | ) | (613,686 | ) | ||||
Total stockholders deficit |
(33,892 | ) | (5,289 | ) | ||||
Total liabilities and stockholders equity |
$ | 646,901 | $ | 658,678 | ||||
See notes to condensed consolidated financial statements.
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KNOLOGY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Three Months Ended September 30, |
Nine Months Ended September 30, |
|||||||||||||||
2009 | 2010 | 2009 | 2010 | |||||||||||||
OPERATING REVENUES: |
||||||||||||||||
Video |
$ | 46,048 | $ | 50,510 | $ | 137,809 | $ | 150,173 | ||||||||
Voice |
32,372 | 31,797 | 98,916 | 95,575 | ||||||||||||
Data |
24,487 | 26,195 | 73,603 | 77,911 | ||||||||||||
Other |
2,895 | 4,375 | 8,088 | 12,323 | ||||||||||||
Total operating revenues |
105,802 | 112,877 | 318,416 | 335,982 | ||||||||||||
OPERATING EXPENSES: |
||||||||||||||||
Direct costs (excluding depreciation and amortization) |
31,896 | 36,710 | 98,660 | 109,210 | ||||||||||||
Selling, general and administrative expenses |
39,566 | 40,063 | 116,638 | 116,609 | ||||||||||||
Depreciation and amortization |
22,436 | 20,832 | 67,997 | 64,525 | ||||||||||||
Total operating expenses |
93,898 | 97,605 | 283,295 | 290,344 | ||||||||||||
OPERATING INCOME |
11,904 | 15,272 | 35,121 | 45,638 | ||||||||||||
OTHER INCOME (EXPENSE): |
||||||||||||||||
Interest income |
180 | 74 | 477 | 288 | ||||||||||||
Interest expense |
(10,363 | ) | (8,349 | ) | (29,611 | ) | (31,129 | ) | ||||||||
Debt modification expense |
(3,422 | ) | 0 | (3,422 | ) | 0 | ||||||||||
Gain (loss) on interest rate swaps |
2,796 | (651 | ) | 6,545 | 8,144 | |||||||||||
Amortization of deferred loss on interest rate swaps |
(4,533 | ) | (451 | ) | (13,846 | ) | (10,324 | ) | ||||||||
Other income, net |
104 | 37 | 462 | 139 | ||||||||||||
Total other expense |
(15,238 | ) | (9,340 | ) | (39,395 | ) | (32,882 | ) | ||||||||
NET INCOME (LOSS) |
$ | (3,334 | ) | $ | 5,932 | $ | (4,274 | ) | $ | 12,756 | ||||||
BASIC NET INCOME (LOSS) PER SHARE |
$ | (0.09 | ) | $ | 0.16 | $ | (0.12 | ) | $ | 0.35 | ||||||
DILUTED NET INCOME (LOSS) PER SHARE |
$ | (0.09 | ) | $ | 0.15 | $ | (0.12 | ) | $ | 0.33 | ||||||
BASIC WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING |
36,031,902 | 37,031,429 | 35,901,886 | 36,811,646 | ||||||||||||
DILUTED WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING |
36,031,902 | 39,128,436 | 35,901,886 | 38,856,821 | ||||||||||||
See notes to condensed consolidated financial statements.
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KNOLOGY, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(DOLLARS IN THOUSANDS)
Nine Months Ended September 30, |
||||||||
2009 | 2010 | |||||||
CASH FLOWS FROM OPERATING ACTIVITIES: |
||||||||
Net income (loss) |
$ | (4,274 | ) | $ | 12,756 | |||
Adjustments to reconcile net loss to net cash provided by operating activities: |
||||||||
Depreciation and amortization |
67,997 | 64,525 | ||||||
Non-cash stock compensation |
4,615 | 4,441 | ||||||
Non-cash bank loan interest expense |
1,997 | 2,176 | ||||||
Non-cash gain on interest rate swaps |
(6,545 | ) | (8,144 | ) | ||||
Non-cash amortization of deferred loss on interest rate swaps |
13,846 | 10,324 | ||||||
Non-cash interest income |
0 | (40 | ) | |||||
Provision for bad debt |
3,950 | 4,683 | ||||||
Gain on sale of short term investments |
0 | (10 | ) | |||||
Gain on disposition of property |
(144 | ) | (42 | ) | ||||
Changes in operating assets and liabilities: |
||||||||
Accounts receivable |
(5,310 | ) | (7,760 | ) | ||||
Prepaid expenses and other assets |
(2,764 | ) | (676 | ) | ||||
Accounts payable |
2,574 | 6,908 | ||||||
Accrued liabilities |
758 | (2,610 | ) | |||||
Unearned revenue |
(432 | ) | 1,763 | |||||
Total adjustments |
80,542 | 75,538 | ||||||
Net cash provided by operating activities |
76,268 | 88,294 | ||||||
CASH FLOWS FROM INVESTING ACTIVITIES: |
||||||||
Capital expenditures |
(40,549 | ) | (57,486 | ) | ||||
Maturities of certificates of deposit |
0 | 20,000 | ||||||
Proceeds from sale of short term investments |
0 | 14,979 | ||||||
Investment in certificates of deposit and other short term investments |
(35,050 | ) | (30,023 | ) | ||||
Investment in Tower Cloud, Inc. |
0 | (328 | ) | |||||
MDU signing bonuses and other intangible expenditures |
(750 | ) | (596 | ) | ||||
Proceeds from sale of property |
218 | 106 | ||||||
Change in restricted cash |
(45 | ) | (676 | ) | ||||
Net cash used in investing activities |
(76,176 | ) | (54,024 | ) | ||||
CASH FLOWS FROM FINANCING ACTIVITIES: |
||||||||
Principal payments on debt and short-term borrowings |
(15,196 | ) | (17,996 | ) | ||||
Expenditures related to issuance and modification of long term debt |
(1,831 | ) | 0 | |||||
Stock options exercised |
328 | 1,076 | ||||||
Net cash used in financing activities |
(16,699 | ) | (16,920 | ) | ||||
NET DECREASE IN CASH AND CASH EQUIVALENTS |
(16,607 | ) | 17,350 | |||||
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR |
57,362 | 44,016 | ||||||
CASH AND CASH EQUIVALENTS AT END OF PERIOD |
$ | 40,755 | $ | 61,366 | ||||
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: |
||||||||
Cash paid during the periods for interest |
$ | 32,307 | $ | 32,373 | ||||
Non-cash financing activities: |
||||||||
Debt acquired in capital lease transactions |
$ | 4,897 | $ | 3,253 | ||||
See notes to condensed consolidated financial statements.
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KNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
AS OF AND FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2010
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
1. ORGANIZATION AND NATURE OF BUSINESS
Knology, Inc. and its subsidiaries, including its predecessors (Knology or the Company), is a publicly traded company incorporated under the laws of the State of Delaware in September 1998.
Knology owns and operates an advanced interactive broadband network and provides residential and business customers broadband communications services, including analog and digital cable television, local and long-distance telephone, high-speed Internet access, and broadband carrier services to various markets in the Southeastern and Midwestern United States. Certain subsidiaries are subject to regulation by state public service commissions of applicable states for intrastate telecommunications services. For applicable interstate matters related to telephone service, certain subsidiaries are subject to regulation by the Federal Communications Commission.
2. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of the Company include the accounts of the Company and all of its subsidiaries. The information included in the condensed consolidated balance sheet at December 31, 2009 has been derived from audited financial statements. The unaudited interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted (GAAP) in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all normally recurring adjustments considered necessary for the fair presentation of the financial statements have been included, and the financial statements present fairly the financial position and results of operations for the interim periods presented. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto, together with managements discussion and analysis of financial condition and results of operations contained in the Companys Annual Report on Form 10-K for the year ended December 31, 2009. The Company operates as one operating segment.
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ACCOUNTING ESTIMATES
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. On an on-going basis, the Company evaluates its estimates, including those related to collectability of accounts receivable, valuation of investments, valuation of stock based compensation, useful lives of property, plant and equipment, recoverability of goodwill and intangible assets, income taxes and contingencies. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. These changes in estimates are recognized in the period they are realized.
RECENTLY ADOPTED ACCOUNTING STANDARDS
In February 2010, the Financial Accounting Standards Board (the FASB) issued new accounting guidance that amends and establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. The new guidance is effective for interim and annual financial periods ending after February 24, 2010. The adoption of this guidance did not have a material impact on the Companys results of operations or financial position.
In January 2010, the FASB issued new accounting guidance that improves fair value measurement disclosures by requiring new disclosures about transfers into and out of levels of the fair value hierarchy. It also requires separate disclosures about purchases, sales, issuances, and settlements related to the fair value hierarchy. The new guidance is effective for interim and annual financial periods beginning after December 15, 2009. The adoption of this guidance did not have a material impact on the Companys results of operations or financial position.
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In June 2009, the FASB issued new accounting guidance that improves financial reporting by enterprises involved with variable interest entities. The new guidance is effective for financial statements issued for fiscal years beginning after November 15, 2009. The adoption of this guidance did not have a material impact on the Companys results of operations or financial position.
In June 2009, the FASB issued new accounting guidance that improves and defines the information that a reporting entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferors continuing involvement, if any, in transferred financial assets. The new guidance is effective for financial statements issued for fiscal years beginning after November 15, 2009. The adoption of this guidance did not have a material impact on the Companys results of operations or financial position.
In April 2009, the FASB issued new accounting guidance related to disclosures about the fair values of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. The new guidance also amends previous accounting literature to require those disclosures in summarized financial information at interim reporting periods. This guidance is effective for interim reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The adoption of this guidance did not have a material impact on the Companys results of operations or financial position.
In April 2009, the FASB issued new accounting guidance related to estimating fair value in accordance with previous accounting literature when the volume and level of activity for the asset or liability have significantly decreased. The new guidance also relates to identifying circumstances that indicate if a transaction is not orderly (i.e., a forced liquidation or distressed sale). This guidance is effective for interim and annual reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The adoption of this guidance did not have a material impact on the Companys results of operations or financial position.
4. CASH
Cash
Cash and cash equivalents are highly liquid investments with a maturity of three months or less at the date of purchase and consist of time deposits and investment in money market accounts with commercial banks and financial institutions. At times throughout the year and at quarter-end, cash balances held at financial institutions were in excess of federally insured limits.
Restricted Cash
Restricted cash is presented as a current asset since the associated maturity dates expire within one year of the balance sheet date. At December 31, 2009 and September 30, 2010, the Company has $725 and $1,401, respectively, of cash that is restricted in use, all of which the Company has pledged as collateral related to certain insurance, franchise and surety bond agreements.
5. SHORT TERM INVESTMENTS
Certificates Of Deposit
Certificates of deposit are short-term investments with original maturities of more than three months and up to twelve months.
Other Short Term Investments
Other short term investments consist of U.S. Treasury Bills with original maturities of twelve months that are classified as available for sale securities.
6. GOODWILL AND INTANGIBLE ASSETS
The Company performs a goodwill impairment test in accordance with the FASBs accounting guidance annually as of January 1. There was no impairment identified as a result of the January 1, 2010 impairment test, nor has there been any event in the nine months ended September 30, 2010 that indicated a need for reassessment.
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7. DERIVATIVE FINANCIAL INSTRUMENTS
On April 18, 2007, the Company entered into an interest rate swap contract to mitigate interest rate risk on an initial notional amount of $555,000 in connection with the term loan associated with the acquisition of PrairieWave Holdings, Inc. (PrairieWave). The swap agreement became effective on May 3, 2007 and ended on July 3, 2010.
On December 19, 2007, the Company entered into a second interest rate swap contract to mitigate interest rate risk on an initial notional amount of $59,000, amortizing 1% annually, in connection with the incremental term loan incurred in connection with the acquisition of Graceba Total Communications Group, Inc. (Graceba). The swap agreement became effective on January 4, 2008 and ended on September 30, 2010.
Until December 31, 2008, the Company matched 3-month LIBOR rates on the term loans and the interest rate swaps, creating effective hedges under the FASBs guidance on accounting for derivative instruments and hedging activities. Due to a significant difference between the 1-month and 3-month LIBOR rates, the Company decided to reset the borrowing rate on the debt using 1-month LIBOR.
| On December 31, 2008, the Company reset the borrowing rate on the $59,000 term loan to 1-month LIBOR (although this became an ineffective hedge under the FASBs accounting guidance, there was no material effect on the Companys financial results for the one day in 2008). |
| On January 2, 2009, the Company reset the borrowing rate on the $555,000 term loan to 1-month LIBOR. |
| The Company will determine LIBOR rates on future reset dates based on prevailing conditions at the time. |
As a result of the LIBOR rates on the term loans (1-month LIBOR) not matching the LIBOR rate on the interest rate swaps (3-month LIBOR), the Company is no longer eligible for hedge accounting related to the interest rate swaps associated with both of these loans.
Until the December 31, 2008 reset of the borrowing rate on the $59,000 term loan, changes in the fair value of the Companys swap agreements were recorded as Accumulated other comprehensive loss in the equity section of the balance sheet, and the swap in variable to fixed interest rate was recorded as Interest expense on the statement of operations when the interest was incurred. Starting with the reset of the borrowing rate on December 31, 2008, changes in the fair value of the interest rate swaps are recorded as Gain (loss) on interest rate swaps in the Other income (expense) section of the statement of operations as they are incurred. The remaining balance in Accumulated other comprehensive loss in the stockholders equity section of the balance sheet that is related to the interest rate swaps is amortized as Amortization of deferred loss on interest rate swaps on the statement of operations over the remaining life of the derivative instruments. The Company recorded amortization expense related to the deferred loss on interest rate swaps in the amounts of $4,533 and $13,846 for the three and nine months ended September 30, 2009. The Company also recorded amortization expense related to the deferred loss on interest rate swaps in the amounts of $451 and $10,324 for the three and nine months ended September 30, 2010. As of September 30, 2010, the entire remaining amount in accumulated other comprehensive loss related to these interest rate swaps has been amortized.
On November 25, 2009, the Company entered into a third interest rate swap contract to mitigate interest rate risk on an initial notional amount of $400,000. The swap agreement, which became effective July 3, 2010 and ends April 3, 2012, fixes $400,000 of the floating rate debt at 1.98% as of September 30, 2010.
The notional amount for the next annual period is summarized below:
Start date |
End date |
Amount | ||
July 3, 2010 |
October 2, 2010 | $400,000 | ||
October 3, 2010 |
January 2, 2011 | $398,800 | ||
January 3, 2011 |
April 2, 2011 | $382,600 | ||
April 3, 2011 |
July 2, 2011 | $381,400 | ||
July 3, 2011 |
October 2, 2011 | $380,200 |
As with the previous two interest rate swaps, this interest rate instrument is not designated as a hedge and therefore does not utilize hedge accounting. Changes in the fair value of the swap agreement are recorded as Gain (loss) on interest rate swaps in the Other income (expense) section of the statement of operations and the swap in variable to fixed interest rate is recorded as Interest expense on the statement of operations when the interest is incurred.
The Company recorded a gain on the change in the fair value of the interest rate swaps in the amounts of $2,796 and $6,545 for the three and nine months ended September 30, 2009. The Company also recorded a gain (loss) on the change in the fair value of the interest rate swaps in the amounts of $(651) and $8,144 for the three and nine months ended September 30, 2010.
The interest rate swaps are valued by an independent third party. An error occurred due to a misinterpretation of the valuation information, specifically related to the inclusion of accrued interest in the third party valuation as well as separately accruing interest payable. The correction of the error in the valuation of the derivative resulted in a credit to other income in the amount of $4,163 in the second quarter of 2010. Further, the Company would have recognized $3,524 less charge to expense from the change in derivative
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value during the first quarter of 2009 had the interest rate swaps been recorded correctly. The effect over all other quarters in 2009 was approximately $783. The Company believes the correction of this non-cash item is immaterial to the users of our financial statements as it has no impact on total revenue; Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA); net operating income and cash flows for the periods affected, and these are key metrics used by analysts, lenders and other users of our financial statements in evaluating the Companys performance. Therefore no restatement of prior period financial statements is deemed necessary. The correction has no impact on the statement of operations prior to January 1, 2009.
8. DEBT
On March 14, 2007, the Company entered into an Amended and Restated Credit Agreement (the Credit Agreement) that provides for a $580,000 credit facility, consisting of a $555,000 term loan (the Initial Term Loan) and a $25,000 revolving credit facility. On April 3, 2007, the Company received proceeds of $555,000 to fund the $255,000 PrairieWave acquisition purchase price, refinance the Companys existing first and second term loans, and pay transaction costs associated with the transactions. This term loan bears interest at LIBOR plus 2.25% and is payable quarterly, with a June 30, 2012 maturity date. Prior to Amendment No. 2 discussed below, this term loan originally amortized at a rate of 1% per annum.
On January 4, 2008, the Company entered into a First Amendment to the Credit Agreement which provides for a $59,000 incremental term loan (the First Amendment Incremental Term Loan) used to fund in part the $75,000 Graceba acquisition purchase price. This term loan bears interest at LIBOR plus 2.75% and is payable quarterly, with a June 30, 2012 maturity date. Prior to Amendment No. 2 discussed below, this term loan originally amortized at a rate of 1% per annum.
On September 28, 2009, the Company entered into Amendment No. 2 to the Credit Agreement (Amendment No. 2) which extends the maturity date of an aggregate $399,000 of existing term loans under the Credit Agreement by two years (the Extended Term Loan). The Extended Term Loan bears interest at LIBOR plus 3.50% and amortizes at a rate of 1% per annum, payable quarterly, with a June 30, 2014 maturity date. Amendment No. 2 also, among other modifications, increases the revolving credit facility to $35,000 from $25,000 and allows for an annual, cumulative restricted payment allowance of $10,000 for dividends and/or share repurchases utilizing excess cash flow and subject to a maximum leverage test.
Long-term debt at December 31, 2009 and September 30, 2010 consisted of the following:
December 31, 2009 |
September 30, 2010 |
|||||||
Initial Term Loan, at a rate of LIBOR plus 2.25% (2.51% at September 30, 2010), with $1,584 annual principal amortization, principal payable quarterly with final principal and any unpaid interest due June 30, 2012 |
$ | 160,586 | $ | 156,433 | ||||
First Amendment Incremental Term Loan, at a rate of LIBOR plus 2.75% (3.01% at September 30, 2010), with $324 annual principal amortization, principal payable quarterly with final principal and any unpaid interest due June 30, 2012 |
32,833 | 31,979 | ||||||
Extended Term Loan, at a rate of LIBOR plus 3.50% (4.03% at September 30, 2010), with $3,917 annual principal amortization, principal payable quarterly with final principal and any unpaid interest due June 30, 2014 |
396,783 | 386,809 | ||||||
Capitalized lease obligations, at various rates, with monthly principal and interest payments through March 2014 |
11,153 | 11,391 | ||||||
Total debt |
601,355 | 586,612 | ||||||
Less current portion of long term debt |
9,841 | 10,593 | ||||||
Total long term debt, net of current portion |
$ | 591,514 | $ | 576,019 | ||||
The Initial Term Loan, the First Amendment Incremental Term Loan, and the Extended Term Loan are guaranteed by all of the Companys subsidiaries. These term loans are also secured by first liens on all of the Companys assets and the assets of its guarantor subsidiaries.
The Credit Agreement contains defined events of default. The Credit Agreement also contains defined representations and warranties and various affirmative and negative covenants, including:
| limitations on the incurrence of additional debt; |
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| limitations on the incurrence of liens; |
| restrictions on investments; |
| restrictions on the sale of assets; |
| restrictions on the payment of cash dividends on and the redemption or repurchase of capital stock; |
| mandatory prepayment of amounts outstanding, as applicable, with excess cash flow, proceeds from asset sales, use of proceeds from the issuance of debt obligations, proceeds from any equity offerings, and proceeds from casualty losses; |
| restrictions on mergers and acquisitions, sale/leaseback transactions and fundamental changes in the nature of our business; |
| limitations on capital expenditures; and |
| maintenance of minimum ratios of debt to EBITDA (as defined in the Credit Agreement) and a minimum interest coverage ratio. |
Knologys entry into the $770,000 first lien credit facility on October 15, 2010 (see Note 13-Subsequent Events) relieved the Companys requirement to submit a compliance certificate in relation to its debt covenants on the credit facility existing at September 30, 2010. Similar covenants exist on our new first lien credit facility.
9. FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company adopted the required provisions of the FASBs accounting guidance pertaining to the valuation of financial instruments on January 1, 2008. This guidance defines fair value, expands related disclosure requirements and specifies a hierarchy of valuation techniques based on the nature of the inputs used to develop the fair value measures. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The FASB accounting guidance establishes a three-tier fair value of hierarchy, which prioritizes the inputs used in measuring fair value as follows:
| Level 1 Observable inputs such as quoted prices in active markets for identical assets or liabilities; |
| Level 2 Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and |
| Level 3 Unobservable inputs that are supported by little or no market activity, which require management judgment or estimation. |
Assets and liabilities measured at fair value on a recurring basis are summarized below:
September 30, 2010 | ||||||||||||||||
Level 1 | Level 2 | Level 3 | Total Assets/Liabilities, at Fair Value |
|||||||||||||
Assets |
||||||||||||||||
Certificates of deposit |
$ | 0 | $ | 21,155 | $ | 0 | $ | 21,155 | ||||||||
Other short term investments |
8,995 | 0 | 0 | 8,995 | ||||||||||||
Total Assets |
$ | 8,995 | $ | 21,155 | $ | 0 | $ | 30,150 | ||||||||
Liabilities |
||||||||||||||||
Interest rate swaps |
$ | 0 | $ | 8,382 | $ | 0 | $ | 8,382 | ||||||||
Total Liabilities |
$ | 0 | $ | 8,382 | $ | 0 | $ | 8,382 | ||||||||
The Company used a discounted cash flow analysis applied to the LIBOR forward yield curve to value the interest rate swaps on its balance sheet at September 30, 2010.
The carrying values of cash and cash equivalents, certificates of deposit, accounts receivable, accounts payable and accrued liabilities are reasonable estimates of their fair values due to the short maturity of these financial instruments.
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The Company recorded in accumulated other comprehensive income unrealized gain (loss) on other short term investments (all U.S. Treasury bills) in the amounts of ($2) and $15 for the three and nine months ended September 30, 2010, respectively. There was no other-than-temporary impairment for the three and nine months ended September 30, 2010.
The estimated fair value of the Companys variable-rate debt is subject to the effects of interest rate risk. On September 30, 2010, the estimated fair value of that debt, based on a dealer quote considering current market rates, approximated the carrying value of $575,221.
10. COMMITMENTS AND CONTINGENCIES
LEGAL PROCEEDINGS
The Company is subject to litigation in the normal course of its business. However, in the Companys opinion, there is no legal proceeding pending against it that would have a material adverse effect on its financial position, results of operations or liquidity. The Company is also a party to regulatory proceedings affecting the segments of the communications industry generally in which it engages in business.
UNUSED LETTERS OF CREDIT
The Companys unused letters of credit for vendors and suppliers was $2,012 as of September 30, 2010, which reduces the funds available under the $35,000 five year senior secured revolving loan and letter of credit facility.
11. NONCASH COMPENSATION EXPENSE
The Company utilizes the recognition provisions of the related FASB accounting guidance, which requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values as the options vest. The fair value of stock options is estimated at the date of grant using the Black-Scholes option pricing model. There have been no changes in the methodology for calculating the expense since the filing of the Companys Annual Report on Form 10-K for the year ended December 31, 2009.
During the third quarter of 2010, the Company granted employees options to purchase 5,715 shares of common stock with a market value of $69. These options vest equally over the next four years. The Company recognized stock-based compensation of $1,563 and $4,615 for the three and nine months ended September 30, 2009, respectively, and $1,500 and $4,441 for the three and nine months ended September 30, 2010, respectively.
12. INCOME TAXES
On January 1, 2007, the Company adopted the provisions of the appropriate FASB accounting guidance in accounting for uncertainty in income taxes. The guidance addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Also, the Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. The accounting literature also provides further guidance on derecognition, classification, interest and penalties on income taxes, accounting in interim periods and requires increased disclosures. Since the date of adoption, the Company has not recorded a liability for unrecognized tax benefits at any time.
The Company recognizes interest and penalties related to uncertain tax positions in income tax expense (as applicable). As of September 30, 2010, the Company made no provisions for interest or penalties related to uncertain tax positions.
The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction and various state jurisdictions. For federal tax purposes, the Companys 2006 through 2009 tax years remain open for examination by the tax authorities under the normal three year statute of limitations. Generally, for state tax purposes, the Companys 2006 through 2009 tax years remain open for examination by the tax authorities under a three year statute of limitations. Should the Company utilize any of its U.S. or state loss carryforwards, its carryforward losses, which date back to 1995, would be subject to examination.
13. SUBSEQUENT EVENTS
Subsequent to quarter end, on October 15, 2010, the Company closed its previously-announced acquisition of the assets of Sunflower Broadband (Sunflower), a provider of video, voice and data services to residential and business customers in Douglas County, Lawrence, Kansas and the surrounding area for $165,000. At December 31, 2009, Sunflower had approximately $35,800 in total assets, $50,000 in annual total revenues, $8,786 in pretax income and $10,925 of equity (all unaudited).
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In connection with the acquisition, Knology has entered into a $770,000 first lien credit facility with proceeds used to partially fund the acquisition purchase price, refinance the companys existing credit facility, and pay related transaction costs. Knology also used approximately $48,000 of cash on hand to partially fund the transaction. The new $770,000 credit agreement includes a $50,000 revolving credit facility, a $175,000 term loan A and a $545,000 term loan B. The revolving credit facility is not being used in connection with the acquisition or refinancing. The term loan A bears interest at LIBOR plus a margin ranging from 3.5% to 4.25% and has a term of five years with annual amortization of $8,750, $8,750, $17,500 and $26,250 in 2012, 2013, 2014 and 2015, respectively, with the balance due at maturity. The term loan B bears interest at LIBOR plus 4%, with a LIBOR floor of 1.5%, and has a term of six years with 1% principal amortization annually with the balance due at maturity.
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ITEM 2. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
The Managements Discussion and Analysis of Financial Condition and Results of Operations and other portions of this quarterly report on Form 10-Q include forward-looking statements within the meaning of the federal securities laws, including the Private Securities Litigation Reform Act of 1995, that are subject to future events, risks and uncertainties that could cause actual results to differ materially from those expressed or implied. Important factors that either individually or in the aggregate could cause actual results to differ materially from those expressed include, without limitation,
| that we will not retain or grow our customer base: |
| that we will fail to be competitive with existing and new competitors: |
| that we will not adequately respond to technological developments that impact our industry and markets: |
| that needed financing will not be available to us if and as needed: |
| that a significant change in the growth rate of the overall U.S. economy will occur such that there is a material impact on consumer and corporate spending: |
| that we will not be able to integrate the assets and operations of Sunflower Broadband, that we will not be able to complete future acquisitions, that we may have difficulties integrating other acquired businesses, or that the cost of such integration will be greater than we expect: and |
| that some other unforeseen difficulties occur, as well as those risks set forth in our Annual Report on Form 10-K for the year ended December 31, 2009, and our other filings with the SEC. |
For convenience in this quarterly report, Knology, we, us, and the Company refer to Knology, Inc. and our consolidated subsidiaries, taken as a whole.
Overview
We were formed as a Delaware corporation in September 1998 and began trading publicly on the NASDAQ Global Market in December 2003. We are a fully integrated provider of video, voice, data and advanced communications services to residential and business customers in ten markets in the Southeastern United States and two markets in the Midwestern United States. We provide a full suite of video, voice and data services in Dothan, Huntsville and Montgomery, Alabama; Panama City and portions of Pinellas County, Florida; Augusta, Columbus and West Point, Georgia; Charleston, South Carolina; Knoxville, Tennessee; and Rapid City and Sioux Falls, South Dakota, as well as portions of Minnesota and Iowa. Our primary business is the delivery of bundled communication services over our own network. In addition to our bundled package offerings, we sell these services on an unbundled basis.
We have built our business through:
| construction and expansion of our broadband network to offer integrated video, voice and data services; |
| organic growth of connections through increased penetration of services to new marketable homes and our existing customer base, along with new service offerings; |
| upgrades of acquired networks to introduce expanded broadband services including bundled video, voice and data services; and |
| acquisitions of other broadband companies. |
The following is a discussion of our consolidated financial condition and results of operations for the nine months ended September 30, 2010, and certain factors that are expected to affect our prospective financial condition. The following discussion and analysis should be read in conjunction with the financial statements and related notes included elsewhere in this Quarterly Report on Form 10-Q.
Recent Developments
Subsequent to quarter end, on October 15, 2010, the Company closed its previously-announced acquisition of the assets of Sunflower Broadband, a provider of video, voice and data services to residential and business customers in Douglas County, Lawrence, Kansas and the surrounding area for $165.0 million. At December 31, 2009, Sunflower Broadband had approximately $35.8 million in total assets, $50.0 million in annual total revenues, $8.8 million in pretax income and $10.9 million of equity (all unaudited).
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In connection with the acquisition, Knology has entered into a $770.0 million first lien credit facility with proceeds used to partially fund the acquisition purchase price, refinance indebtedness under the companys existing credit facility, and pay related transaction costs. Knology also used approximately $48.0 million of cash on hand to partially fund the transaction. The new $770.0 million credit agreement includes a $50.0 million revolving credit facility, a $175.0 million term loan A and a $545.0 million term loan B. The revolving credit facility is not being used in connection with the acquisition or refinancing. The term loan A bears interest at LIBOR plus a margin ranging from 3.5% to 4.25% and has a term of five years with annual amortization of $8.8 million, $8.8 million, $17.5 million and $26.3 million in 2012, 2013, 2014 and 2015, respectively, with the balance due at maturity. The term loan B bears interest at LIBOR plus 4%, with a LIBOR floor of 1.5%, and has a term of six years with 1% principal amortization annually with the balance due at maturity.
In November 2009, we completed the $7.5 million acquisition of the assets of Private Cable Co., LLC (PCL Cable), which has delivered small increases in key operating and financial metrics as well as being free cash flow accretive. The transaction was funded using $7.5 million from cash on hand.
We plan to spend approximately $17.9 million to expand our coverage in certain sections of our existing markets as well as build network in a new franchise area.
Connections
Because we deliver multiple services to our customers, we report the total number of connections for video, voice and data rather than the total number of customers. We count each video, voice or data purchase as a separate connection. For example, a single customer who purchases cable television, local telephone and Internet access services would count as three connections. We do not record the purchase of digital video services by an analog video customer as an additional connection.
Critical Accounting Policies
Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States, which require us to make estimates and assumptions. See our consolidated financial statements and related notes thereto contained in our Annual Report on Form 10-K for the year ended December 31, 2009, which contains accounting policies including those that may involve a higher degree of judgment and complexity and other disclosures required by accounting principles generally accepted in the United States.
Revenues
Our operating revenues are primarily derived from monthly charges for video, voice and Internet data services and other services to residential and business customers. We provide these services over our network. Our products and services involve different types of charges and in some cases several methods of accounting for or recording revenues. Below is a description of our significant sources of revenue:
| Video revenues. Our video revenues consist of fixed monthly fees for expanded basic, premium and digital cable television services, as well as fees from pay-per-view movies, fees for video-on-demand and events such as boxing matches and concerts that involve a charge for each viewing. Video revenues accounted for approximately 44.7% of our consolidated revenues for both the three and nine months ended September 30, 2010, compared to 43.5% and 43.3% for the three and nine months ended September 30, 2009, respectively. |
| Voice revenues. Our voice revenues consist primarily of fixed monthly fees for local service and enhanced services, such as call waiting, voice mail and measured and flat rate long-distance service. Voice revenues accounted for approximately 28.2% and 28.4% of our consolidated revenues for the three and nine months ended September 30, 2010, respectively, compared to 30.6% and 31.1% for the three and nine months ended September 30, 2009, respectively. |
| Data revenues. Our data revenues consist primarily of fixed monthly fees for data service and rental of cable modems. Data revenues accounted for approximately 23.2% of our consolidated revenues for both the three and nine months ended September 30, 2010, compared to 23.1% for the three and nine months ended September 30, 2009. |
| Other revenues. Other revenues result principally from broadband carrier services and dark fiber sales. Other revenues accounted for approximately 3.9% and 3.7% of our consolidated revenues for the three and nine months ended September 30, 2010, respectively, compared to 2.7% and 2.5% of our consolidated revenues for the three and nine months ended September 30, 2009, respectively. |
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Our ability to increase the number of our connections and, as a result, our revenues is directly affected by the level of competition we face in each of our markets with respect to each of our service offerings:
| In providing video services, we currently compete with AT&T Inc., Bright House Networks, CenturyTel, Inc., Charter Communications, Inc., Comcast Corporation, Mediacom Communications Corporation, Midcontinent Communications, Qwest Communications, Time Warner Cable, Inc. and Verizon Communications Inc. We also compete with satellite television providers such as DirecTV, Inc. and Echostar Communications Corporation. Our other competitors include broadcast television stations and other satellite television companies. We expect in the future to face additional competition from telephone companies providing video services within their service areas. |
| In providing local and long-distance telephone services, we compete with the incumbent local exchange carriers (ILECs) and various long-distance providers in each of our markets. AT&T, CenturyTel, Qwest and Verizon are the incumbent local phone companies in our markets. They offer both local and long-distance services in our markets and are particularly strong competitors. We also compete with providers of long-distance telephone services, such as AT&T, CenturyTel (which acquired Embarq Communications in 2009) and Verizon. We expect an increase in the deployment of voice over internet protocol (VoIP) services and expect to continue to compete with Vonage Holding Company, cable competitors as they roll out VoIP and other providers. |
| In providing data services, we compete with ILECs that offer dial-up and DSL services, providers of satellite-based Internet access services, cable television companies, providers of wireless high-speed data services, and providers of dial-up Internet service. Data services and Internet access is a rapidly growing business and competition is increasing in each of our markets. |
Some of our competitors have competitive advantages such as greater experience, resources, marketing capabilities and stronger name recognition.
Costs and Expenses
Our operating expenses include direct cost of services, selling, general and administrative expenses, and depreciation and amortization.
Direct costs of services include:
| Direct costs of video services. Direct costs of video services consist primarily of monthly fees to the National Cable Television Cooperative and other programming providers. Programming costs are our largest single cost and we expect this trend to continue. Programming costs as a percentage of video revenue were approximately 51.9% for both the three and nine months ended September 30, 2010, compared to 51.0% and 51.9% for the three and nine months ended September 30, 2009, respectively. We have entered into contracts with various entities to provide programming to be aired on our network. We pay a monthly fee for these programming services, generally based on the average number of subscribers to the program, although some fees are adjusted based on the total number of subscribers to the system and/or the system penetration percentage. Since programming cost is partially based on number of subscribers, it will increase as we add more subscribers. It will also increase as costs per channel increase over time. |
| Direct costs of voice services. Direct costs of voice services consist primarily of transport cost and network access fees. The direct cost of voice services as a percentage of voice revenues was approximately 17.9% and 18.3% for the three and nine months ended September 30, 2010, respectively, compared to 18.0% for both the three and nine months ended September 30, 2009. |
| Direct costs of data services. Direct costs of data services consist primarily of transport cost and network access fees. The direct cost of data services as a percentage of data revenue was approximately 7.9% and 7.7% for the three and nine months ended September 30, 2010, respectively, compared to 7.3% and 6.9% for the three and nine months ended September 30, 2009, respectively. |
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| Direct costs of other services. Direct costs of other services consist primarily of transport cost, network access fees and costs of dark fiber sales. The direct cost of other services as a percentage of other revenue was approximately 34.0% and 33.7% for the three and nine months ended September 30, 2010, respectively, compared to 19.7% and 19.2% for the three and nine months ended September 30, 2009, respectively. The increase is due mainly to the costs of dark fiber sales recorded during the quarter ended September 30, 2010. |
| Pole attachment and other network rental expenses. Pole attachment and other network rental expenses consist primarily of pole attachment rents paid to utility companies for space on their utility poles to deliver our various services and network hub rents. Pole attachment and other network rental expenses as a percentage of total revenue was approximately 1.1% for both the three and nine months ended September 30, 2010, compared to 0.2% and 0.9% for the three and nine months ended September 30, 2009, respectively. |
Selling, general and administrative expenses include:
| Sales and marketing expenses. Sales and marketing expenses include the cost of sales and marketing personnel and advertising and promotional expenses. |
| Network operations and maintenance expenses. Network operations and maintenance expenses include payroll and departmental costs incurred for network design, 24 hours a day, seven days a week maintenance monitoring and plant maintenance activity. |
| Service and installation expenses. Service and installation expenses include payroll and departmental costs incurred for customer installation and service technicians. |
| Customer service expenses. Customer service expenses include payroll and departmental costs incurred for customer service representatives and customer service management, primarily at our centralized call center. |
| General and administrative expenses. General and administrative expenses consist of corporate and subsidiary management and administrative costs. |
Depreciation and amortization expenses include depreciation of our interactive broadband networks and equipment and amortization of costs in excess of net assets and other intangible assets related to acquisitions.
As our sales and marketing efforts continue and our networks expand, we expect to add customer connections resulting in increased revenue. We also expect our cost of services and operating expenses to increase as we add connections and grow our business.
Results of Operations
Three months ended September 30, 2010 compared to three months ended September 30, 2009
The following table sets forth financial data as a percentage of operating revenues for the three months ended September 30, 2009 and 2010.
Three months ended September 30, |
||||||||
2009 | 2010 | |||||||
Operating revenues: |
||||||||
Video |
43 | % | 45 | % | ||||
Voice |
31 | 28 | ||||||
Data |
23 | 23 | ||||||
Other |
3 | 4 | ||||||
Total |
100 | 100 | ||||||
Operating expenses: |
||||||||
Direct costs |
30 | 32 | ||||||
Selling, general and administrative |
38 | 36 | ||||||
Depreciation and amortization |
21 | 19 | ||||||
Total |
89 | 87 | ||||||
Operating income |
11 | 13 | ||||||
Interest income |
0 | 0 | ||||||
Interest expense |
(10 | ) | (7 | ) | ||||
Debt modification expense |
(3 | ) | 0 | |||||
Loss on interest rate derivative instrument |
(1 | ) | (1 | ) | ||||
Other income (expense), net |
0 | 0 | ||||||
Total other expense |
(14 | ) | (8 | ) | ||||
Income (loss) from continuing operations |
(3 | ) | 5 | |||||
Net income (loss) |
(3 | ) | 5 | |||||
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Revenues. Operating revenues increased 6.7% from $105.8 million for the three months ended September 30, 2009, to $112.9 million for three months ended September 30, 2010. Operating revenues from video services increased 9.7% from $46.0 million for the three months ended September 30, 2009, to $50.1 million for the same period in 2010. Operating revenues from voice services decreased 1.8% from $32.4 million for the three months ended September 30, 2009, to $31.8 million for the same period in 2010. Operating revenues from data services increased 7.0% from $24.5 million for the three months ended September 30, 2009, to $26.2 million for the same period in 2010. Operating revenues from other services increased 51.1% from $2.9 million for the three months ended September 30, 2009, to $4.4 million for the same period in 2010.
The increased revenues are due primarily to an increase in the number of connections, from 681,920 as of September 30, 2009, to 700,476 as of September 30, 2010 and rate increases effective in the first quarter of 2010. The additional connections resulted primarily from:
| continued growth in our bundled customers; |
| continued growth in business data sales; and |
| continued penetration in our mature markets. |
The decreased voice services revenues are due primarily to a decrease in residential local service revenue and features revenue as a result of customers choosing our discounted service plans offering discounted features such as voicemail, call waiting, and call forwarding. The Company also experienced a decline in business service revenue and business toll.
The increase in operating revenues from other services included $361,000 of dark fiber sales recorded during the three months ended September 30, 2009, compared to $1.4 million for the same period of 2010. The increase in operating revenues from other services also resulted from increased broadband carrier services.
Direct Costs. Direct costs increased 15.1% from $31.9 million for the three months ended September 30, 2009, to $36.7 million for the three months ended September 30, 2010. Direct costs of video services increased 11.6% from $23.5 million for the three months ended September 30, 2009, to $26.2 million for the same period in 2010. Direct costs of voice services decreased 2.2% from $5.8 million for the three months ended September 30, 2009, to $5.7 million for the same period in 2010. Direct costs of data services increased 16.0% from $1.8 million for the three months ended September 30, 2009, to $2.1 million for the same period in 2010. Direct costs of other services increased 160.0% from $571,000 for the three months ended September 30, 2009, to $1.5 million for the same period in 2010. Pole attachment and other network rental expenses increased 439.3% from $231,000 for the three months ended September 30, 2009, to $1.2 million for the same period in 2010 as a result of credits for pole rent available to Knology for the period in 2009. We expect our cost of services to increase in amount as we add more connections. The increase in direct costs of video services is primarily due to programming costs increases, which have been increasing over the last several years on an aggregate basis due to an increase in subscribers and on a per subscriber basis due to an increase in costs per program channel. Further, local commercial television broadcast stations are charging retransmission fees similar to fees charged by other program providers. We expect the trend of annual increases to continue and we may not be able to pass these higher costs on to customers because of competitive factors, which could adversely affect our cash flow and gross profit. We expect increases in voice, data and other direct costs of services with the additions of leased facilities used to backhaul our traffic to our switching facilities as connections and data capacity requirements increase.
Selling, general and administrative expenses. Our selling, general and administrative expenses increased 1.3% from $39.6 million for the three months ended September 30, 2009, to $40.1 million for the three months ended September 30, 2010. The increase in our operating costs, included in selling, general and administrative expenses, is consistent with our growth in connections and customers since the third quarter of 2009, and consists mainly of increases in rents and leases, bad debt expense and employee related expenses. These increases were offset by reductions in taxes and licenses, and sales and marketing expenses. Our non-cash stock option compensation expense, included in selling, general and administrative expenses, decreased from $1.6 million for the three months ended September 30, 2009, to $1.5 million for the three months ended September 30, 2010 as a result of the issuance of fewer additional stock awards.
Depreciation and amortization. Our depreciation and amortization decreased from $22.4 million for the three months ended September 30, 2009, to $20.8 million for the three months ended September 30, 2010, primarily due to the maturing of our asset base.
Interest expense. Interest expense decreased from $10.4 million for the three months ended September 30, 2009, to $8.3 million for the three months ended September 30, 2010. The decrease in interest expense is primarily a result of the decrease in interest rates on our term loans resulting from the commencement of our new interest rate swap. In addition, we recorded $4.5 million and $451,000 in amortization of deferred loss associated with our derivative instruments for the three months ended September 30, 2009 and 2010, respectively. A gain of $2.8 million and a loss of $651,000 was recorded on the value of the interest rate swaps for the three months ended September 30, 2009 and 2010, respectively.
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Debt modification charge. We recorded an expense of $3.4 million during the three months ended September 30, 2009 related to the modification of the debt under the Credit Agreement in accordance with the terms of Amendment No. 2, which provides for the extension of the maturity date of an aggregate $397 million of term loans by two years.
Net income ( loss). We incurred a net loss of $3.3 million and net income of $5.9 million for the three months ended September 30, 2009 and 2010, respectively.
Nine months ended September 30, 2010 compared to nine months ended September 30, 2009
The following table sets forth financial data as a percentage of operating revenues for the nine months ended September 30, 2009 and 2010.
Nine months ended September 30, |
||||||||
2009 | 2010 | |||||||
Operating revenues: |
||||||||
Video |
43 | % | 45 | % | ||||
Voice |
31 | 28 | ||||||
Data |
23 | 23 | ||||||
Other |
3 | 4 | ||||||
Total |
100 | 100 | ||||||
Operating expenses: |
||||||||
Direct costs |
31 | 32 | ||||||
Selling, general and administrative |
37 | 35 | ||||||
Depreciation and amortization |
21 | 19 | ||||||
Total |
89 | 86 | ||||||
Operating income |
11 | 14 | ||||||
Interest income |
0 | 0 | ||||||
Interest expense |
(9 | ) | (9 | ) | ||||
Debt modification expense |
(1 | ) | 0 | |||||
Loss on interest rate derivative instrument |
(2 | ) | (1 | ) | ||||
Other income (expenses), net |
0 | 0 | ||||||
Total other expense |
(12 | ) | (10 | ) | ||||
Income (loss) from continuing operations |
(1 | ) | 4 | |||||
Net income (loss) |
(1 | ) | 4 | |||||
Revenues. Operating revenues increased 5.5% from $318.4 million for the nine months ended September 30, 2009, to $336.0 million for the nine months ended September 30, 2010. Operating revenues from video services increased 9.0% from $137.8 million for the nine months ended September 30, 2009, to $150.2 million for the same period in 2010. Operating revenues from voice services decreased 3.4% from $98.9 million for the nine months ended September 30, 2009, to $95.6 million for the same period in 2010. Operating revenues from data services increased 5.9% from $73.6 million for the nine months ended September 30, 2009, to $77.9 million for the same period in 2010. Operating revenues from other services increased 52.4% from $8.1 million for the nine months ended September 30, 2009, to $12.3 million for the same period in 2010.
The increased revenues are due primarily to an increase in the number of connections, from 681,920 as of September 30, 2009, to 700,476 as of September 30, 2010 and rate increases effective in the first quarter of 2010. The additional connections resulted primarily from:
| continued growth in our bundled customers; |
| continued growth in business data sales; and |
| continued penetration in our mature markets. |
The operating revenues from other services increased as a result of dark fiber sales and increased broadband carrier services.
Direct Costs. Direct costs increased 10.7% from $98.7 million for the nine months ended September 30, 2009, to $109.2 million for the nine months ended September 30, 2010. Direct costs of video services increased 9.0% from $71.5 million for the nine months ended September 30, 2009, to $77.9 million for the same period in 2010. Direct costs of voice services decreased 1.8% from $17.8 million for the nine months ended September 30, 2009, to $17.5 million for the same period in 2010. Direct costs of data services increased 17.5% from $5.1 million for the nine months ended September 30, 2009, to $6.0 million for the same period in 2010. Direct costs of other services increased 166.9% from $1.6 million for the nine months ended September 30, 2009, to $4.2 million for the same period in 2010. Pole attachment and other network rental expenses increased 34.2% from $2.8 million for the nine months ended September 30, 2009, to $3.7 million for the same period in 2010. As discussed above in the results for the three months ended September 30, 2010, the causes of our changes are consistent for the nine months period.
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Selling, general and administrative. Our selling, general and administrative expenses remained unchanged at $116.6 million for both the nine months ended September 30, 2009 and 2010. Although unchanged, our operating costs, included in selling, general and administrative expenses contained increases in rents and leases, bad debt expense, and repairs and maintenance expenses for the nine months ended September 30, 2010. These increases were partially offset by decreases in sales and marketing, and taxes and licenses. Our non-cash stock option compensation expense, included in selling, general and administrative, decreased from $4.6 million for the nine months ended September 30, 2009, to $4.4 million for the nine months ended September 30, 2010.
Depreciation and amortization. Our depreciation and amortization decreased from $68.0 million for the nine months ended September 30, 2009, to $64.5 million for the nine months ended September 30, 2010, primarily due to the maturing of our asset base.
Interest expense. Interest expense increased from $29.6 million for the nine months ended September 30, 2009, to $31.1 million for the nine months ended September 30, 2010. The increase in interest expense is primarily a result of the increase in interest rates on our term loans prior to the commencement of our new interest rate swap during the quarter ended September 30, 2010. In addition, we recorded $13.8 million and $10.3 million in amortization of deferred loss associated with our derivative instruments for the nine months ended September 30, 2009 and 2010, respectively. A gain of $6.5 million and $8.1 million was recorded on the value of the interest rate swaps for the nine months ended September 30, 2009 and 2010, respectively.
Debt modification charge. We recorded an expense of $3.4 million during the nine months ended September 30, 2009 related to the modification of the debt under the Credit Agreement in accordance with the terms of Amendment No. 2, which provides for the extension of the maturity date of an aggregate $397 million of term loans by two years.
Net income ( loss). We incurred a net loss of $4.3 million and net income $12.8 million for the nine months ended September 30, 2009 and 2010, respectively.
Liquidity and Capital Resources
Overview.
As of September 30, 2010, we had approximately $92.9 million of cash, cash equivalents and restricted cash, certificates of deposit and U.S. Treasury Bills on our balance sheet. Our net working capital on September 30, 2010 and December 31, 2009 was $53.5 million and $26.2 million, respectively.
On January 4, 2008, the Company entered into a First Amendment to the Credit Agreement which provides for a $59.0 million incremental term loan. The proceeds of the term loan were used to fund in part the $75.0 million Graceba acquisition purchase price. This term loan bears interest at LIBOR plus 2.75%. Prior to Amendment No. 2 discussed below, this term loan amortized at a rate of 1.0% per annum, payable quarterly, with a June 30, 2012 maturity date. As of September 30, 2010, $32.0 million is outstanding on the incremental term loan. In December 2007, the Company entered into a new interest rate swap contract to mitigate interest rate risk on a notional amount of $59.0 million. The swap agreement, which became effective January 4, 2008, fixes $57.5 million of the floating rate debt at 3.995% until September 30, 2010.
On September 28, 2009, the Company entered into Amendment No. 2 which extends the maturity date of an aggregate $397 million of term loans under the Credit Agreement by two years. The extended term loan bears interest at LIBOR plus 3.50% and amortizes at a rate of 1% per annum, payable quarterly, with a June 30, 2014 maturity date. Amendment No. 2 also, among other modifications, increases the revolving credit facility to $35.0 million from $25.0 million and allows for an annual, cumulative restricted payment allowance of $10 million for dividends and/or share repurchases utilizing excess cash flow and subject to a maximum leverage test. As of September 30, 2010, $386.8 million is outstanding under the extended term loan. On November 25, 2009, the Company entered into a third interest rate swap contract to mitigate interest rate risk on an initial notional amount of $400 million. The swap agreement, which became effective July 3, 2010 and ends April 3, 2012, fixes $400.0 million of the floating rate debt at 1.98% as of September 30, 2010.
The Credit Agreement is guaranteed by substantially all of the Companys subsidiaries and secured by a first-priority lien and security interest in substantially all of the Companys assets and the assets of its subsidiaries. The Credit Agreement contains customary representations, warranties, various affirmative and negative covenants and customary events of default. As of September 30, 2010, we are in compliance with all our debt covenants.
Subsequent to quarter end, on October 15, 2010, the Company closed its previously-announced acquisition of the assets of Sunflower Broadband, a provider of video, voice and data services to residential and business customers in Douglas County, Lawrence, Kansas and the surrounding area for $165.0 million. At December 31, 2009, Sunflower Broadband had approximately $35.8 million in total assets, $50.0 million in annual total revenues, $8.8 million in pretax income and $10.9 million of equity (all unaudited).
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In connection with the acquisition, Knology has entered into a $770.0 million first lien credit facility with proceeds used to partially fund the acquisition purchase price, refinance indebtedness under the companys existing credit facility described below, and pay related transaction costs. Knology also used approximately $48.0 million of cash on hand to partially fund the transaction. The new $770.0 million credit agreement includes a $50.0 million revolving credit facility, a $175.0 million term loan A and a $545.0 million term loan B. The revolving credit facility is not being used in connection with the acquisition or refinancing. The term loan A bears interest at LIBOR plus a margin ranging from 3.5% to 4.25% and has a term of five years with annual amortization of $8.8 million, $8.8 million, $17.5 million and $26.3 million in 2012, 2013, 2014 and 2015, respectively, with the balance due at maturity. The term loan B bears interest at LIBOR plus 4%, with a LIBOR floor of 1.5%, and has a term of six years with 1% principal amortization annually with the balance due at maturity.
We believe there is adequate liquidity from cash on hand, cash provided from operations and funds available under our $50.0 million revolving credit facility to meet our capital spending requirements and to execute our current business plan.
Operating, Investing and Financing Activities.
Net cash provided by operating activities from continuing operations totaled $76.3 million and $88.3 million for the nine months ended September 30, 2009 and 2010, respectively. The net cash flow activity related to operations consists primarily of changes in operating assets and liabilities and adjustments to net income for non-cash transactions including:
| depreciation and amortization; |
| non-cash stock compensation; |
| non-cash amortization of deferred loss on interest rate swaps; |
| non-cash bank loan interest expense; |
| non-cash interest income; |
| gain on sale of short term investments; |
| non-cash gain (loss) on interest rate derivative instrument; |
| provision for bad debt; and |
| gain on disposition of assets |
Net cash used in investing activities was $76.2 million and $54.0 million for the nine months ended September 30, 2009 and 2010, respectively. Our investing activities for the nine months ended September 30, 2009 consisted primarily of $40.5 million of capital expenditures and $35.1 million for the purchase of certificates of deposit. Investing activities for the nine months ended September 30, 2010 consisted primarily of $57.5 million of capital expenditures and $30.0 million for the purchase of certificates of deposit, offset by $20.0 million of maturities of certificates of deposit and $15.0 million from the sale of U.S Treasury Bills.
Net cash used by our financing activities was $16.7 million and $16.9 million for the nine months ended September 30, 2009 and 2010, respectively. For the nine months ended September 30, 2009, financing activities consisted of $15.2 million in principal payments on debt and $1.8 million of expenditures related to the modification of long-term debt, offset by $328,000 proceeds from the exercise of stock options. Financing activities for the nine months ended September 30, 2010 consisted of $18.0 million in principal payments on debt, offset by $1.1 million proceeds from the exercise of stock options.
Capital Expenditures.
We spent approximately $57.5 million in capital expenditures during the nine months ended September 30, 2010, of which $23.5 million related to the purchase and installation of customer premise equipment, $16.9 million related to plant extensions and enhancements and $17.1 million related to network equipment, billing and information systems and other capital items.
We expect to spend approximately $71.0 million in capital expenditures during 2010. We believe we will have sufficient cash on hand and cash from internally generated cash flow to cover our planned operating expenses and capital expenditures and to service our debt during 2010. Our existing indebtedness limits the amount of our capital expenditures on an annual basis.
Recent Accounting Pronouncements
See the Notes to Condensed Consolidated Financial Statements included in Part I, Item 1 of this report and the Notes to our Consolidated Financial Statements contained in our Annual Report on Form 10-K for the year ended December 31, 2009.
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ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
We use interest rate swap and interest rate cap contracts to manage the impact of interest rate changes on earnings and operating cash flows. Interest rate swaps involve the receipt of variable-rate amounts in exchange for fixed-rate payments over the life of the agreements without exchange of the underlying principal amount. Interest rate caps involve the receipt of variable-rate amounts beyond a specified strike price over the life of the agreements without exchange of the underlying principal amount. We believe that these agreements are with counterparties who are creditworthy financial institutions.
Until the December 31, 2008 reset of the borrowing rate on the $59.0 million term loan, changes in the fair value of the Companys swap agreements were recorded as Accumulated other comprehensive loss in the equity section of the balance sheet, and the swap in variable to fixed interest rate was recorded as Interest expense on the statement of operations when the interest was incurred. Starting with the reset of the borrowing rate on December 31, 2008, changes in the fair value of the interest rate swaps are recorded as Gain (loss) on interest rate swaps in the Other income (expense) section of the statement of operations as they are incurred. The remaining balance in Accumulated other comprehensive loss in the stockholders equity section of the balance sheet that is related to the interest rate swaps is amortized as Amortization of deferred loss on interest rate swaps on the statement of operations over the remaining life of the derivative instruments. The Company recorded amortization expense related to the deferred loss on interest rate swaps in the amounts of $4.5 million and $13.8 million for the three and nine months ended September 30, 2009. The Company also recorded amortization expense related to the deferred loss on interest rate swaps in the amounts of $451,000 and $10.3 million for the three and nine months ended September 30, 2010. As of September 30, 2010, the entire remaining amount in accumulated other comprehensive loss related to these interest rate swaps has been amortized.
On November 25, 2009, the Company entered into a third interest rate swap contract to mitigate interest rate risk on an initial notional amount of $400.0 million. The swap agreement, which became effective July 3, 2010 and ends April 3, 2012, fixes $400.0 million of the floating rate debt at 1.98% as of September 30, 2010.
The notional amount for the next annual period is summarized below:
Start date |
End date |
Amount | ||
July 3, 2010 |
October 2, 2010 | $400.0 | ||
October 3, 2010 |
January 2, 2011 | $398.8 | ||
January 3, 2011 |
April 2, 2011 | $382.6 | ||
April 3, 2011 |
July 2, 2011 | $381.4 | ||
July 3, 2011 |
October 2, 2011 | $380.2 |
As with the previous two interest rate swaps, this interest rate instrument is not designated as a hedge and therefore does not utilize hedge accounting. Changes in the fair value of the swap agreement are recorded as Gain (loss) on interest rate swaps in the Other income (expense) section of the statement of operations and the swap in variable to fixed interest rate is recorded as Interest expense on the statement of operations when the interest is incurred.
The Company recorded a gain on the change in the fair value of the interest rate swaps in the amounts of $2.8 million and $6.5 million for the three and nine months ended September 30, 2009. The Company also recorded a gain (loss) on the change in the fair value of the interest rate swaps in the amounts of $(651,000) and $8.1 million for the three and nine months ended September 30, 2010.
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ITEM 4. | CONTROLS AND PROCEDURES |
Evaluation of Disclosure Controls and Procedures. The Companys management, with the participation of the Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Companys disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of September 30, 2010. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of September 30, 2010, the Companys disclosure controls and procedures are effective.
Changes in Internal Control over Financial Reporting. There have been no changes in our internal control over financial reporting that occurred during the quarter ended September 30, 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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ITEM 1. | Legal Proceedings |
We are subject to litigation in the normal course of our business. However, in our opinion there is no legal proceeding pending against us which would have a material adverse effect on our financial position, results of operations or liquidity. We are also a party to regulatory proceedings affecting the segments of the communications industry generally in which we engage in business.
We have been named as a defendant in a lawsuit captioned Manard v. Knology, Inc. filed in the United States District Court for the Middle District of Georgia. The complaint was filed on February 2, 2010 as a putative class action. The case arose out of an online advertising trial of a system designed by a third-party advertising company, NebuAd Inc., for delivery of advertising to computer users while they are navigating the Internet. The complaint, which was filed on behalf of Knology customers using the Internet during the trial period, alleges that electronic communications were intercepted and used in violation of the federal and state privacy statutes and seeks statutory damages for such alleged violations. The action was initially filed in California against Knology and other defendants where it was dismissed for lack of jurisdiction. Counsel for the plaintiff has filed new complaints against the same defendants but they filed separate complaints against each company trialing NebuAds system. Knology filed its motion to dismiss on March 26, 2010. On April 22, 2010, Knology filed a motion to compel arbitration and stay the proceedings in the District Court. On June 18, 2010, the District Court granted our motion to compel arbitration and stay court proceedings and determined that Knologys motion to dismiss was moot. We intend to vigorously defend the case in arbitration. Given that this claim is still in its initial stages, it is premature to estimate the impact it could have to our results of operation, financial condition or cash flows.
ITEM 1A. | Risk Factors |
In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part I, Item 1A. Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2009, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K and in this Quarterly Report on Form 10-Q are not the only risks that we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.
ITEM 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
None.
ITEM 3. | Default Upon Senior Securities |
None.
ITEM 4. | (Removed and Reserved) |
ITEM 5. | Other Information |
None
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ITEM 6. | Exhibits |
Exhibit Number |
Exhibit Description | |
2.1 | Asset Purchase Agreement, dated as of August 3, 2010, by and between The World Company and Knology of Kansas, Inc. | |
3.1 | Amended and Restated Certificate of Incorporation of Knology, Inc. (Incorporated herein by reference to Exhibit 3.1 to Knology, Inc.s Quarterly Report Form 10-Q for the period ended June 30, 2004). | |
3.2 | Certificate of Designations of Powers, Preferences, Rights, Qualifications, Limitations and Restrictions of Series X Junior Participating Preferred Stock of Knology, Inc. (Incorporated herein by reference to Exhibit 3.1 to Knology, Inc.s Current Report on Form 8-K filed July 29, 2005). | |
3.3 | Bylaws of Knology, Inc. (Incorporated herein by reference to Exhibit 3.2 to Knology Inc.s Registration Statement on Form S-1 (File No. 333-89179)). | |
31.1 | Certification of Chief Executive Officer of Knology, Inc. pursuant to Securities Exchange Act Rules 13a-14. | |
31.2 | Certification of Chief Financial Officer of Knology, Inc. pursuant to Securities Exchange Act Rules 13a-14. | |
32.1 | Statement of the Chief Executive Officer of Knology, Inc. pursuant to 18 U.S.C. § 1350. | |
32.2 | Statement of the Chief Financial Officer of Knology, Inc. pursuant to 18 U.S.C. § 1350. |
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Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
KNOLOGY, INC. | ||||
November 5, 2010 | By: | /s/ Rodger L. Johnson | ||
Rodger L. Johnson | ||||
Chairman and Chief Executive Officer | ||||
November 5, 2010 | By: | /s/ M. Todd Holt | ||
M. Todd Holt | ||||
President and Chief Financial Officer |
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