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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
Annual Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 2002
Commission file numbers: 333-63677
333-63677-01
333-63677-02
Coaxial Communications of Central Ohio, Inc.
Phoenix Associates
Insight Communications of Central Ohio, LLC
(Exact name of registrants as specified in their respective charters)
Ohio 31-0975825
Florida 59-1798351
Delaware 13-4017803
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Numbers)
c/o Insight Communications Company, Inc.
810 Seventh Avenue
New York, NY 10019
(917) 286-2300
(Address and telephone number of registrants' principal executive offices)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether each 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 if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrants' knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K: Not Applicable
Indicate by check mark whether any registrant is an accelerated filer
(as defined in Exchange Act Rule 12b-2). Yes No X
State the aggregate market value of the voting and non-voting common
equity held by non-affiliates of the registrants: Not Applicable
Indicate the number of shares outstanding of the registrants' common
stock: Not Applicable
Forward-Looking Statements
This annual report contains "forward-looking statements," including
statements containing the words "believes," "anticipates," "expects" and words
of similar import, which concern, among other things, the operations, economic
performance and financial condition of the System (as defined below). All
statements other than statements of historical fact included in this annual
report regarding Coaxial Communications of Central Ohio, Inc. ("Coaxial"),
Phoenix Associates ("Phoenix") and Insight Communications of Central Ohio, LLC
("Insight Ohio") or any of the transactions described in this report, including
the timing, financing, strategies and effects of such transactions, are
forward-looking statements. Such forward-looking statements are based upon a
number of assumptions and estimates, which are inherently subject to significant
uncertainties and contingencies, many of which are beyond the control of
Coaxial, Phoenix and Insight Ohio, and reflect future business decisions which
are subject to change. Although Coaxial, Phoenix and Insight Ohio believe that
the expectations reflected in such forward-looking statements are reasonable,
they can give no assurance that such expectations will prove to be correct.
Important factors that could cause actual results to differ materially from
expectations include, without limitation:
o the ability of Coaxial and Phoenix to make scheduled payments with respect
to the Senior Notes (as defined below) will depend on the financial and
operating performance of Insight Ohio;
o a substantial portion of Insight Ohio's cash flow from operations is
required to be dedicated to the payment of principal and interest on its
indebtedness and the required distributions with respect to its Series A
Preferred Interest and its Series B Preferred Interest, thereby reducing
the funds available to Insight Ohio for its operations and future business
opportunities;
o Coaxial and Phoenix have no significant assets other than Coaxial's
ownership of common membership interests, Series A Preferred Interests and
Series B Preferred Interests in Insight Ohio; and
o the indenture governing the terms of the Senior Notes imposes restrictions
on Coaxial, Phoenix and Insight Ohio and the Senior Credit Facility of
Insight Ohio imposes restrictions on Insight Ohio.
Coaxial, Phoenix and Insight Ohio do not intend to update these forward-looking
statements.
PART I
Item 1. Business
In this report, we rely on and refer to information and statistics
regarding the cable television industry and our market share in the sectors in
which we compete. We obtained this information and statistics from various
third-party sources, discussions with our customers and our own internal
estimates. We believe that these sources and estimates are reliable, but we have
not independently verified them and cannot guarantee their accuracy or
completeness.
Overview
Insight Ohio owns and operates a cable television system in the
Columbus, Ohio metropolitan area (the "System"). As of December 31, 2002, the
System passed approximately 198,700 homes and served approximately 88,100 basic
customers in the eastern portion of the City of Columbus and the surrounding
suburban communities. All of the System's customers are served from a single
headend allowing for efficient capital deployment for new services. A headend
processes signals received for distribution to customers over our network.
Insight Communications Company, Inc. ("Insight"), through its wholly-owned
subsidiary Insight Communications Company, L.P., serves as the manager of the
System.
The System
The System serves the eastern portion of the City of Columbus and
surrounding suburban communities. The City of Columbus is the 34th largest
designated market area ("DMA") in the United States, is the capital of Ohio and
is the home of The Ohio State University. Besides the state government and
university, the Columbus economy is well diversified with a significant presence
of prominent companies such as The Limited, Merck, Wendy's, Nationwide
Insurance, Borden and Worthington Industries. The median household income of the
System's service area is approximately $40,300 per year, while the median family
income is approximately $50,600 per year. As of December 31, 2002, the System
passed approximately 198,700 homes and served approximately 88,100 basic
customers from a single headend.
The System enjoys a high level of population growth in the suburban
communities east of Columbus. Since December 31, 1996, approximately 37,600
homes passed have been added to the System through new plant extensions,
primarily in new housing developments. This represents a 3.5% compound annual
growth rate of homes passed for the System for the six years ended December 31,
2002.
Portions of the System operate in a competitive environment. Customers
in those areas have access to two wired cable television providers -- Insight
Ohio and WideOpenWest which acquired the assets of Ameritech in December 2001.
The System also competes with direct broadcast satellite television systems
("DBS") and multipoint multichannel distribution systems ("MMDS"). The areas of
the System served by both Insight Ohio and WideOpenWest pass approximately
129,100 homes, representing 65% of the System's total homes passed. In this
competitive environment, the System's basic customers decreased from
approximately 86,000 at the end of 1995, prior to Ameritech's entry into the
marketplace, to approximately 84,200 as of December 31, 1999 but has steadily
increased to approximately 88,100 as of December 31, 2002.
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As of December 31, 2002, the System had 2,600 miles of plant, including
1,900 miles of 870 MegaHertz (MHz) capacity, or "bandwidth," plant and 700 miles
of 450 MHz. Approximately 91% of Insight Ohio's customers are served by its
upgraded network which enables delivery of an advanced suite of entertainment,
information and communications services, including interactive digital video,
high-speed data access and telephone services. Insight Ohio's upgrade efforts
are continuing.
The Manager
Insight is the ninth largest cable television system operator in the
United States based on customers served. Through its wholly-owned and managed
systems, Insight currently serves approximately 1.4 million customers, all of
which are concentrated in the four contiguous states of Indiana, Kentucky,
Illinois and Ohio. In addition to its geographic concentration, our manager's
communications network is tightly-grouped, or "clustered," with approximately
95% of our manager's customers served from fourteen headends after giving effect
to the remaining network upgrades of its Illinois systems, expected to be
substantially completed by mid-2003. As a result, the amount of capital
necessary to deploy new and enhanced products and services is significantly
reduced on a per home basis because of the large number of customers served by a
single headend. Clustering enables our manager to efficiently deploy a bundled
suite of entertainment, information and communications services. This
combination of geographic concentration and clustering has enabled Insight to
offer, under the Insight Digital brand, a complete bundle of interactive digital
video, high-speed data access and telephone services.
We have entered into long-term agreements with Comcast Cable Holdings,
LLC (formerly known as AT&T Broadband, LLC) to facilitate the delivery of local
telephone services. Telephone services recently have been deployed in areas
within Columbus, and are available to approximately 73,500 households. Under the
terms of these agreements, we lease for a fee certain capacity on our network to
Comcast Cable. We also provide certain services and support for which we receive
additional payments. The capital required to deploy telephone over our networks
is shared, with Comcast Cable responsible for switching and transport
facilities.
Insight Business Strategy
Our manager's strategy is to become a competitive, full-service
provider of entertainment, information and communications services. This
strategy is centered on the deployment of new and enhanced products and services
for the communities served by our networks and consists of the following
elements:
o Focus on operating large, tightly-grouped clusters of cable systems
with attractive technical and demographic profiles;
o Expeditiously upgrade our network;
o Introduce new and enhanced products and services, including interactive
Insight Digital service, high-speed data service and telephone service;
o Leverage strong local presence to enhance customer and community
relations; and
o Pursue value-enhancing transactions in nearby or adjacent geographies.
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Our manager's marketing strategy is to offer our customers an array of
entertainment, information and communications services on a bundled basis. By
bundling our products and services, we provide our customers with an increased
choice of services in value-added packages, which we believe results in higher
customer satisfaction, increased use of our services and greater customer
retention. Our manager began deploying new and enhanced products and services,
such as interactive digital video and high-speed data access, during 1999, and
we have launched a telephone service alternative to SBC (Ameritech) through our
arrangement with Comcast Cable.
The System is an integral part of Insight's long-term business
strategy. The System has a strong market presence in a state capital and
academic center with a diverse, growing economy. All of the System's customers
are served from a single headend allowing for efficient capital deployment for
new services. Moreover, Insight Ohio estimates that it serves approximately 91%
of the subscribers in the System with upgraded network. Insight Ohio began
launching the interactive Insight Digital service on a node-by-node basis in
November 1999, including a video-on-demand and interactive informational service
and launched its high-speed Internet service during the second quarter of 2000.
Nodes are the point of interface between our headend and our network.
System Operating Strategy
The System fits the profile of cable television systems that Insight
seeks to own and operate. The System is large enough to have a significant
market presence and all customers are serviced from one headend. In addition,
Columbus is geographically proximate to other Insight cable systems with a
customer universe having the type of demographic profile that Insight believes
will widely accept new telecommunications offerings. Insight Ohio intends to
aggressively implement Insight's upgrade strategy in Columbus.
Insight has substantially completed rebuilding the System to 870 MHz,
and began servicing customers from the rebuilt network in November 1999. Insight
Ohio has launched its signature interactive Insight Digital service with
exclusive interactive programming including Local Source, an Internet-styled
information service, and a video-on-demand service by SeaChange International.
As of December 31, 2002, the System passed 81,700 homes with its digital service
and served approximately 29,400 customers with such service, representing a
penetration level of almost 36%. Management expects to increase revenues as the
System upgrade is completed by increasing the deployment of its digital cable,
high-speed modem and telephone services. Insight Ohio has an agreement with Road
Runner to deploy the Road Runner service over cable modems. As of December 31,
2002, approximately 18,600 customers subscribed to the Road Runner service.
In addition, the System provides exclusive sports programming under the
"Sport TV!" brand, featuring sporting events from Ohio State University.
Overbuild
In 1996, Ameritech obtained a citywide cable television franchise for
the City of Columbus and suburban communities in Franklin County. WideOpenWest
acquired the assets of Ameritech in December 2001, and has built its citywide
franchise, both in our service area and in the Time Warner service area on the
west side of Columbus. Insight Ohio and Time Warner service virtually distinct
areas and therefore do not compete with one another. As of December 31, 2002,
the areas of the System served by both Insight Ohio and WideOpenWest passed
approximately 129,100 homes, representing 65% of the System's total homes
passed.
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When the System was acquired by Insight Ohio in August 1999, it
implemented a strategy to end deep discounting as a defense against Ameritech.
Management believed that a relatively small customer loss, caused by
discontinuing discounts, would be preferable in exchange for achieving an
increase in the average monthly revenue per customer. As a result of this
strategy, from June 30, 1998 to December 31, 2002, the average monthly revenue
per customer increased from $43.30 to $62.44 while the number of customers
decreased from 91,100 to 88,100.
Technological Developments
Management believes that in order to achieve consistently high levels
of customer service, reduce operating costs, maintain a strong competitive
position and deploy important new technologies, we will need to install and
maintain a state-of-the-art technical platform. As of December 31, 2002, the
System was comprised of 2,600 miles of plant passing approximately 198,700 homes
resulting in a density of 76.4 homes per mile. Approximately 91% of the
customers are served by a network upgraded to 870 MHz, which enables delivery of
an advanced suite of entertainment, information and communications services,
including our interactive digital video, high-speed data access and telephone
services.
Insight Ohio's upgrade efforts are continuing. The deployment of fiber
optic cable, which has a capacity for a very large number of channels, an
increase in the bandwidth to 870 MHz, activation of a two-way communications
network and the installation of digital equipment will allow us to deliver new
and enhanced products and services.
All of the System's basic customers currently have access to
addressable technology and approximately 80% have addressable converters in
their homes as of December 31, 2002. Addressable technology enables the System
to electronically control the cable television services being delivered to the
customer's home. As a result, the System can electronically upgrade or downgrade
services to a customer immediately, from its customer service center, without
the delay or expense associated with dispatching a technician to the customer's
home. Addressable technology also reduces premium service theft, is an effective
enforcement tool in the collection of delinquent payments and enables the System
to offer pay-per-view services, including movies and special events.
Management believes that active use of fiber optic technology as a
supplement to coaxial cable plays a major role in expanding channel capacity and
improving the performance of the System. Fiber optic strands are capable of
carrying hundreds of video, data and voice channels over extended distances
without the extensive signal amplification typically required for coaxial cable.
The System will continue to deploy fiber optic cable to further reduce amplifier
cascades while improving picture quality and system reliability.
High-speed cable modems and set-top boxes using digital compression
technology have become commercially viable. These developments allow for the
introduction of high-speed data services and Internet access and will increase
the programming services available to customers. Digital compression technology
provides for a significant expansion of channel capacity with up to 12 digital
channels to be carried in the bandwidth of one analog channel. The upgrade of
the System has given the System the ability to package a "Digital Gateway"
brand. For $7.95 customers receive the following services:
o A digital set-top box;
o An interactive navigational program guide for all analog and digital
channels;
o A local, interactive Internet-style information and entertainment
service;
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o A multi-channel premium service for customers who separately subscribe
to premium channels, such as HBO and Showtime;
o Video-on-demand;
o Mag Rack, a video magazine service with full video-on-demand
functionality; and
o A digital 40-channel audio music service.
Insight Ohio began launching the Insight Digital service in the System
on a node-by-node basis in November 1999, including its video-on-demand service
and the Local Source interactive information service, and as of December 31,
2002 served approximately 29,400 subscribers with its digital service. Insight
Ohio launched the Road Runner high-speed Internet service during the second
quarter of 2000 and served approximately 18,600 customers with this service as
of December 31, 2002.
Marketing, Programming and Rates
Marketing
The System's marketing programs and campaigns are based upon offering a
variety of cable services creatively packaged and tailored to appeal to its
different markets and to segments within its markets. The System surveys its
customer base to ensure that it is meeting the demands of its customers and
stays abreast of its competition in order to effectively counter competitors'
promotional campaigns. The System uses a coordinated array of marketing tactics
to attract and retain customers and to increase premium service penetration,
including door-to-door and direct mail solicitation, telemarketing, media
advertising, local promotional events typically sponsored by programming
services and cross-channel promotion of new services. The rebuild of the plant
allows Insight Ohio to deploy its suite of services including interactive
digital, high-speed data and telephone services. In November 1999, Insight Ohio
began to launch its interactive digital, video-on-demand and Local Source
informational product on a node-by-node basis. Insight Ohio has also deployed
its Road Runner high-speed Internet service. Using a skilled team of marketing
professionals, the System has competed by supporting an innovative variety of
marketing activities.
Programming
Insight has various contracts to obtain basic and premium programming
for the System from program suppliers whose compensation is typically based on a
fixed fee per customer. Because of our manager's relationship with Comcast Cable
(formerly known as AT&T Broadband), we have the right to purchase certain
programming services for our systems through Comcast Cable's programming
supplier Satellite Services, Inc. We believe that Satellite Services has
attractive programming costs. In addition, some program suppliers provide volume
discount pricing structures or offer marketing and launch support to the System.
The System's successful marketing of multiple premium service packages
emphasizing customer value enables the System to take advantage of such cost
incentives. The System's overall programming costs are expected to increase in
the future due to additional programming being provided to its customers,
inflationary increases and other factors affecting the cable television
industry. The System also has various retransmission consent arrangements with
commercial broadcast stations which generally have been renewed through 2003.
None of these consents require payment of fees for carriage.
The System offers a "basic service tier," consisting primarily of local
television channels (network and independent stations) available over-the-air,
and local public, governmental and educational access channels. The System also
offers, for a monthly fee, an expanded basic tier of various
satellite-delivered, non-broadcast channels (such as CNN, ESPN, MTV, TNT, and
USA). In addition to these services, the
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System provides premium services such as HBO, Cinemax, Showtime, The Movie
Channel and Starz!, which have unique appeal to various segments of the viewing
audience. These services are satellite-delivered channels consisting principally
of feature films, original programming, live sports events, concerts and other
special entertainment features, usually presented without commercial
interruption. Such premium programming services are offered by the System both
on a per-channel basis and as part of premium service packages designed to
enhance customer value and to enable the System to take advantage of programming
agreements offering cost incentives based on premium service unit growth.
Customers may subscribe to one or more premium service units. A "premium service
unit" is a single premium service for which a customer must pay an additional
monthly fee in order to receive the service.
Management is upgrading the System to digital using fiber optic
technology, which has allowed the System to expand the number of multiplexed
premium screens (additional channels such as Showtime Women and HBO Family)
providing greater value for the customer. Moreover, the upgrade has given the
System the ability to offer its Insight Digital service including interactive
television and multiple packaging options through the addition of niche
programming services. Management believes that these additional features and
options will increase basic and premium penetration as well as revenue per basic
customer. The System also provides video-on-demand, a digital service consisting
principally of feature films, adult movies, concerts and other special events,
presented without commercial interruption. Such services are offered by the
System on a "per viewing" basis, with customers only paying for programs which
they select for viewing. Mag Rock is an added-value digital service offering a
library of video magazines - from cooking to classic cars to yoga - offered on a
"per view" basis at no additional charge.
Rates
Monthly customer rates for services vary from market to market,
primarily according to the amount of programming provided. As of December 31,
2002, the System's stated monthly basic service rate for residential customers
was $11.95, the System's monthly expanded basic service rates for residential
customers was $20.45, and per-channel premium service rates (not including
special promotions) ranged from $6.95 to $13.95 per service.
A one-time installation fee, which the System may wholly or partially
waive during a promotional period, is charged to new customers. The System
charges monthly fees for converters and remote control devices. The System also
charges administrative fees for delinquent payments for service. Customers are
free to discontinue service at any time without additional charge and may be
charged a reconnection fee to resume service. Commercial customers, such as
hotels, motels and hospitals, are charged negotiated monthly fees and a
non-recurring fee for the installation of service. These multiple dwelling unit
("MDU") accounts may be offered a bulk rate in exchange for single-point billing
and basic service to all units.
On February 11, 1997, a Petition for Determination of Effective
Competition filed by the prior owner of the System challenging the certification
of the City of Columbus was granted by the FCC. This petition effectively
revoked the City of Columbus' right to regulate the System's basic cable and
equipment rates.
6
Employees
As of December 31, 2002, the System employed 216 full-time equivalent
employees, none of whom is represented by a union or covered by a collective
bargaining obligation. Management believes that its relations with its employees
are good. Approximately 51% of the full-time employees have tenure of five years
or longer. Management believes that it will continue to be successful in
attracting and retaining highly qualified employees and maintaining good working
relationships with its current employees.
Customer Service and Community Relations
The System is dedicated to quality customer service. Plans to make
significant system improvements are designed in part to strengthen customer
service through greater system reliability and the introduction of new services.
Management seeks a high level of customer satisfaction by also employing a
well-trained staff of customer service representatives and experienced field
technicians.
The System is dedicated to fostering strong community relations in the
communities served by the System. The System supports local charities and
community causes through staged events and promotional campaigns, including
Children's Hospital Miracle Network Telethon, the Penny-A-Day for Children
Program and Red Cross Blood Drive donations. The System also installs and
provides free cable television service and Internet access to all eligible local
schools, as well as free cable television service for government buildings in
its franchise areas. The System has teamed up with its neighboring cable
operator Time Warner to develop a local sports and entertainment channel called
"Sport TV!" which features a broad range of local programming - including high
school sports, Major League Soccer, with the Columbus Crew, Ohio State
University sports, Columbus Clippers baseball, and Smooth Jazz Concert series -
on an exclusive basis to cable customers. Management believes that its relations
with the communities in which the System operates are generally excellent.
Franchises
Cable television systems are generally constructed and operated under
fixed-term non-exclusive franchises or other types of operating authorities that
are granted by local governmental authorities. These franchises typically
contain many conditions, such as:
o time limitations on commencement and completion of construction;
o conditions of service, including number of channels, types of
programming and the provision of free service to schools and certain
other public institutions;
o the maintenance of insurance and indemnity bonds; and
o the payment of fees to communities.
The provisions of local franchises are subject to federal regulation
under the Communications Act of 1934, as amended (the "Communications Act").
The System provides cable television service to residents of 42
governmental jurisdictions. Within each of these governmental jurisdictions, the
System operates under authority granted by the local community or the State of
Ohio. Actual franchise agreements are maintained with 28 jurisdictions that
possess the legal
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basis to grant such franchises consistent with federal and state law. These
franchises, which are non-exclusive, provide for the payment of fees to the
issuing authority. In the System, such franchise fees are passed through
directly to the customers. The Cable Television Consumer Protection and
Competition Act of 1992 (the "1992 Cable Act") and the Cable Communications
Policy Act of 1984 (the "1984 Cable Act" and, together with the 1992 Cable Act,
the "Cable Acts") prohibit franchising authorities from imposing franchise fees
in excess of 5% of gross revenue and also permit the cable television system
operator to seek renegotiation and modification of franchise requirements if
warranted by changed circumstances.
The majority of the System's basic customers are in governmental
jurisdictions that require a franchise. The table below groups all of the
System's governmental jurisdictions by year of expiration of the System's
franchises and presents the approximate number and percentage of basic customers
for each group as of December 31, 2002.
Percentage
of Total
Number of Percentage of Basic
Year of Franchise Expiration Franchises Total Franchises Customers
- ---------------------------- ---------- ---------------- ---------
Expired* ......................... 3 10.7% 1.1%
2003 and 2004 .................... 4 14.3% 3.2%
2005 and beyond .................. 21 75.0% 93.7%
---- ---- ----
Total ...................... 28 100.0% 98.0%
==== ===== ====
* Such franchises are operated on a month-to-month basis and are in the process
of being renewed.
The Cable Acts provide, among other things, for an orderly franchise
renewal process in which franchise renewal will not be unreasonably withheld or,
if renewal is denied and the franchising authority acquires ownership of the
system or effects a transfer of the system to another person, the operator
generally is entitled to the "fair market value" for the system covered by such
franchise. In addition, the Cable Acts established comprehensive renewal
procedures which require, when properly elected by an operator, that an
incumbent franchisee's renewal application be assessed on its own merits and not
as part of a comparative process with competing applications.
Management believes that the System generally has good relationships
with its franchising communities. The System has never had a franchise revoked
or failed to have a franchise renewed. In addition, all of the franchises of the
System eligible for renewal have been renewed or extended at or prior to their
stated expirations, and no franchise community has refused to consent to a
franchise transfer to the System.
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Competition
Cable systems face increasing competition from alternative methods of
receiving and distributing their core video business. Both wireline and wireless
competitors have made inroads in competing against incumbent cable operators.
The extent to which a cable operator is competitive depends, in part, upon its
ability to provide to customers, at a reasonable price, a greater variety of
programming and other communications services than are available off-air or
through alternative delivery sources and upon superior technical performance and
customer service.
Congress has enacted legislation and the FCC has adopted regulatory
policies providing a more favorable operating environment for new and existing
technologies, in particular direct broadcast satellite television systems
operators, that have the potential to provide increased competition to cable
systems. Congress has also enacted legislation which permits direct broadcast
satellite companies to retransmit local television signals, eliminating one of
the objections of consumers about switching to satellites.
The 1996 Telecom Act makes it easier for local exchange telephone
companies and others to provide a wide variety of video services competitive
with services provided by cable systems. Local exchange telephone companies and
other companies also provide facilities for the transmission and distribution to
homes and businesses of interactive computer-based services, including the
Internet, as well as data and other non-video services. The ability of local
exchange telephone companies to cross-subsidize video, data and
telecommunication services also poses some threat to cable operators.
Cable television systems are operated under non-exclusive franchises
granted by local authorities thereby allowing more than one cable system to be
built in the same area. Although the number of municipal and commercial
overbuild cable systems is small, the potential profitability of a cable system
is adversely affected if the local customer base is divided among multiple
systems. Additionally, constructing a competing cable system is a capital
intensive process which involves a high degree of risk. We believe that in order
to be successful, a competitor's overbuild would need to be able to serve the
homes in the overbuilt area on a more cost-effective basis than we can. Any such
overbuild operation would require either significant access to capital or access
to facilities already in place that are capable of delivering cable television
programming. The major source of competition for the System is the wireline
overbuild by WideOpenWest. WideOpenWest has overbuilt approximately 129,100
homes passed in the System's service area, or approximately 65% of the total
homes in the service territory as of December 31, 2002.
Franchised cable systems compete with private cable systems for the
right to service condominiums, apartment complexes and other multiple unit
residential developments. The operators of these private systems, known as
satellite master antenna television systems often enter into exclusive
agreements with apartment building owners or homeowners' associations that
preclude franchised cable television operators from serving residents of such
private complexes. However, the 1984 Cable Act gives franchised cable operators
the right to use existing compatible easements within their franchise areas on
nondiscriminatory terms and conditions. Accordingly, where there are preexisting
compatible easements, cable operators may not be unfairly denied access or
discriminated against with respect to access to the premises served by those
easements. Conflicting judicial decisions have been issued interpreting the
scope of the access right granted by the 1984 Cable Act, particularly with
respect to easements located entirely on private property.
The 1996 Telecom Act may exempt some of our competitors from regulation
as cable systems. The 1996 Telecom Act amends the definition of a "cable system"
such that providers of competitive video programming are only regulated and
franchised as "cable systems" if they use public rights-of-way. Thus, a
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broader class of entities providing video programming, including operators of
satellite master antenna television systems, may be exempt from regulation as
cable television systems under the 1996 Telecom Act. This exemption may give
these entities a competitive advantage over us. As of December 31, 2002, the
System passed approximately 527 multiple dwelling unit ("MDU") complexes within
its service territory and had entry agreements, either exclusive or
non-exclusive, with complexes totaling approximately 71,177 MDUs. As of December
31, 2002, the System provided programming to approximately 31,983 of these MDUs,
or approximately 45% of the total MDUs passed.
Direct broadcast satellite television systems use digital video
compression technology to increase the channel capacity of their systems. Direct
broadcast satellite television systems' programming is currently available to
individual households, condominiums and apartment and office complexes through
conventional, medium and high-power satellites. High-power direct broadcast
satellite television system service is currently being provided by DIRECTV,
Inc., and EchoStar Communications Corporation. Direct broadcast satellite
television systems have some advantages over cable systems that were not
upgraded, such as greater channel capacity and digital picture quality. In
addition, legislation has been enacted which permits direct broadcast satellite
television systems to retransmit the signals of local television stations in
their local markets. However, direct broadcast satellite television systems have
a limited ability to offer locally produced programming, and do not have a
significant local presence in the community. In addition, direct broadcast
satellite television systems packages can be more expensive than cable,
especially if the subscriber intends to view the service on more than one
television in the household. Finally, direct broadcast satellite television
systems do not have the same full two-way capability, which we believe will
limit their ability to compete in a meaningful way in interactive television,
high-speed data and voice communications. Management estimates that there were
approximately 12,300 direct broadcast satellite customers in the System's
service areas as of December 31, 2002.
Several telephone companies are introducing digital subscriber line
technology ("DSL"), which allows Internet access over traditional phone lines at
data transmission speeds greater than those available by a standard telephone
modem. Although these transmission speeds are not as great as the transmission
speeds of a cable modem, we believe that the transmission speeds of DSL
technology are sufficiently high that such technology will compete with cable
modem technology. The FCC is currently considering its authority to promulgate
rules to facilitate the deployment of these services and regulate areas
including high-speed data and interactive Internet services. We cannot predict
the outcome of any FCC proceedings, or the impact of that outcome on the success
of our Internet access services or on our operations. In addition to DSL and
dialup modems for providing Internet access, other technologies are entering the
marketplace. For example, there is a wireless technology popularly known as
"Wi-Fi," which is faster than dial-up, but slower than cable modem technology.
As we expand our offerings to include telephony services, our telephone
services will be subject to competition from existing providers, including both
local exchange telephone companies and long-distance carriers. The
telecommunications industry is highly competitive and many telephone service
providers may have greater financial resources than we have, or have established
relationships with regulatory authorities. We cannot predict the extent to which
the presence of these competitors will influence customer penetration in our
telephone service areas. While our manager intends to add our telephone service
offering to its various markets, the service has only been launched in selected
markets and has not yet achieved any material penetration levels.
Other new technologies may become competitive with services that cable
communications systems can offer. Advances in communications technology, as well
as changes in the marketplace and the
10
regulatory and legislative environment are constantly occurring. Thus, we cannot
predict the effect of ongoing or future developments on the cable communications
industry or on our operations.
Legislation and Regulation
The cable television industry is regulated by the FCC, some state
governments and the applicable local governments. In addition, various
legislative and regulatory proposals under consideration from time to time by
Congress and various federal agencies have in the past, and may in the future,
materially affect us. The following is a summary of federal laws and regulations
materially affecting the growth and operation of the cable television industry
and a description of certain state and local laws. We believe that the
regulation of the cable television industry remains a matter of interest to
Congress, the FCC and other regulatory authorities. There can be no assurance as
to what, if any, future actions such legislative and regulatory authorities may
take or the effect thereof on us.
Federal Legislation
The principal federal statute governing the cable television industry
is the Communications Act. As it affects the cable television industry, the
Communications Act has been significantly amended on three occasions, by the
1984 Cable Act, the 1992 Cable Act and the 1996 Telecom Act. The 1996 Telecom
Act altered the regulatory structure governing the nation's telecommunications
providers. It removed barriers to competition in both the cable television
market and the local telephone market. Among other things, it also reduced the
scope of cable rate regulation.
Federal Regulation
The FCC, the principal federal regulatory agency with jurisdiction over
cable television, has adopted regulations covering such areas as cross-ownership
between cable television systems and other communications businesses, carriage
of television broadcast programming, cable rates, consumer protection and
customer service, leased access, indecent programming, programmer access to
cable television systems, programming agreements, technical standards, consumer
electronics equipment compatibility, ownership of home wiring, program
exclusivity, equal employment opportunity, consumer education and lockbox
enforcement, origination cablecasting and sponsorship identification, children's
programming, signal leakage and frequency use, maintenance of various records,
and antenna structure notification, marking and lighting. The FCC has the
authority to enforce these regulations through the imposition of substantial
fines, the issuance of cease and desist orders and/or the imposition of other
administrative sanctions, such as the revocation of FCC licenses needed to
operate certain transmission facilities often used in connection with cable
operations. A brief summary of certain of these federal regulations as adopted
to date follows.
Rate Regulation
The 1984 Cable Act codified existing FCC preemption of rate regulation
for premium channels and optional non-basic program tiers. The 1984 Cable Act
also deregulated basic cable rates for cable television systems determined by
the FCC to be subject to effective competition. The 1992 Cable Act substantially
changed the previous statutory and FCC rate regulation standards. The 1992 Cable
Act replaced the FCC's old standard for determining effective competition, under
which most cable television systems were not subject to rate regulation, with a
statutory provision that resulted in nearly all cable television systems
becoming subject to rate regulation of basic service. The 1996 Telecom Act
expanded
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the definition of effective competition to cover situations where a local
telephone company or its affiliate, or any multichannel video provider using
telephone company facilities, offers comparable video service by any means
except direct broadcast satellite television systems. Satisfaction of this test
deregulates all rates.
For cable systems not subject to effective competition, the 1992 Cable
Act required the FCC to adopt a formula for franchising authorities to assure
that basic cable rates are reasonable; allowed the FCC to review rates for cable
programming service tiers, other than per-channel or per-program services, in
response to complaints filed by franchising authorities and/or cable customers;
prohibited cable television systems from requiring basic customers to purchase
service tiers above basic service in order to purchase premium services if the
system is technically capable of compliance; required the FCC to adopt
regulations to establish, on the basis of actual costs, the price for
installation of cable service, remote controls, converter boxes and additional
outlets; and allowed the FCC to impose restrictions on the retiring and
rearrangement of cable services under certain limited circumstances. The 1996
Telecom Act limited the class of complainants regarding cable programming
service tier rates to franchising authorities only, and ended FCC regulation of
cable programming service tier rates on March 31, 1999. The 1996 Telecom Act
also relaxes existing uniform rate requirements by specifying that such
requirements do not apply where the operator faces effective competition, and by
exempting bulk discounts to multiple dwelling units, although complaints about
predatory pricing may be lodged with the FCC.
The FCC's implementing regulations contain standards for the regulation
of basic service rates. Local franchising authorities are empowered to order a
reduction of existing rates which exceed the maximum permitted level for basic
services and associated equipment, and refunds can be required. The FCC adopted
a benchmark price cap system for measuring the reasonableness of existing basic
service rates. Alternatively, cable operators have the opportunity to make
cost-of-service showings which, in some cases, may justify rates above the
applicable benchmarks. The rules also require that charges for cable-related
equipment, converter boxes and remote control devices, for example, and
installation services be unbundled from the provision of cable service and based
upon actual costs plus a reasonable profit. The regulations also provide that
future rate increases may not exceed an inflation-indexed amount, plus increases
in certain costs beyond the cable operator's control, such as taxes, franchise
fees and increased programming costs. Cost-based adjustments to these capped
rates can also be made in the event a cable television operator adds or deletes
channels. There is also a streamlined cost-of-service methodology available to
justify a rate increase on the basic tier for "significant" system upgrades.
Finally, there are regulations which require cable television systems
to permit customers to purchase video programming on a per channel or a per
program basis without the necessity of subscribing to any tier of service, other
than the basic service tier.
Carriage of Broadcast Television Signals
The 1992 Cable Act contains signal carriage requirements which allow
commercial television broadcast stations that are "local" to a cable television
system, that is to say that the system is located in the station's designated
market area, to elect every three years whether to require the cable television
system to carry the station, subject to certain exceptions, or whether the cable
television system will have to negotiate for "retransmission consent" to carry
the station. The most recent election between must-carry and retransmission
consent was October 1, 2002. A cable television system is generally required to
devote up to one-third of its activated channel capacity for the carriage of
local commercial television stations whether pursuant to mandatory carriage
requirements or the retransmission consent requirements of the 1992 Cable Act.
Local non-commercial television stations are also given mandatory carriage
rights, subject to certain exceptions, within the larger of: (i) a 50 mile
radius from the station's city of license; or (ii) the
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station's Grade B contour, a measure of signal strength. Unlike commercial
stations, noncommercial stations are not given the option to negotiate
retransmission consent for the carriage of their signal. In addition, cable
television systems have to obtain retransmission consent for the carriage of all
"distant" commercial broadcast stations, except for certain "superstations,"
which are commercial satellite-delivered independent stations such as WGN. To
date, compliance with the "retransmission consent" and "must carry" provisions
of the 1992 Cable Act has not had a material effect on us, although this result
may change in the future depending on such factors as market conditions, channel
capacity and similar matters when such arrangements are renegotiated. The FCC
has issued a decision in a rulemaking proceeding dealing with the carriage of
television signals in a digital format, both high definition and standard
digital. The rules require carriage of local television broadcast stations that
transmits in both analog and digital format during the current several-year
transition period is entitled to carriage for only its analog signal. The FCC
has been asked to reconsider this decision. The FCC is also considering whether
the mandatory carriage obligation should extend beyond the primary video signal
to multiple services transmitted by a station over its digital channel. The
outcome of these proceedings could have a material effect on the number of
services that a cable operator will be required to carry.
Deletion of Certain Programming
Cable television systems that have 1,000 or more customers must, upon
the appropriate request of a local television station, delete the simultaneous
or nonsimultaneous network programming of a distant station when such
programming has also been contracted for by the local station on an exclusive
basis. FCC regulations also enable television stations that have obtained
exclusive distribution rights for syndicated programming in their market to
require a cable television system to delete or "black out" such programming from
other television stations which are carried by the cable television system.
Franchise Fees
Although franchising authorities may impose franchise fees under the
1984 Cable Act, such payments cannot exceed 5% of a cable television system's
annual gross revenues from the provision of cable services. Under the 1996
Telecom Act, franchising authorities may not exact franchise fees from revenues
derived from telecommunications services, although they may be able to exact
some additional compensation for the use of public rights-of-way. The FCC has
ruled that franchise fees may not be imposed on revenue from cable modem
services. Franchising authorities are also empowered, in awarding new franchises
or renewing existing franchises, to require cable television operators to
provide cable-related facilities and equipment and to enforce compliance with
voluntary commitments. In the case of franchises in effect prior to the
effective date of the 1984 Cable Act, franchising authorities may enforce
requirements contained in the franchise relating to facilities, equipment and
services, whether or not cable-related. The 1984 Cable Act, under certain
limited circumstances, permits a cable operator to obtain modifications of
franchise obligations.
Renewal of Franchises
The 1984 Cable Act and the 1992 Cable Act establish renewal procedures
and criteria designed to protect incumbent franchisees against arbitrary denials
of renewal and to provide specific grounds for franchising authorities to
consider in making renewal decisions, including a franchisee's performance under
the franchise and community needs. Even after the formal renewal procedures are
invoked, franchising authorities and cable television operators remain free to
negotiate a renewal outside the formal process. Nevertheless, renewal is by no
means assured, as the franchisee must meet certain statutory standards. Even if
a franchise is renewed, a franchising authority may impose new and more onerous
13
requirements such as upgrading facilities and equipment, although the
municipality must take into account the cost of meeting such requirements.
Similarly, if a franchising authority's consent is required for the purchase or
sale of a cable television system or franchises, such authority may attempt to
impose burdensome or onerous franchise requirements in connection with a request
for such consent. Historically, franchises have been renewed for cable
television operators that have provided satisfactory services and have complied
with the terms of their franchises. At this time, we are not aware of any
current or past material failure on our part to comply with our franchise
agreements. We believe that we have generally complied with the terms of our
franchises and have provided quality levels of service.
The 1992 Cable Act makes several changes to the process under which a
cable television operator seeks to enforce its renewal rights which could make
it easier in some cases for a franchising authority to deny renewal. Franchising
authorities may consider the "level" of programming service provided by a cable
television operator in deciding whether to renew. For alleged franchise
violations occurring after December 29, 1984, franchising authorities are no
longer precluded from denying renewal based on failure to substantially comply
with the material terms of the franchise where the franchising authority has
"effectively acquiesced" to such past violations. Rather, the franchising
authority is estopped if, after giving the cable television operator notice and
opportunity to cure, it fails to respond to a written notice from the cable
television operator of its failure or inability to cure. Courts may not reverse
a denial of renewal based on procedural violations found to be "harmless error."
Channel Set-Asides
The 1984 Cable Act permits local franchising authorities to require
cable television operators to set aside certain television channels for public,
educational and governmental access programming. The 1984 Cable Act further
requires cable television systems with thirty-six or more activated channels to
designate a portion of their channel capacity for commercial leased access by
unaffiliated third parties to provide programming that may compete with services
offered by the cable television operator. The 1992 Cable Act requires leased
access rates to be set according to a formula determined by the FCC.
Ownership
The 1996 Telecom Act repealed the statutory ban against local exchange
carriers providing video programming directly to customers within their local
exchange telephone service areas. Consequently, the 1996 Telecom Act permits
telephone companies to compete directly with operations of cable television
systems. Under the 1996 Telecom Act and FCC rules adopted to implement the 1996
Telecom Act, local exchange carriers may provide video service as broadcasters,
common carriers, or cable operators. In addition, local exchange carriers and
others may also provide video service through "open video systems," a regulatory
regime that may give them more flexibility than traditional cable television
systems. Open video system operators (including local exchange carriers) can,
however, be required to obtain a local cable franchise, and they can be required
to make payments to local governmental bodies in lieu of cable franchise fees.
In general, open video system operators must make their systems available to
programming providers on rates, terms and conditions that are reasonable and
nondiscriminatory. Where carriage demand by programming providers exceeds the
channel capacity of an open video system, two-thirds of the channels must be
made available to programmers unaffiliated with the open video system operator.
The 1996 Telecom Act generally prohibits local exchange carriers from
purchasing a greater than 10% ownership interest in a cable television system
located within the local exchange carrier's telephone service area, prohibits
cable operators from purchasing local exchange carriers whose service areas are
located within the cable operator's franchise area, and prohibits joint ventures
between operators of cable
14
television systems and local exchange carriers operating in overlapping markets.
There are some statutory exceptions, including a rural exemption that permits
buyouts in which the purchased cable television system or local exchange carrier
serves a non-urban area with fewer than 35,000 inhabitants, and exemptions for
the purchase of small cable television systems located in non-urban areas. Also,
the FCC may grant waivers of the buyout provisions in certain circumstances.
The 1996 Telecom Act made several other changes to relax ownership
restrictions and regulations of cable television systems. The 1996 Telecom Act
repealed the 1992 Cable Act's three-year holding requirement pertaining to sales
of cable television systems. The statutory broadcast/cable cross-ownership
restrictions imposed under the 1984 Cable Act were eliminated in 1996, although
the parallel FCC regulations prohibiting broadcast/cable common-ownership
remained in effect. The U.S. Court of Appeals for the District of Columbia
circuit struck down these rules. The FCC's rules also generally prohibit cable
operators from offering satellite master antenna service separate from their
franchised systems in the same franchise area, unless the cable operator is
subject to "effective competition" there.
The 1996 Telecom Act amended the definition of a "cable system" under
the Communications Act so that competitive providers of video services will be
regulated and franchised as "cable systems" only if they use public
rights-of-way. Thus, a broader class of entities providing video programming may
be exempt from regulation as cable television systems under the Communications
Act.
The 1996 Telecom Act provides that registered utility holding companies
and subsidiaries may provide telecommunications services, including cable
television, notwithstanding the Public Utilities Holding Company Act of 1935, as
amended. Electric utilities must establish separate subsidiaries known as
"exempt telecommunications companies" and must apply to the FCC for operating
authority. Due to their resources, electric utilities could be formidable
competitors to traditional cable television systems.
Access to Programming
The 1992 Cable Act imposed restrictions on the dealings between cable
operators and cable programmers. Of special significance from a competitive
business posture, the 1992 Cable Act precludes video programmers affiliated with
cable companies from favoring their affiliated cable operators and requires such
programmers to sell their programming to other multichannel video distributors.
This provision limits the ability of vertically integrated cable programmers to
offer exclusive programming arrangements to cable companies. The prohibition on
certain types of exclusive programming arrangements is set to expire on October
5, 2002, but the FCC has determined that a five-year extension of the
prohibition is necessary to preserve and protect competition in video
programming distribution.
Privacy
The 1984 Cable Act imposes a number of restrictions on the manner in
which cable television operators can collect and disclose data about individual
system customers. The statute also requires that the system operator
periodically provide all customers with written information about its policies
regarding the collection and handling of data about customers, their privacy
rights under federal law and their enforcement rights. In the event that a cable
television operator was found to have violated the customer privacy provisions
of the 1984 Cable Act, it could be required to pay damages, attorneys' fees and
other costs. Under the 1992 Cable Act, the privacy requirements were
strengthened to require that cable television operators take such actions as are
necessary to prevent unauthorized access to personally identifiable information.
Certain of these requirements were modified by the Electronic Communications
Privacy Act of 2001.
15
Franchise Transfers
The 1992 Cable Act requires franchising authorities to act on any
franchise transfer request submitted after December 4, 1992 within 120 days
after receipt of all information required by FCC regulations and by the
franchising authority. Approval is deemed to be granted if the franchising
authority fails to act within such period.
Technical Requirements
The FCC has imposed technical standards applicable to all classes of
channels which carry downstream National Television System Committee video
programming. The FCC also has adopted additional standards applicable to cable
television systems using frequencies in the 108 to 137 MHz and 225 to 400 MHz
bands in order to prevent harmful interference with aeronautical navigation and
safety radio services and has also established limits on cable television system
signal leakage. Periodic testing by cable television operators for compliance
with the technical standards and signal leakage limits is required and an annual
filing of the results of these measurements is required. The 1992 Cable Act
requires the FCC to periodically update its technical standards to take into
account changes in technology. Under the 1996 Telecom Act, local franchising
authorities may not prohibit, condition or restrict a cable television system's
use of any type of customer equipment or transmission technology.
The FCC has adopted regulations to implement the requirements of the
1992 Cable Act designed to improve the compatibility of cable television systems
and consumer electronics equipment. These regulations, among other things,
generally prohibit cable television operators from scrambling their basic
service tier. The 1996 Telecom Act directs the FCC to set only minimal standards
to assure compatibility between television sets, VCRs and cable television
systems, and otherwise to rely on the marketplace. Pursuant to the 1992 Cable
Act, the FCC has adopted rules to assure the competitive availability to
consumers of customer premises equipment, such as converters, used to access the
services offered by cable television systems and other multichannel video
programming distributors. Pursuant to those rules, consumers are given the right
to attach compatible equipment to the facilities of their multichannel video
programming distributors so long as the equipment does not harm the network,
does not interfere with the services purchased by other customers and is not
used to receive unauthorized services. As of July 1, 2000, multichannel video
programming distributors, other than operators of direct broadcast satellite
television systems, were required to separate security from non-security
functions in the customer premises equipment which they sell or lease to their
customers and offer their customers the option of using component security
modules obtained from the multichannel video programming distributors with
set-top units purchased or leased from retail outlets. As of January 1, 2005,
multichannel video programming distributors will be prohibited from distributing
new set-top equipment integrating both security and non-security functions to
their customers.
Inside Wiring; Customer Access
FCC rules require an incumbent cable operator upon expiration of a
multiple dwelling unit service contract to sell, abandon, or remove "home run"
wiring that was installed by the cable operator in a multiple dwelling unit
building. These inside wiring rules assist building owners in their attempts to
replace existing cable operators with new programming providers who are willing
to pay the building owner a higher fee, where such a fee is permissible. The FCC
has also issued an order preempting state, local and private restrictions on
over- the-air reception antennas placed on rental properties in areas where a
tenant has exclusive use of the property, such as balconies or patios. However,
tenants may not install
16
such antennas on the common areas of multiple dwelling units, such as on roofs.
This order limits the extent to which multiple dwelling unit owners may enforce
certain aspects of multiple dwelling unit agreements which otherwise would
prohibit, for example, placement of direct broadcast satellite television
systems television receiving antennae in multiple dwelling unit areas, such as
apartment balconies or patios, under the exclusive occupancy of a renter.
Pole Attachments
The FCC currently regulates the rates and conditions imposed by certain
public utilities for use of their poles unless state public service commissions
are able to demonstrate that they adequately regulate the rates, terms and
conditions of cable television pole attachments. A number of states and the
District of Columbia have certified to the FCC that they adequately regulate the
rates, terms and conditions for pole attachments. Illinois, Ohio and Kentucky,
states in which we operate, have made such a certification. In the absence of
state regulation, the FCC administers such pole attachment and conduit use rates
through use of a formula which it has devised. Pursuant to the 1996 Telecom Act,
the FCC has adopted a new rate formula for any attaching party, including cable
television systems, which offers telecommunications services. This new formula
will result in higher attachment rates than at present, but they will apply only
to cable television systems which elect to offer telecommunications services.
Any increases pursuant to this new formula began in 2001, and will be phased in
by equal increments over the five ensuing years. The FCC ruled that the
provision of Internet services will not, in and of itself, trigger use of the
new formula. The United States Supreme Court affirmed this decision and also
held that the FCC's authority to regulate rates for attachments to utility poles
extended to attachments by cable operators and telecommunications carriers that
are used to provide Internet service or for wireless telecommunications service.
This development benefits our business and will place a constraint on the prices
that utilities can charge with regard to the cable facilities over which we also
provide Internet access service. However, the FCC has also initiated a
proceeding to determine whether it should adjust certain elements of the current
rate formula. If adopted, these adjustments could increase rates for pole
attachments and conduit space.
Other FCC Matters
FCC regulation pursuant to the Communications Act also includes matters
regarding a cable television system's carriage of local sports programming;
restrictions on origination and cablecasting by cable television operators;
rules governing political broadcasts; equal employment opportunity; deletion of
syndicated programming; registration procedure and reporting requirements;
customer service; closed captioning; obscenity and indecency; program access and
exclusivity arrangements; and limitations on advertising contained in
nonbroadcast children's programming.
The FCC has recently issued a Notice of Inquiry covering a wide range
of issues relating to Interactive Television ("ITV"). Examples of ITV services
are interactive electronic program guides and access to a graphic interface that
provides supplementary information related to the video display. In the near
term, cable systems are likely to be the platform of choice for the distribution
of ITV services. The FCC has posed a series of questions including the
definition of ITV, the potential for discrimination by cable systems in favor of
affiliated ITV providers, enforcement mechanisms, and the proper regulatory
classification of ITV service.
Copyright
Cable television systems are subject to federal copyright licensing
covering carriage of broadcast signals. In exchange for making semi-annual
payments to a federal copyright royalty pool and meeting
17
certain other obligations, cable television operators obtain a statutory license
to retransmit broadcast signals. The amount of this royalty payment varies,
depending on the amount of system revenues from certain sources, the number of
distant signals carried, and the location of the cable television system with
respect to over-the-air television stations. Any future adjustment to the
copyright royalty rates will be done through an arbitration process to be
supervised by the U.S. Copyright Office. Cable television operators are liable
for interest on underpaid and unpaid royalty fees, but are not entitled to
collect interest on refunds received for overpayment of copyright fees.
Various bills have been introduced into Congress over the past several
years that would eliminate or modify the cable television compulsory license.
Without the compulsory license, cable television operators would have to
negotiate rights from the copyright owners for all of the programming on the
broadcast stations carried by cable television systems. Such negotiated
agreements would likely increase the cost to cable television operators of
carrying broadcast signals. The 1992 Cable Act's retransmission consent
provisions expressly provide that retransmission consent agreements between
television broadcast stations and cable television operators do not obviate the
need for cable operators to obtain a copyright license for the programming
carried on each broadcaster's signal.
Copyrighted music performed in programming supplied to cable television
systems by pay cable networks, such as HBO, and basic cable networks, such as
USA Network, is licensed by the networks through private agreements with the
American Society of Composers and Publishers, generally known as ASCAP, and BMI,
Inc., the two major performing rights organizations in the United States. Both
the American Society of Composers and Publishers and BMI offer "through to the
viewer" licenses to the cable networks which cover the retransmission of the
cable networks' programming by cable television systems to their customers.
Licenses to perform copyrighted music by cable television systems
themselves, including on local origination channels, in advertisements inserted
locally on cable television networks, and in cross-promotional announcements,
must be obtained by the cable television operator from the American Society of
Composers and Publishers, BMI and/or SESAC, Inc.
State and Local Regulation
Cable television systems generally are operated pursuant to
nonexclusive franchises, permits or licenses granted by a municipality or other
state or local government entity. The terms and conditions of franchises vary
materially from jurisdiction to jurisdiction, and even from city to city within
the same state, historically ranging from reasonable to highly restrictive or
burdensome. Franchises generally contain provisions governing fees to be paid to
the franchising authority, length of the franchise term, renewal, sale or
transfer of the franchise, territory of the franchise, design and technical
performance of the system, use and occupancy of public streets and number and
types of cable television services provided. The terms and conditions of each
franchise and the laws and regulations under which it was granted directly
affect the profitability of the cable television system. The 1984 Cable Act
places certain limitations on a franchising authority's ability to control the
operation of a cable television system. The 1992 Cable Act prohibits exclusive
franchises, and allows franchising authorities to exercise greater control over
the operation of franchised cable television systems, especially in the area of
customer service and rate regulation. The 1992 Cable Act also allows franchising
authorities to operate their own multichannel video distribution system without
having to obtain a franchise and permits states or local franchising authorities
to adopt certain restrictions on the ownership of cable television systems.
Moreover, franchising authorities are immunized from monetary damage awards
arising from regulation of cable television systems or decisions made on
franchise grants, renewals, transfers and amendments. The 1996 Telecom Act
prohibits a
18
franchising authority from either requiring or limiting a cable television
operator's provision of telecommunications services.
Various proposals have been introduced at the state and local levels
with regard to the regulation of cable television systems, and a number of
states have adopted legislation subjecting cable television systems to the
jurisdiction of centralized state governmental agencies, some of which impose
regulation of a character similar to that of a public utility. To date, none of
the states in which we currently operate has enacted state level regulation.
The foregoing describes all material present and proposed federal,
state and local regulations and legislation relating to the cable television
industry. Other existing federal regulations, copyright licensing and, in many
jurisdictions, state and local franchise requirements, currently are the subject
of a variety of judicial proceedings, legislative hearings and administrative
and legislative proposals which could change, in varying degrees, the manner in
which cable television systems operate. Neither the outcome of these proceedings
nor their impact upon the cable television industry or us can be predicted at
this time.
Internet Access Service
We offer a service which enables consumers to access the Internet at
high speeds via high capacity broadband transmission facilities and cable
modems. We compete with many other providers of Internet access services which
are known as Internet service providers ("ISPs"). ISPs include such companies as
America Online and Mindspring Enterprises as well as major telecommunications
providers, including AT&T and local exchange telephone companies. A number of
local franchising authorities have attempted to require cable companies offering
Internet access service over their broadband facilities to allow access to those
facilities on an unbundled basis to other ISPs. To date, all such efforts have
been overturned in the courts. However, many ISPs and local franchising
authorities have continued to ask the U.S. Congress and the FCC to mandate such
access, or at least to allow local authorities to impose such a requirement.
Although the FCC has thus far declined to impose such an access requirement on
cable companies, the issue remains under consideration. The FCC has recently
decided that cable Internet service should be classified for regulatory purposes
as an "information service" rather than either a "cable service" or a
"telecommunications service." Concurrently the FCC has initiated a wide-ranging
rulemaking proceeding in which it seeks comment on the regulatory ramifications
of this classification. Among the issues to be decided are whether the FCC
should permit local authorities to impose an access requirement, whether local
authorities should be prohibited from imposing fees on cable Internet service
revenues, and what regulatory role local authorities should be permitted to
play. The outcome of this proceeding could have a material impact on our
provision of cable Internet service.
There are currently few laws or regulations which specifically regulate
communications or commerce over the Internet. Section 230 of the Communications
Act, added to that act by the 1996 Telecom Act, declares it to be the policy of
the United States to promote the continued development of the Internet and other
interactive computer services and interactive media, and to preserve the vibrant
and competitive free market that presently exists for the Internet and other
interactive computer services, unfettered by federal or state regulation. One
area in which Congress did attempt to regulate content over the Internet
involved the dissemination of obscene or indecent materials. The provisions of
the 1996 Telecom Act, generally referred to as the Communications Decency Act,
were found to be unconstitutional, in part, by the United States Supreme Court
in 1997. In response, Congress passed the Child Online Protection Act. The
constitutionality of this act is currently being challenged in the courts. In
May 2002, the Supreme Court reversed the finding by the Third Circuit Court of
Appeals that the use of "contemporary community standards" to identify material
"harmful to minors" was overly broad and
19
therefore violative of the First Amendment. The Supreme Court, however, remanded
the matter to the Third Circuit to determine the validity of other challenges to
the constitutionality of the Child Online Protection Act and kept the stay
prohibiting government enforcement in place until further action by the lower
courts. Finally, disclosure of customer communications or records is governed by
the Electronic Communications Privacy Act of 2001 and the Cable Act, both of
which were amended by the USA Patriot Act.
Local Telecommunications Services
The 1996 Telecom Act provides that no state or local laws or
regulations may prohibit or have the effect of prohibiting any entity from
providing any interstate or intrastate telecommunications service. States are
authorized, however, to impose "competitively neutral" requirements regarding
universal service, public safety and welfare, service quality and consumer
protection. State and local governments also retain their authority to manage
the public rights-of-way and may require fair and reasonable, competitively
neutral and non-discriminatory compensation for management of the public
rights-of-way when cable operators provide telecommunications service. State and
local governments must publicly required compensation from telecommunications
providers for use of public rights-of-way.
We have long-term agreements with Comcast Cable (formerly known as AT&T
Broadband) that allow Comcast Cable to provide to customers telephone services
using our network infrastructure and Comcast Cable's switching and long distance
transport facilities. Local telecommunications service is subject to regulation
by state utility commissions. Use of local telecommunications facilities to
originate and terminate long distance services, a service commonly referred to
as "exchange access," is subject to regulation both by the FCC and by state
utility commissions. As a provider of local exchange service, Comcast Cable
would be subject to the requirements imposed upon local exchange carriers by the
1996 Telecom Act and state law. These include requirements governing just and
reasonable rates and practices, service quality, resale, telephone number
portability, dialing parity, access to rights-of-way, reciprocal compensation,
access for people with disabilities and truth-in-billing. Although we do not
provide telecommunications services, and are not currently regulated with regard
to Comcast Cable's provision of telecommunications services over our facilities,
there is a possibility that we could be subject to increased regulation in the
future. Although we cannot predict whether and the extent to which the state may
seek to regulate us, increased regulation would likely increase our cost of
doing business.
Item 2. Properties
The System's principal physical assets consist of cable television
operating plant and equipment, including signal receiving, encoding and decoding
devices, headend and distribution systems and customer house drop equipment for
its cable television systems. The signal receiving apparatus includes a tower,
antenna, ancillary electronic equipment and earth stations for reception of
satellite signals. The headend, consisting of associated electronic equipment
necessary for the reception, amplification and modulation of signals, is located
near the receiving devices. Most basic customers of the System utilize
converters that can be addressed by sending coded signals from the headend
facility over the cable network. The System's distribution system consists
primarily of coaxial and fiber optic cables and related electronic equipment.
The System owns parcels of real property for signal reception sites
(one antenna tower and one headend). The System also leases one small office and
one hub location. Management believes that its properties, both owned and
leased, are in suitable condition adequate for the System's operations.
20
The System's cables generally are attached to utility poles under pole
rental agreements with local public utilities, although in some areas the
distribution cable is buried in underground ducts or trenches. The physical
components of the System require periodic upgrading to improve system
performance and capacity.
Item 3. Legal Proceedings
There are no material pending legal proceedings to which any of the
Registrants is a party or to which any of their properties are subject.
Item 4. Submission of Matters to a Vote of Security Holders
None.
21
PART II
Item 5. Market for Registrant's Common Stock and Related Stockholder Matters
There is no public trading market for the equity of Coaxial, Phoenix and
Insight Ohio. There are three, holders each of the equity of Coaxial and Phoenix
and the common equity of Insight Ohio is held by Insight Holdings of Ohio, LLC,
a wholly-owned subsidiary of Insight Midwest, L.P.
Item 6. Selected Financial Data
The following tables present selected historical financial data for
Coaxial, Phoenix and Insight Ohio as of and for the five years ended December
31, 2002. As a result of the August 8, 2000 purchase by Insight Ohio of
Coaxial's 25% common equity interest held by Coaxial and certain amendments to
Insight Ohio's operating agreement, the operating results of Coaxial include the
operating results of Insight Ohio only through August 8, 2000. These tables
should be read in conjunction with "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and the financial statements and
the notes thereto included elsewhere in this report.
Under Insight Ohio's franchise agreements, it is obligated to pay to
local franchising authorities a percentage of it's revenue derived from
providing cable and other services the majority of which are passed through to
customers. Insight Ohio has historically recorded revenue net of franchise fees
charged to its customers. Staff Announcement D-103, issued by the FASB in
November 2001, specifies that reimbursements received from a customer should be
reflected as revenues and not as a reduction of expenses. This Staff
Announcement applies to financial reporting periods beginning after December 15,
2001. Upon application of this Staff Announcement, comparative financial
statements for prior periods are required to be reclassified to comply with the
guidance in this Staff Announcement. Consequently, Insight Ohio has reclassified
the prior period amounts in the accompanying consolidated statements of
operations to reflect franchise fees on a gross basis with reimbursements as
revenue and payments as expense. The effect on the prior period statements of
operations was to increase both revenue and selling, general and administrative
costs by $1.5 million, $1.4 million, $1.3 million and $1.3 million for each of
the years ended December 31, 2001, 2000, 1999 and 1998.
Additionally, the consolidated financial statements of Coaxial have been
adjusted to reflect such prior period reclassifications. The effect on the prior
period statements of operations was to increase both revenue and selling,
general and administrative costs by $824,000 for the period from January 1, 2000
through August 8, 2000 and $1.3 million for the years ended 1999 and 1998.
22
Coaxial Communications of Central Ohio, Inc.
(dollars in thousands)
Year Ended December 31,
2002 2001 2000 1999 1998
------------ ------------ ------------ ------------ -----------
Statement of Operations Data:
Revenues ................................. $ - $ - $ 28,920 $ 48,032 $ 49,274
Operating costs and expenses:
Programming and other operating costs - - 10,955 16,863 18,130
Selling general and administrative .... - - 7,300 12,041 12,883
Severance and transaction structure ...
costs ............................ - - - - 4,822
Depreciation and amortization ......... 628 628 6,474 7,769 5,471
------------ ------------ ------------ ------------ -----------
Total operating costs and expenses 628 628 24,729 36,673 41,306
Operating income (loss) .................. (628) (628) 4,191 11,359 7,968
Interest expense, net ................. (14,000) (14,000) (14,861) (14,297) (5,434)
Gain on sale of common
equity interest(1) ............... - - 171,460 - -
Dividend on preferred interest ........ 20,107 19,432 7,882 - -
Other income (expense) ................ - - 31 92 (421)
------------ ------------ ------------ ------------ -----------
Income (loss) before extraordinary
item ............................. 5,479 4,804 168,703 (2,846) 2,113
Extraordinary loss on extinguishments
of debt .......................... - - - - (847)
------------ ------------ ------------ ------------ -----------
Net income (loss) ........................ $ 5,479 $ 4,804 $ 168,703 $ (2,846) $ 1,266
============ ============ ============ ============ ===========
Financial Data:
Capital expenditures ..................... $ - $ - $ 19,943 $ 26,656 $ 7,369
Net cash provided by (used in)
operating activities ............. (3,444) (3,444) 7,224 19,043 12,597
Net cash used in investing activities .... - - 20,950 26,754 3,470
Net cash provided by (used in) financing
activities ....................... 3,444 3,444 12,844 (116) (993)
Balance Sheet Data: (at end of period)
Total assets ............................. $ 209,261 $ 213,206 $ 207,874 $ 61,135 $ 48,849
Total debt ............................... 140,000 140,000 140,000 151,000 141,248
Total liabilities ........................ 145,250 145,250 145,250 170,914 155,237
Total shareholders' equity (deficit) ..... 64,011 67,956 62,624 (109,779) (106,388)
23
Phoenix Associates
(dollars in thousands)
Year Ended December 31,
2002 2001 2000 1999 1998
------------ ------------ ------------ ------------ -----------
Statement of Operations Data:
Operating loss:
Interest and amortization expense,
net ............................... $ (14,496) $ (14,470) $ (14,470) $ (14,470) $ (13,709)
Other expense - - - - 96
------------ ------------ ------------ ------------ -----------
Net loss before extraordinary gain ........ (14,496) (14,470) (14,470) (14,470) (13,613)
Gain on settlement of notes receivable
from related parties .................. 1,917 - - - -
------------ ------------ ------------ ------------ -----------
Net loss .................................. $ (12,579) $ (14,470) $ (14,470) $ (14,470) $ (13,613)
============ ============ ============ ============ ===========
Balance Sheet Data: (at end of period)
Total assets .............................. $ 2,287 $ 4,402 $ 4,872 $ 5,342 $ 5,747
Total debt ................................ 140,000 140,000 140,000 140,000 140,000
Total liabilities ......................... 145,250 145,250 145,250 145,250 145,250
Total partners' deficit ................... (142,963) (140,848) (140,378) (139,908) (139,503)
24
Insight Communications of Central Ohio, LLC
(dollars in thousands)
Year Ended December 31,
2002 2001 2000 1999 1998
------------ ------------ ------------ ------------ -----------
Statement of Operations Data:
Revenues .................................. $ 63,140 $ 57,019 $ 51,116 $ 48,032 $ 49,274
Operating costs and expenses:
Programming and other operating costs .. 22,268 22,129 19,509 16,863 18,130
Selling general and administrative ..... 12,367 12,270 11,436 10,606 11,019
Severance and transaction
structure costs ................... - - - - 4,822
Management fee ......................... 1,895 1,664 1,493 1,435 493
Home office ............................ - - - - 1,371
Depreciation and amortization .......... 17,987 13,397 10,882 7,148 5,311
------------ ------------ ------------ ------------ -----------
Total operating costs and expenses .. 54,517 49,460 43,320 36,052 41,146
Operating income .......................... 8,623 7,559 7,796 11,980 8,128
Interest income (expense), net ............ (927) (1,682) (1,792) (297) 59
Other income (expense) .................... 80 (279) (274) 92 (422)
------------ ------------ ------------ ------------ -----------
Net income ................................ $ 7,776 $ 5,598 $ 5,730 $ 11,775 $ 7,765
============ ============ ============ ============ ===========
Financial Data:
Operating Cash Flow (2) ................... $ 26,610 $ 20,956 $ 18,678 $ 19,128 $ 18,261
Operating Cash Flow margin (3) ............ 42.1% 36.8% 36.5% 39.8% 37.1%
Capital expenditures ...................... 33,662 28,409 35,982 26,656 7,369
Net cash provided by operating activities 24,226 23,023 15,995 22,425 14,399
Net cash used in investing activities ..... 33,890 28,534 36,073 26,754 6,679
Net cash provided by (used in) financing
activities ........................ 8,500 6,500 20,365 (1,498) (1,585)
Operating Data: (at end of period)
Homes passed (4) .......................... 198,682 190,959 184,427 178,310 171,753
Basic customers (5) ....................... 88,145 86,042 85,415 84,236 87,637
Basic penetration (6) ..................... 44.4% 45.1% 46.3% 47.2% 51.0%
Premium service units (7) ................. 66,374 66,684 84,648 98,202 90,032
Premium penetration (8) ................... 73.0% 77.5% 99.1% 116.6% 102.7%
Balance Sheet Data: (at end of period)
Total assets .............................. $ 112,314 $ 98,657 $ 83,359 $ 56,964 $ 41,967
Total debt, including preferred interests 216,820 210,713 205,281 186,673 171,666
Total liabilities ......................... 45,745 48,364 45,164 19,782 15,248
Total member's deficit .................... (125,251) (135,420) (142,086) (149,491) (144,719)
25
Notes To Selected Financial and Operating Data
(1) Represent gain on redemption of common equity interests in Insight
Ohio.
(2) Operating Cash Flow ("OCF") represents operating income before
depreciation and amortization and severance and transaction structure
costs. Insight Ohio believes that OCF is commonly used in the cable
television industry to analyze and compare cable television companies
on the basis of operating performance, leverage and liquidity. However,
OCF is not intended to be a performance measure that should be regarded
as an alternative to, or more meaningful than, either operating income
or net income as an indicator of operating performance or cash flows as
a measure of liquidity, as determined in accordance with accounting
principles generally accepted in the United States. Refer to Insight
Ohio's financial statements; including it's statements of cash flows,
which appear elsewhere in this report.
(3) Represents OCF as a percentage of revenue.
(4) Homes passed are the number of single residence homes, apartments and
condominium units passed by the cable distribution network in a cable
system's service area.
(5) Basic customers are customers of a cable television system who receive
a package of over-the-air broadcast stations, local access channels and
certain satellite-delivered cable television services, other than
premium services, and who are usually charged a flat monthly rate for a
number of channels.
(6) Basic penetration represents basic customers as a percentage of total
number of homes passed.
(7) Premium service units represents the number of subscriptions to premium
services, which are paid for on an individual unit basis.
(8) Premium penetration represents premium service units as a percentage of
the total number of basic customers. A customer may purchase more than
one premium service, each of which is counted as a separate premium
service unit. This ratio may be greater than 100% if the average
customer subscribes to more than one premium service unit.
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The following discussion should be read in conjunction with the
financial statements and related notes that are included elsewhere in this
report.
Offering of Senior Discount Notes and Senior Notes and Acquisition of System by
Insight Ohio
Coaxial LLC and Coaxial Financing Corp. completed on August 21, 1998 a
private offering (the "Senior Discount Notes Offering") of $55,869,000 aggregate
principal amount at maturity of their 12 7/8% Senior Discount Notes due in 2008
(the "Senior Discount Notes") in connection with a Financing Plan (the
"Financing Plan") which included the contribution of Coaxial's cable television
system (the "System") to Insight Ohio. On February 16, 1999, Coaxial LLC and
Coaxial Financing Corp. consummated an exchange of registered Senior Discount
Notes for their privately issued Senior Discount Notes. Coaxial LLC and Coaxial
Financing Corp. have only nominal assets except for Coaxial LLC's ownership of
67.5%
26
of the common stock of Coaxial and notes of Coaxial DJM LLC and Coaxial DSM LLC
(the other two owners of Coaxial), which notes are secured by the remaining
32.5% of the common stock of Coaxial. The Senior Discount Notes are guaranteed
on a conditional basis by Insight Ohio. The limited liability companies that own
Coaxial are referred to herein as the "Individual LLCs".
As part of the Financing Plan, Coaxial and Phoenix Associates, an
affiliated general partnership, completed a private offering (the "Senior Notes
Offering") of $140,000,000 aggregate principal amount of their 10% Senior Notes
due in 2006 (the "Senior Notes"). On February 16, 1999, Coaxial and Phoenix
consummated an exchange of registered Senior Notes for their privately issued
Senior Notes. The Senior Notes are also guaranteed on a conditional basis by
Insight Ohio. The conditional guarantee of the Senior Discount Notes is
subordinated to the conditional guarantee of the Senior Notes. Coaxial has only
nominal assets. Coaxial holds the Series A Preferred Interest and the Series B
Preferred Interest of Insight Ohio (together the "Preferred Interests").
The Preferred Interests have distribution priorities that provide for
distributions to Coaxial. The distributions from the Series B Preferred Interest
will be used to pay dividends to the Individual LLCs, which dividends will be
used to pay interest and principal on the Senior Discount Notes and the
distributions from the Series A Preferred Interest are used to pay interest and
principal on the Senior Notes. Distributions by Insight Ohio are subject to
certain financial covenants and other conditions set forth in its Senior Credit
Facility.
Coaxial LLC and Coaxial Financing Corp. do not conduct any business and
are dependent upon the cash flow of Insight Ohio to meet their obligations under
the Senior Discount Notes. Insight LP serves as the manager of the System.
On August 8, 2000, Insight Ohio purchased Coaxial's 25% non-voting
common equity interest in Insight Ohio, resulting in Insight LP owning 100% of
the common equity of Insight Ohio. The purchase price was 800,000 shares of
common stock of Insight and cash paid by Insight to the principals of the
Individual LLCs in the amount of $2.6 million. In connection with the purchase,
Insight Ohio's operating agreement was amended to, among other things, remove
certain participating rights of the principals of the Individual LLCs, and vest
in the common equity interests of Insight Ohio 70% of its total voting power and
in the preferred equity interests 30% of its total voting power. As a result of
this purchase Coaxial LLC no longer consolidates the results of Insight Ohio
subsequent to August 8, 2000.
On January 5, 2001, Insight Midwest, L.P. ("Insight Midwest"), a 50-50
partnership between Insight LP and an indirect subsidiary of AT&T Broadband (now
known as "Comcast Cable"), entered into definitive agreements with Insight LP
and certain subsidiaries of AT&T Corp. ("AT&T Cable Subsidiaries") for the
acquisition of additional cable television systems, including Insight Ohio.
Through a series of transactions, Insight Midwest acquired all of Insight LP's
wholly owned systems serving approximately 280,000 customers, including the
approximately 85,400 customers then served by Insight Ohio and including systems
which Insight LP purchased from AT&T Cable Subsidiaries. At the same time,
Insight Midwest acquired from AT&T Cable Subsidiaries systems serving
approximately 250,000 customers. Insight Ohio is an unrestricted subsidiary
under the indentures governing Insight's and Insight Midwest's senior notes and
is prohibited by the terms of its indebtedness from making distributions to
Insight Midwest. On November 28, 2002, Comcast Corporation acquired the
broadband business of AT&T Corp. The transaction did not result in any direct
change in Insight Midwest's ownership structure, and Insight Midwest remains
equally owned by Insight LP and Comcast Cable, and Insight LP continues to
27
serve as the general partner and manages and operates the Insight Midwest
systems, including Insight Ohio.
Insight Ohio's conditional guarantee of the Senior Notes and the
Senior Discount Notes remains in place. If at any time the Senior Notes or the
Senior Discount Notes are repaid or significantly modified, or in any case after
August 15, 2008, the principals of the Individual LLCs may require Insight LP to
purchase the Preferred Interests for a purchase price equal to the difference,
if any, of $32.6 million less the then market value of the 800,000 shares of
Insight Inc. common stock issued on August 8, 2000.
The following discussion relates to the operations of Insight Ohio for
years ended December 31, 2002, 2001 and 2000. The financial statements of
Insight Ohio are included in the consolidated financial statements of Coaxial
through August 8, 2000 and Coaxial was deemed to be a subsidiary of Coaxial LLC
and, as such, the financial statements of Coaxial are included in the
consolidated financial statements of Coaxial LLC. The historical operating
results of Coaxial LLC reflect the actual results of the System through August
8, 2000 in addition to certain financing activities unrelated to the operation
of the System. These financing activities relate primarily to the offering of
the Senior Discount Notes and Senior Notes discussed above as well as certain
borrowings and repayments of debt with affiliated companies. These activities
resulted in related financing and interest costs. The historical results of
Coaxial LLC appear elsewhere in this report under the heading "Coaxial LLC."
Introduction
Insight Ohio relies on Insight LP for all of its strategic, managerial,
financial and operational oversight and advice. Insight LP also centrally
purchases programming and equipment and provides the associated discount to
Insight Ohio. In exchange for all such services provided to Insight Ohio and
subject to certain restrictions contained in the covenants with respect to
Insight Ohio's Senior Credit Facility and the Senior Notes, Insight LP receives
management fees of 3.0% of gross revenues of Insight Ohio. Such management fees
are payable only after distributions have been made with respect to the
Preferred Interests and only to the extent that such payments would be permitted
by an exception to the restricted payments covenants of the Senior Notes as well
as Insight Ohio's Senior Credit Facility.
Results of Operations
Revenues are earned from customer fees for cable television programming
services including premium, digital and pay-per-view services and ancillary
services, such as rental of converters and remote control devices, installations
and from selling advertising. In addition, Insight Ohio earns revenues from
providing high-speed data services and from facilitating the delivery of
telephone services as well as from commissions for products sold through home
shopping networks.
Under Insight Ohio's franchise agreements, it is obligated to pay to
local franchising authorities a percentage of it's revenue derived from
providing cable and other services the majority of which are passed through to
customers. Insight Ohio has historically recorded revenue net of franchise fees
charged to it's customers. Staff Announcement D-103, issued by the FASB in
November 2001, specifies that reimbursements received from a customer should be
reflected as revenues and not as a reduction of expenses. This Staff
Announcement applies to financial reporting periods beginning after December 15,
2001. Upon application of this Staff Announcement, comparative financial
statements for prior periods are required to be reclassified to comply with the
guidance in this Staff Announcement. Consequently, Insight
28
Ohio has reclassified the prior period amounts in the accompanying consolidated
statements of operations to reflect franchise fees on a gross basis with
reimbursements as revenue and payments as expense. The effect on the prior
period statements of operations was to increase both revenue and selling,
general and administrative costs by $1.5 million and $1.4 million for each of
the years ended December 31, 2001 and 2000, respectively.
The following table is derived for the periods presented from
Insight Ohio's financial statements that are included in this report and sets
forth certain statement of operations data for the System:
Year ended December 31,
2002 2001 2000
---------------------------------
(in thousands)
Revenue $63,140 $57,019 $51,116
Operating costs and expenses:
Programming and other operating costs 22,268 22,129 19,509
Selling, general and administrative 12,367 12,270 11,436
Management fees 1,895 1,664 1,493
Depreciation and amortization 17,987 13,397 10,882
-------
Total operating costs and expenses 54,517 49,460 43,320
-------
Operating income 8,623 7,559 7,796
Operating cash flow 26,610 20,956 18,678
Interest expense 949 1,732 1,883
Net income 7,776 5,598 5,730
Net cash provided by operating activities 24,226 23,023 15,995
Net cash used in investing activities 33,890 28,534 36,073
Net cash provided by financing activities 8,500 6,500 20,365
Operating Cash Flow ("OCF") represents operating income before
depreciation and amortization. Insight Ohio believes that OCF is commonly used
in the cable television industry to analyze and compare cable television
companies on the basis of operating performance, leverage and liquidity.
However, OCF is not intended to be a performance measure that should be regarded
as an alternative to, or more meaningful than, either operating income or net
income as an indicator of operating performance or cash flows as a measure of
liquidity, as determined in accordance with accounting principles generally
accepted in the United States. Refer to Insight Ohio's financial statements,
including its statements of cash flows, which appear elsewhere in this report.
29
The following calculations of OCF are not necessarily comparable to similarly
titled amounts of other companies:
Year ended December 31,
2002 2001 2000
------------------------------
(in thousands)
Operating income $ 8,623 $ 7,559 $ 7,796
Adjustments:
Depreciation and amortization 17,987 13,397 10,882
-------
Operating Cash Flow $26,610 $20,956 $18,678
-------
Year Ended December 31, 2002 Compared to Year Ended December 31, 2001
Revenue for the year ended December 31, 2002 increased $6.1 million or
11% to $63.1 million from $57.0 million for the year ended December 31, 2001.
For the year ended December 31, 2002, customers served averaged approximately
87,400 compared to approximately 85,800 during the year ended December 31, 2001.
The increase in revenue was primarily attributable to increases in our basic,
digital and high-speed data services.
30
Revenue by service offering was as follows for the year ended
December 31, (in thousands):
2002 Revenue 2001 Revenue
by Service % of Total by Service % of Total
Offering Revenue Offering Revenue
-------------- -------------- ---------------------------
Basic $ 31,097 49.3% $ 29,046 50.9%
Digital 5,282 8.4% 3,861 6.8%
High-speed data 8,260 13.1% 4,349 7.6%
Premium 6,159 9.7% 6,705 11.8%
Analog pay-per-view 562 .9% 1,194 2.1%
Advertising sales 4,503 7.1% 4,385 7.7%
Franchise fees 1,577 2.5% 1,525 2.7%
Other 5,700 9.0% 5,954 10.4%
-------------- -------------- ---------------------------
Total $ 63,140 100.0% $ 57,019 100.0%
============== ============== ===========================
RGUs (Revenue Generating Units) were approximately 137,600 as of
December 31, 2002 compared to approximately 120,000 as of December 31, 2001.
This represents an annual growth rate of 15%. RGUs represent the sum of basic,
digital, high-speed data and telephone customers.
Average monthly revenue per basic customer for the year ended December
31, 2002 was $60.18 compared to $55.37 for the year ended December 30, 2001.
Average monthly revenue per basic customer for digital and high-speed data
services was $12.90 for the year ended December 31, 2002 compared to $7.97 for
the year ended December 31, 2001. As of December 31, 2002, there were
approximately 29,400 digital customers compared to approximately 22,600 digital
customers as of December 31, 2001, representing penetrations of 36% and 34%,
respectively. As of December 31, 2002, there were approximately 18,600
high-speed data customers compared to approximately 11,400 high-speed data
customers as of December 31, 2001, representing penetrations of 10% and 7%,
respectively.
Programming and other operating costs remained relatively flat from
2001 increasing $139,000 or .6% to $22.3 million for the year ended December 31,
2002 from $22.1 million for the year ended December 31, 2001. The increase was
primarily attributable to increased digital programming and increased
programming rates associated with classic services offset by decreased
engineering salaries, video-on-demand and high-speed data charges.
Selling, general and administrative expenses remained relatively flat
from 2001 increasing $97,000 or .8% to $12.4 million for the year ended December
31, 2002 from $12.3 million for the year ended December 31, 2001. The increase
was primarily attributable to increases in employee related costs such as
salaries and benefits offset by decreases in marketing and other general
corporate expenses.
Management fees are directly related to revenue as these fees are
calculated as approximately 3% of revenues.
Depreciation and amortization expense for the year ended December 31,
2002 increased $4.6 million or 34% to $18.0 million from $13.4 million for the
year ended December 31, 2001. This increase was primarily attributable to
increased capital expenditures associated with the launch of new services, the
near completion of the rebuild of plant and an $871,000 write-down of the
carrying value of current video-
31
on-demand equipment, which was replaced as of December 31, 2002 in connection
with our transition to a new video-on-demand service provider.
OCF increased $5.7 million or 27% to $26.6 million for the year ended
December 31, 2002 from $21.0 million for the year ended December 31, 2001. This
increase was primarily due to increased digital and high-speed data revenue,
partially offset by slight increases in programming and other operating costs
and selling, general and administrative costs.
Interest expense for the year ended December 31, 2002 decreased
$783,000 or 45% to $949,000 from $1.7 million for the year ended December 31,
2001. This decrease was primarily attributable to lower interest rates.
For the year ended December 31, 2002, the net income was $7.8 million
primarily for the reasons set forth above.
Year Ended December 31, 2001 Compared to Year Ended December 31, 2000
Revenue for the year ended December 31, 2001 increased $5.9 million or
12% to $57.0 million from $51.1 million for the year ended December 31, 2000.
For the year ended December 31, 2001, customers served averaged approximately
85,800 compared to approximately 84,800 during the year ended December 31, 2000.
The increase in revenue was primarily attributable to new product launches,
specifically digital services and high-speed data services.
32
Revenue by service offering was as follows for the year ended December
31, (in thousands):
2001 Revenue 2000 Revenue
by Service % of Total by Service % of Total
Offering Revenue Offering Revenue
-------------- -------------- --------------- -------------
Basic $ 29,046 50.9% $ 27,457 53.7%
Digital 3,861 6.8% 1,604 3.1%
High-speed data 4,349 7.6% 887 1.7%
Premium 6,705 11.8% 6,941 13.6%
Analog pay-per-view 1,194 2.1% 1,763 3.4%
Advertising sales 4,385 7.7% 4,781 9.4%
Franchise fees 1,525 2.7% 1,367 2.7%
Other 5,954 10.4% 6,316 12.4%
-------------- -------------- --------------- -------------
Total $ 57,019 100.0% $ 51,116 100.0%
============== ============== =============== =============
RGUs (Revenue Generating Units) were approximately 120,000 as of
December 31, 2001 compared to approximately 103