SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2002
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________to _________
Commission file number 000-27927
Charter Communications, Inc.
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12405 Powerscourt Drive
St. Louis, Missouri 63131
(314) 965-0555
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark whether the registrants are accelerated filers (as defined in Rule 12b-2 of the Exchange Act).YES [X] NO [ ]
Charter Communications, Inc.
Quarterly Report on Form 10-Q for the Period ended September 30, 2002
Table of Contents
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Page No. |
| Independent Accountants' Review Report |
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| PART I. FINANCIAL INFORMATION |
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| Item 1. Financial Statements - Charter Communications, Inc. and Subsidiaries |
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| Consolidated Balance Sheets as of September 30, 2002 and December 31, 2001 |
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| Consolidated Statements of Operations for the three and nine months ended September 30, 2002 and 2001 |
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| Consolidated Statements of Cash Flows for the nine months ended September 30, 2002 and 2001 |
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| Notes to Consolidated Financial Statements |
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| Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations |
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| Item 3. Quantitative and Qualitative Disclosures About Market Risk |
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| Item 4. Controls and Procedures |
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| PART II. OTHER INFORMATION |
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| Item 1. Legal Proceedings |
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| Item 4. Submission of Matters to a Vote of Security Holders |
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| Item 6. Exhibits and Reports on Form 8-K |
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| Signatures |
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| Certifications |
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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS:
This Quarterly Report includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, as amended, regarding, among other things, our plans, strategies and prospects, both business and financial. Although we believe that our plans, intentions and expectations reflected in or suggested by these forward-looking statements are reasonable, we cannot assure you that we will achieve or realize these plans, intentions or expectations. Forward-looking statements are inherently subject to risks, uncertainties and assumptions, including without limitation, the factors described under "Certain Trends and Uncertainties" under Part I, Item 2 ("Management's Discussion and Analysis of Financial Condition and Results of Operations") in this Quarterly Report. Many of the forward-looking statements contained in this Quarterly Report may be identified by the use of forward-looking words such as "believe," "expect," "anticipate," "should," "planned," "will," "may," "intend," "estimated," and "potential," among others. Important factors that could cause actual results to differ materially from the forward-looking statements we make in this Quarterly Report are set forth in this Quarterly Report and in other reports or documents that we file from time to time with the United States Securities and Exchange Commission, or the SEC, and include, but are not limited to:
All forward-looking statements attributable to us or a person acting on our behalf are expressly qualified in their entirety by this cautionary statement. We are under no obligation to update any of the forward-looking statements after the date of this Quarterly Report to conform these statements to actual results or to changes in our expectations.
Independent Accountants' Review Report
The Board of Directors and Shareholders
Charter Communications, Inc.:
We have reviewed the consolidated balance sheet of Charter Communications, Inc., and subsidiaries as of September 30, 2002, and the related consolidated statements of operations for the three-month and nine-month periods ended September 30, 2002, and the related consolidated statements of cash flows for the nine-month period ended September 30, 2002. These consolidated financial statements are the responsibility of the Company's management.
We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with generally accepted auditing standards, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should be made to the consolidated financial statements referred to above for them to be in conformity with accounting principles generally accepted in the United States of America.
The consolidated balance sheet of the Company as of December 31, 2001 was audited by other auditors who have ceased operations. As described in Note 2, the consolidated balance sheet has been restated. We have not audited, reviewed or applied any procedures to the December 31, 2001 consolidated balance sheet and, accordingly, we do not express an opinion or any other form of assurance on the consolidated balance sheet as of December 31, 2001. Additionally, the consolidated statements of operations for the three- month and nine-month periods ended September 30, 2001, and the related consolidated statements of cash flows for the nine-month period ended September 30, 2001, which have also been restated as described in Note 2, were not reviewed or audited by us and, accordingly, we do not express an opinion or any other form of assurance on them.
/s/ KPMG LLP
St. Louis, Missouri
November 18, 2002
PART I. FINANCIAL INFORMATION.
ITEM 1. FINANCIAL STATEMENTS.
CHARTER COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
(Unaudited)
September 30, December 31,
2002 2001
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(restated)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents..................................................... $ 508,174 $ 1,679
Accounts receivable, less allowance for doubtful accounts of -- --
$21,947 and $32,866, respectively........................................... 242,606 290,504
Receivables from related party................................................ 7,313 4,634
Prepaid expenses and other current assets..................................... 63,099 70,362
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Total current assets.................................................... 821,192 367,179
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INVESTMENT IN CABLE PROPERTIES:
Property, plant and equipment, net of accumulated
depreciation of $2,587,183 and $2,009,195, respectively..................... 7,396,550 7,149,483
Franchises, net of accumulated amortization
of $3,456,256 and $3,367,149, respectively.................................. 18,287,177 18,338,776
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Total investment in cable properties, net............................... 25,683,727 25,488,259
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OTHER ASSETS..................................................................... 367,253 306,388
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Total assets............................................................. $ 26,872,172 $ 26,161,826
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LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued expenses......................................... $ 1,265,086 $ 1,374,994
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Total current liabilities............................................... 1,265,086 1,374,994
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LONG-TERM DEBT................................................................... 18,451,785 16,342,873
DEFERRED MANAGEMENT FEES - RELATED PARTY......................................... 13,751 13,751
OTHER LONG-TERM LIABILITIES...................................................... 1,674,948 1,494,641
MINORITY INTEREST................................................................ 3,219,203 4,001,615
PREFERRED STOCK - REDEEMABLE; $.001 par value; 1 million -- --
shares authorized; 505,664 shares issued and outstanding..................... 50,566 50,566
SHAREHOLDERS' EQUITY:
Class A common stock; $.001 par value; 1.75 billion shares authorized;
294,646,658 and 294,536,830 shares issued and outstanding, respectively.... 295 294
Class B common stock; $.001 par value; 750 million
shares authorized; 50,000 shares issued and outstanding..................... -- --
Preferred stock; $.001 par value; 250 million shares
authorized; no non-redeemable shares issued and outstanding................. -- --
Additional paid-in capital.................................................... 5,029,948 5,028,418
Accumulated deficit........................................................... (2,783,414) (2,127,718)
Accumulated other comprehensive loss.......................................... (49,996) (17,608)
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Total shareholders' equity............................................. 2,196,833 2,883,386
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Total liabilities and shareholders' equity............................. $ 26,872,172 $ 26,161,826
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See accompanying notes to consolidated financial statements.
CHARTER COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
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2002 2001 2002 2001
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(restated) (restated)
REVENUES........................................................... $ 1,178,511 $ 1,043,844 $ 3,415,258 $ 2,846,116
COSTS AND EXPENSES:
Operating (excluding those items listed below).................. 475,826 400,644 1,375,503 1,084,404
Selling, general and administrative............................. 190,300 160,644 544,989 435,459
Depreciation and amortization................................... 513,660 798,417 1,492,797 2,261,222
Option compensation expense..................................... 788 (57,083) 2,141 (46,195)
Corporate expenses.............................................. 15,464 15,014 47,555 42,728
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1,196,038 1,317,636 3,462,985 3,777,618
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Loss from operations........................................ (17,527) (273,792) (47,727) (931,502)
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OTHER EXPENSE:
Interest expense, net........................................... (380,139) (340,308) (1,116,694) (965,958)
Other, net...................................................... (80,745) (88,917) (116,976) (172,825)
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(460,884) (429,225) (1,233,670) (1,138,783)
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Loss before income taxes and minority interest ............. (478,411) (703,017) (1,281,397) (2,070,285)
INCOME TAX BENEFIT (EXPENSE)....................................... (15,000) 3,750 (15,000) 11,250
MINORITY INTEREST.................................................. 254,559 372,908 681,379 1,162,056
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Net loss before cumulative effect of accounting change...... (238,852) (326,359) (615,018) (896,979)
CUMULATIVE EFFECT OF ACCOUNTING CHANGE, NET........................ -- -- (38,492) --
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Net loss.................................................... (238,852) (326,359) (653,510) (896,979)
Dividends on preferred stock - redeemable................... (732) (243) (2,186) (243)
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Net loss applicable to common stock......................... $ (239,584) $ (326,602) $ (655,696) $ (897,222)
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LOSS PER COMMON SHARE, basic and diluted........................... $ (0.81) $ (1.11) $ (2.23) $ (3.43)
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Weighted average common shares outstanding, basic and diluted...... 294,454,659 294,250,549 294,434,575 261,240,101
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See accompanying notes to consolidated financial statements.
CHARTER COMMUNICATIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLARS IN THOUSANDS)
(Unaudited)
Nine Months Ended
September 30,
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2002 2001
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(restated)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.......................................................................... $ (653,510) $ (896,979)
Adjustments to reconcile net loss to net cash flows from operating activities:
Minority interest.............................................................. (681,379) (1,162,056)
Depreciation and amortization.................................................. 1,492,797 2,261,222
Option compensation expense.................................................... 2,141 (46,195)
Noncash interest expense....................................................... 293,027 208,880
Loss on equity investments..................................................... 1,556 46,846
Loss on derivative instruments and hedging activities, net..................... 105,790 108,974
Cumulative effect of accounting change, net.................................... 38,492 --
Gain on disposed assets........................................................ 1,070 9,491
Noncash income tax expense (benefit)........................................... 15,000 (11,250)
Changes in operating assets and liabilities, net of effects from acquisitions:
Accounts receivable............................................................ 42,689 (31,522)
Prepaid expenses and other current assets...................................... 14,665 (10,778)
Accounts payable and accrued expenses.......................................... (127,405) (189,509)
Receivables from and payables to related party,
including deferred management fees........................................... (2,679) 15,416
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Net cash flows from operating activities................................... 542,254 302,540
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CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment........................................ (1,698,850) (2,159,782)
Payments for acquisitions, net of cash acquired................................... (139,646) (1,792,195)
Purchases of investments.......................................................... (11,700) (10,113)
Other investing activities........................................................ (297) (6,410)
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Net cash flows from investing activities................................... (1,850,493) (3,968,500)
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CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock............................................ 1,184 1,230,367
Borrowings of long-term debt...................................................... 3,334,962 6,557,199
Repayments of long-term debt...................................................... (1,486,734) (4,148,873)
Payments for debt issuance costs.................................................. (34,678) (88,230)
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Net cash flows from financing activities................................... 1,814,734 3,550,463
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NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS................................. 506,495 (115,497)
CASH AND CASH EQUIVALENTS, beginning of period....................................... 1,679 130,702
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CASH AND CASH EQUIVALENTS, end of period............................................. $ 508,174 $ 15,205
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CASH PAID FOR INTEREST............................................................... $ 693,976 $ 608,893
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NONCASH TRANSACTIONS:
Reclassification of redeemable securities to equity and minority interest......... $ -- $ 1,104,327
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Exchange of cable system for acquisition.......................................... $ -- $ 24,440
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Issuances of preferred stock - redeemable, as payment for acquisitions............ $ -- $ 50,566
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See accompanying notes to consolidated financial statements.
CHARTER COMMUNICATIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Charter Communications, Inc. (Charter) is a holding company whose primary asset at September 30, 2002 is a 46.5% controlling common equity interest in Charter Communications Holding Company, LLC (Charter Holdco), which, in turn, is the sole owner of Charter Communications Holdings, LLC (Charter Holdings). Charter, Charter Holdco and its subsidiaries are collectively referred to herein as the "Company." All material intercompany transactions and balances have been eliminated in consolidation. The Company owns and operates cable systems serving approximately 6.7 million customers in 40 states at September 30, 2002. The Company provides a full range of traditional analog television services to the home, along with advanced broadband services, including television on an advanced digital programming platform and high-speed Internet access. The Company also provides commercial high-speed data, video, telephony and Internet services as well as advertising sales and production services.
Our consolidated financial statements include the accounts of Charter, all of its wholly-owned subsidiaries and those subsidiaries over which Charter exercises voting control. Charter Holdco is the only subsidiary consolidated on the basis of voting control.
Reclassifications
Certain 2001 amounts have been reclassified to conform with the 2002 presentation.
The Company has determined that certain adjustments are required to the consolidated financial statements as of December 31, 2000 and 2001 and for the years then ended that the Company previously filed on Form 10- K. These adjustments were necessary to properly reflect franchise costs and deferred tax liabilities relating to the differences between the financial statement and tax basis of assets acquired in business combinations that existed at the dates of acquisition. The effects of the adjustments for the three and nine months ended September 30, 2001 and as of December 31, 2001 are reflected in this Form 10-Q.
We have engaged KPMG LLP to perform reaudits as of and for the years ended December 31, 2001 and 2000 as a result of the restatement process. We will attempt to conclude these reaudits promptly. All December 31, 2001 balance sheet information contained in this Form 10-Q is considered unaudited until the reaudit is completed and amended consolidated financial statements are filed with the SEC.
Throughout 1999 and 2000, the Company acquired and combined 18 cable businesses and recorded approximately $24 billion in total assets relating to these acquisitions and combinations. The Company has determined that an additional $1.4 billion of franchise costs and $1.2 billion of deferred income tax liability should have been recorded relating to the differences between the financial statement and tax basis of the assets acquired in these transactions that existed at the dates of the acquisitions. The balance of the adjustment is recorded as $105.1 million of minority interest and $68.9 million of additional paid in capital. Accordingly, the Company will restate previously issued financial statements for the years ended December 31, 2001 and 2000. These adjustments also will result in the Company restating prior periods to record $178.8 million of amortization expense related to periods prior to 2002 as these additional franchise costs should have been recorded at the time of the acquisitions. Additionally, the recording of the additonal franchise cost resulted in a reassessment by management of the transition impairment of franchises with indefinite lives as of January 1, 2002, the date of adoption for SFAS No. 142 by Charter. This reassessment resulted in recognition of impairment at adoption of $38.5 million, resulting in an additional $0.13 of loss per common share (approximately $82.8 million before minority interest effects). Accordingly, this adjustment will be recorded by Charter as of January 1, 2002 and has been reflected in the results of operations for the nine months ended September 30, 2002 financial statements.
The adjustments increased the net loss applicable to common stock in the third quarter of 2001 and for the nine months ended September 30, 2001 by $8.9 million, or $.03 per share, and by $25.0 million or $.09 per share, respectively. The adjustments also increased the accumulated deficit of the Company at December 31, 2001 by $54.2 million. The following tables summarize the effects of the adjustments on the December 31, 2001 consolidated balance sheet and the consolidated statements of operations for the three and nine month periods ended September 30, 2001 (dollars in thousands, except per share data).
Consolidated Balance Sheet
As of December 31, 2001
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As Previously
Reported Restated
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Franchises, net........................... $ 17,138,774 $ 18,338,776
Total Assets.............................. 24,961,824 26,161,826
Other Long-Term Liabilities............... 341,057 1,494,641
Minority Interest......................... 3,976,791 4,001,615
Additional Paid-in Capital................ 4,952,633 5,028,418
Accumulated Deficit....................... (2,073,527) (2,127,718)
Total Shareholders' Equity................ 2,861,792 2,883,386
Consolidated Statement of Operations
Three Months Ended
September 30, 2001
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As Previously
Reported Restated
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Depreciation and Amortization............. $ 775,438 $ 798,417
Loss from Operations...................... (250,813) (273,792)
Income Tax Benefit........................ -- 3,750
Minority Interest......................... 362,611 372,908
Net Loss Applicable to Common Stock....... (317,670) (326,602)
Loss per Common Share..................... (1.08) (1.11)
Consolidated Statement of Operations
Nine Months Ended
September 30, 2001
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As Previously
Reported Restated
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Depreciation and Amortization............. $ 2,192,285 $ 2,261,222
Loss from Operations...................... (862,565) (931,502)
Income Tax Benefit........................ -- 11,250
Minority Interest......................... 1,129,357 1,162,056
Net Loss Applicable to Common Stock....... (872,234) (897,222)
Loss per Common Share..................... (3.34) (3.43)
The restatements will result in an increase in net loss for the year ended December 31, 2000 of $20.3 million, or $.09 per share, to $848.9 million and an increase in net loss for the year ended December 31, 2001 of $33.9 million, or $.12 per share, to $1.212 billion. The adjustments had no effect on the Company's cash flow from operations or compliance with debt covenants for the presented periods.
The Company will also restate the financial statements contained in its previously filed March 31, 2002 Form 10-Q and its June 30, 2002 Form 10-Q to reflect the transition impairment loss in 2002 and the effects of the adjustments discussed above.
Throughout the financial statements and footnotes, all amounts presented for the three and nine months ended September 30, 2001 and as of December 31, 2001 have been adjusted to reflect the aforementioned adjustments.
The accompanying consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and the rules and regulations of the Securities and Exchange Commission. Accordingly, certain information and footnote disclosures typically included in the Company's Annual Report on Form 10-K have been condensed or omitted for this Quarterly Report. The accompanying consolidated financial statements are unaudited and are subject to review by regulatory authorities. However, in the opinion of management, such statements include all adjustments, which consist of only normal recurring adjustments, necessary for a fair presentation of the results for the periods presented. Interim results are not necessarily indicative of results for a full year.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
During the second and third quarters in 2001, the Company acquired cable systems in two separate transactions. In connection with the acquisitions, the Company paid aggregate cash consideration of $1.8 billion, transferred a cable system valued at $25.1 million, issued 505,664 shares of Charter Series A Convertible Redeemable Preferred Stock valued at $50.6 million, and expects in the first quarter of 2003 to issue additional shares of Series A Convertible Redeemable Preferred Stock valued at $5.1 million to certain sellers subject to certain holdback provisions of the acquisition agreement. The purchase prices were allocated to assets acquired and liabilities assumed based on fair values, including amounts assigned to franchises of $1.4 billion.
On February 28, 2002, CC Systems, LLC, a subsidiary of the Company, and High Speed Access Corp. (HSA) closed the Company's acquisition from HSA of the contracts and associated assets, and assumed related liabilities, that served certain of the Company's high-speed data customers. At closing, the Company paid $77.5 million in cash and delivered 37,000 shares of HSA's Series D convertible preferred stock and all the warrants to buy HSA common stock owned by the Company. In addition, HSA purchased 38,000 shares of its Series D convertible preferred stock from Vulcan Ventures Inc. (Vulcan Ventures), an entity 100% owned by the Company's principal shareholder and Chairman, Paul G. Allen. An additional $2.0 million of purchase price was retained to secure indemnity claims. The purchase price was allocated to assets acquired and liabilities assumed based on fair values, including $74.9 million assigned to goodwill. During the period from 1997 to 2000, certain subsidiaries of the Company entered into Internet-access related service agreements with HSA, and both Vulcan Ventures and certain of the Company's subsidiaries made equity investments in HSA.
In April 2002, Interlink Communications Partners, LLC, Rifkin Acquisition Partners, LLC and Charter Communications Entertainment I, LLC, each an indirect, wholly-owned subsidiary of Charter Holdings, completed the purchase of certain assets of Enstar Income Program II-2, L.P., Enstar Income Program IV- 3, L.P., Enstar Income/Growth Program Six-A, L.P., Enstar Cable of Macoupin County and Enstar IV/PBD Systems Venture, serving in the aggregate approximately 21,600 customers, for a total cash purchase price of $48.3 million. In September 2002, Charter Communications Entertainment I, LLC purchased all of Enstar Income Program II-1, L.P.'s Illinois cable television systems, serving approximately 6,400 customers, for a cash purchase price of $14.7 million. Enstar Communications Corporation, a direct subsidiary of Charter Holdco, is a general partner of the Enstar limited partnerships but does not exercise control over them. The purchase prices were allocated to assets acquired based on fair values, including $44.2 million assigned to franchises.
The transactions described above were accounted for using the purchase method of accounting, and, accordingly, the results of operations of the acquired assets and assumed liabilities have been included in the consolidated financial statements from their respective dates of acquisition. The purchase prices were allocated to assets acquired and liabilities assumed based on fair values. The allocation of the purchase prices for the 2002 acquisitions are based, in part, on preliminary information with respect to the allocation of value to identifiable intangibles and goodwill. The Company has engaged a third party valuation expert to perform a study in the fourth quarter 2002 to verify the appropriateness of the preliminary purchase price allocation to goodwill (HSA acquisition) and franchises (Enstar acquisition). Management believes that finalization of the allocation of the purchase prices will not have a material impact on the consolidated results of operations or financial position of the Company.
The summarized operating results of the Company that follow are presented on a pro forma basis as if the following had occurred on January 1, 2001 (dollars in thousands, except per share data): all significant acquisitions and dispositions completed during 2001 and the nine months ended September 30, 2002; the issuance of Charter Holdings senior notes and senior discount notes in January 2002 and 2001; the issuance of Charter Holdings senior notes and senior discount notes in May 2001; and the issuance of and sale by Charter of convertible senior notes and Class A common stock in May 2001. Adjustments have been made to give effect to amortization of franchises acquired prior to July 1, 2001, interest expense, minority interest, and certain other adjustments. Pro forma results for the nine months ended September 30, 2002 would not differ significantly from historical results.
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Pro Forma Nine Months Ended September 30, 2001 |
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Revenues |
$ 3,013,640 |
The unaudited pro forma financial information does not purport to be indicative of the consolidated results of operations had these transactions been completed as of the assumed date or which may be obtained in the future. Information regarding debt transactions that occurred during 2001 is included in the Company's 2001 Annual Report on Form 10-K.
On January 1, 2002, the Company adopted SFAS No. 142, which eliminates the amortization of goodwill and indefinite lived intangible assets. Accordingly, beginning January 1, 2002, all franchises that qualify for indefinite life treatment under SFAS No. 142 are no longer amortized against earnings but instead will be tested for impairment annually, or more frequently as warranted by events or changes in circumstances. During the first quarter of 2002, the Company had an independent appraiser prepare valuations of its franchises as of January 1, 2002. Franchises were aggregated into essentially inseparable reporting units to conduct the valuations. The appraiser assessed that the fair value of each of the Company's reporting units exceeded their carrying amount at that time. As a result, no impairment charge was initially recorded upon adoption, however, in the third quarter of 2002, the Company determined that it was necessary to restate previously issued financial statements including financial statements for the first and second quarter of 2002. In connection with this restatement, an additional $1.4 billion of franchise costs was recorded to properly reflect deferred tax liabilities relating to prior business combinations. (See Note 2). Management determined that a portion of the incremental franchises recorded in connection with the restatement was impaired and as a result, the Company recorded the cumulative effect of the change in accounting principle of $38.5 million (approximately $82.8 million before minority interest effects). This adjustment has been reflected in the nine months ended September 30, 2002 financial statements. As required by SFAS No. 142, the standard has not been retroactively applied to the results for the period prior to adoption.
In determining whether our franchises have an indefinite life, we considered the exclusivity of the franchise, our history of franchise renewals, and the technological state of the associated cable systems with a view to whether or not we are in compliance with any technology upgrading requirements. Certain franchises did not qualify for indefinite-life treatment due to technological or operational factors that limit their lives. These franchise costs will be amortized on a straight-line basis over 10 years.
The effect of the adoption of SFAS No. 142 as of September 30, 2002 and December 31, 2001 is presented in the following table (dollars in thousands):
September 30, 2002 December 31, 2001 (Restated)
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Gross Net Gross Net
Carrying Accumulated Carrying Carrying Accumulated Carrying
Amount Amortization Amount Amount Amortization Amount
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Indefinite-lived
intangible assets:
Franchises with
indefinite lives........ $ 21,641,073 $ 3,434,802 $ 18,206,271 $ 21,606,865 $ 3,351,971 $ 18,254,894
Goodwill................. 74,876 -- 74,876 -- -- --
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$ 21,715,949 $ 3,434,802 $ 18,281,147 $ 21,606,865 $ 3,351,971 $ 18,254,894
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Finite-lived
intangible assets:
Franchises with
finite lives......... $ 102,360 $ 21,454 $ 80,906 $ 99,060 $ 15,178 $ 83,882
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Franchise amortization expense for the nine months ended September 30, 2002 was $6.3 million, which represents the amortization relating to franchises that did not qualify for indefinite-life treatment under SFAS No. 142, including costs associated with franchise renewals. For each of the next five years, amortization expense relating to these franchises is expected to be approximately $8.5 million.
A reconciliation of net loss for the three and nine months ended September 30, 2002 and 2001, respectively, as if SFAS No. 142 had been adopted as of January 1, 2001, is presented below (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
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2002 2001 2002 2001
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NET LOSS: (restated) (restated)
Reported net loss applicable to common stock.......... $ (239,584) (326,602) $ (655,696) $ (897,222)
Add back: amortization of indefinite-lived franchises. -- 361,886 -- 1,037,959
Less: minority interest............................... -- (193,790) -- (588,350)
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Adjusted net loss applicable to common stock....... $ (239,584) (158,506) $ (655,696) $ (447,613)
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BASIC AND DILUTED LOSS PER COMMON SHARE:
Reported net loss per share........................... $ (0.81) (1.11) $ (2.23) $ (3.43)
Add back: amortization of indefinite-lived franchises. -- 1.23 -- 3.97
Less: minority interest............................... -- (0.66) -- (2.25)
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Adjusted net loss per share........................ $ (0.81) (0.54) $ (2.23) $ (1.71)
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Long-term debt consists of the following as of September 30, 2002 and December 31, 2001 (dollars in thousands):
September 30, 2002 December 31, 2001
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Face Value Accreted Value Face Value Accreted Value
----------- --------------- ----------- ---------------
LONG-TERM DEBT:
Charter Communications, Inc.:
October and November 2000
5.750% convertible senior notes due 2005........ $ 750,000 $ 750,000 $ 750,000 $ 750,000
May 2001
4.750% convertible senior notes due 2006........ 632,500 632,500 632,500 632,500
Charter Holdings:
March 1999
8.250% senior notes due 2007.................... 600,000 599,107 600,000 598,957
8.625% senior notes due 2009.................... 1,500,000 1,497,045 1,500,000 1,496,702
9.920% senior discount notes due 2011........... 1,475,000 1,275,393 1,475,000 1,186,726
January 2000
10.000% senior notes due 2009................... 675,000 675,000 675,000 675,000
10.250% senior notes due 2010................... 325,000 325,000 325,000 325,000
11.750% senior discount notes due 2010.......... 532,000 409,683 532,000 376,073
January 2001
10.750% senior notes due 2009................... 900,000 899,374 900,000 899,307
11.125% senior notes due 2011................... 500,000 500,000 500,000 500,000
13.500% senior discount notes due 2011.......... 675,000 439,313 675,000 398,308
May 2001
9.625% senior notes due 2009.................... 350,000 350,000 350,000 350,000
10.000% senior notes due 2011................... 575,000 575,000 575,000 575,000
11.750% senior discount notes due 2011.......... 1,018,000 673,173 1,018,000 618,129
January 2002
9.625% senior notes due 2009.................... 350,000 347,775 -- --
10.000% senior notes due 2011................... 300,000 297,863 -- --
12.125% senior discount notes due 2012.......... 450,000 271,638 -- --
Renaissance Media Group LLC:
10.000% senior discount notes due 2008............. 114,413 110,864 114,413 103,566
CC V Holdings, LLC:
11.875% senior discount notes due 2008............. 179,750 158,477 179,750 146,292
Other long-term debt.................................. 1,056 1,056 1,313 1,313
CREDIT FACILITIES:
Charter Operating..................................... 4,775,524 4,775,524 4,145,000 4,145,000
CC VI Operating....................................... 955,000 955,000 901,000 901,000
Falcon Cable Communications........................... 742,250 742,250 582,000 582,000
CC VIII Operating..................................... 1,190,750 1,190,750 1,082,000 1,082,000
----------- --------------- ----------- ---------------
$19,566,243 $ 18,451,785 $17,512,976 $ 16,342,873
=========== =============== =========== ===============
The accreted values presented above represent the face value of the notes less the original issue discount at the time of sale plus the accretion to the balance sheet date.
The following additions or modifications occurred relative to the Company's long-term debt since January 1, 2002:
JANUARY 2002 CHARTER HOLDINGS NOTES. In January 2002, Charter Holdings and Charter Communications Holding Capital Corporation (Charter Capital), issued $1.1 billion in aggregate principal amount at maturity of senior notes and senior discount notes. The January 2002 Charter Holdings notes consisted of $350.0 million in aggregate principal amount of 9.625% senior notes due 2009, $300.0 million in aggregate principal amount of 10.000% senior notes due 2011 and $450.0 million in aggregate principal amount at maturity of 12.125% senior discount notes due 2012. The net proceeds of approximately $872.8 million were primarily used to repay a portion of the amounts outstanding under the revolving credit facilities of the Company's subsidiaries.
The 9.625% senior notes are not redeemable prior to maturity. Interest is payable semi-annually in arrears on May 15 and November 15, beginning May 15, 2002, until maturity.
The 10.000% senior notes are redeemable at the option of the issuers at amounts decreasing from 105.000% to 100% of par value plus accrued and unpaid interest beginning on May 15, 2006, to the date of redemption. At any time prior to May 15, 2004, the issuers may redeem up to 35% of the aggregate principal amount of the 10.000% senior notes at a redemption price of 110.000% of the principal amount under certain conditions. Interest is payable semi- annually in arrears on May 15 and November 15, beginning May 15, 2002, until maturity.
The 12.125% senior discount notes are redeemable at the option of the issuers at amounts decreasing from 106.063% to 100% of accreted value beginning January 15, 2007. At any time prior to January 15, 2005, the issuers may redeem up to 35% of the aggregate principal amount of the 12.125% senior discount notes at a redemption price of 112.125% of the accreted value under certain conditions. Cash interest is payable semi-annually in arrears on January 15 and July 15 beginning July 15, 2007, until maturity. The discount on the 12.125% senior discount notes is being accreted using the effective interest method.
CC VIII OPERATING CREDIT FACILITIES. The CC VIII Operating, LLC (CC VIII Operating) credit facilities were amended and restated on January 2, 2002 and provided for borrowings of up to $1.55 billion, which were reduced to $1.51 billion as of September 30, 2002, as described below. The CC VIII Operating credit facilities provide for three term facilities: two Term A facilities with a reduced current aggregate principal amount of $462.5 million, that continues reducing quarterly until they reach maturity in June 2007, and a Term B facility with a reduced current principal amount of $496.25 million, that continues reducing quarterly until it reaches maturity in February 2008. The CC VIII Operating credit facilities also provide for two reducing revolving credit facilities, in the aggregate amount of $547.1 million, which reduce quarterly beginning in March 2002 and September 2005, respectively, with maturity dates in June 2007. At the option of the lenders, supplemental facilities in the amount of $300.0 million may be available. Amounts under the CC VIII Operating credit facilities bear interest at the base rate or the Eurodollar rate, as defined, plus a margin of up to 2.75% for Eurodollar loans and up to 1.75% for base rate loans. A quarterly commitment fee of between 0.25% and 0.375% is payable on the unborrowed balance of the revolving credit facilities.
In January 2002, the Company repaid $107.0 million under the revolving portion of the CC VIII Operating credit facilities with proceeds from the issuance of the January 2002 Charter Holdings notes. As of September 30, 2002, outstanding borrowings were $1.2 billion, and unused availability was $315.9 million.
CHARTER OPERATING CREDIT FACILITIES. The Charter Communications Operating, LLC (Charter Operating) credit facilities were amended and restated on January 2, 2002 to provide for borrowings of up to $5.2 billion and provide for four term facilities: two Term A facilities with a current aggregate principal amount of $1.11 billion that mature in September 2007, each with different amortization schedules, one beginning in June 2002 and one beginning in September 2005; and two Term B facilities with a current aggregate principal amount of $2.74 billion, of which $1.84 billion matures in March 2008 and $895.5 million matures in September 2008. The Charter Operating credit facilities also provide for two revolving credit facilities, in an aggregate amount of $1.34 billion, which will reduce annually beginning in March 2004 and September 2005, with a maturity date in September 2007. At the option of the lenders, supplemental credit facilities in the amount of $100.0 million may be available. Amounts under the Charter Operating credit facilities bear interest at the Base Rate or the Eurodollar rate, as defined, plus a margin of up to 2.75% for Eurodollar loans and 1.75% for base rate loans. A quarterly commitment fee of between 0.25% and 0.375% per annum is payable on the unborrowed balance of the revolving credit facilities.
In January 2002, the Company repaid $465.0 million under the revolving portion of the Charter Operating credit facilities with proceeds from the issuance of the January 2002 Charter Holdings notes. As of September 30, 2002, outstanding borrowings were approximately $4.8 billion and unused availability was $407.9 million.
The Company is a holding company whose primary asset is a controlling equity interest in Charter Holdco, the indirect owner of the Company's cable systems. Minority interest on the Company's consolidated balance sheets represents the ownership percentages of Charter Holdco not owned by us, or 53.5% of total members' equity of Charter Holdco, plus $664.7 million and $654.9 million of preferred equity in CC VIII, LLC (CC VIII), an indirect subsidiary of Charter Holdco, as of September 30, 2002 and December 31, 2001, respectively. As more fully described in Note 17 below, this preferred interest arises from the approximately $630 million of preferred units issued by CC VIII in connection with the Bresnan acquisition in February, 2000. Members' equity in Charter Holdco was $4.8 billion and $6.2 billion as of September 30, 2002 and December 31, 2001, respectively. Gains and losses arising from the issuance by Charter Holdco of its membership units are recorded as capital transactions, thereby increasing or decreasing shareholders' equity and decreasing or increasing minority interest on the accompanying consolidated balance sheets. Changes to minority interest consist of the following for the periods presented (dollars in thousands):
Balance, December 31, 2001 (restated).................... $ 4,001,615
Minority interest in net loss............................ (681,379)
Cumulative effect of accounting change................... (44,339)
Changes in fair value of interest rate agreements........ (37,318)
Other.................................................... (19,376)
-----------
Balance, September 30, 2002.............................. $ 3,219,203
===========
Investments in equity securities are accounted for at cost, under the equity method of accounting or in accordance with SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities." The Company recognizes losses for any decline in value considered to be other than temporary. Certain marketable equity securities are classified as available-for- sale and reported at market value with unrealized gains and losses recorded as accumulated other comprehensive loss on the accompanying consolidated balance sheets. The Company reports changes in the fair value of interest rate agreements designated as hedging instruments of the variability of cash flows associated with floating-rate debt obligations, that meet the effectiveness criteria of SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," in accumulated other comprehensive loss. Comprehensive loss for the three months ended September 30, 2002 and 2001 was $265.8 million and $338.6 million, respectively. Comprehensive loss for the nine months ended September 30, 2002 and 2001 was $685.9 million and $915.3 million, respectively.
The Company uses interest rate risk management derivative instruments, such as interest rate swap agreements and interest rate collar agreements (collectively referred to herein as interest rate agreements) as required under the terms of its credit facilities. The Company's policy is to manage interest costs using a mix of fixed and variable rate debt. Using interest rate swap agreements, the Company agrees to exchange, at specified intervals through 2007, the difference between fixed and variable interest amounts calculated by reference to an agreed-upon notional principal amount. Interest rate collar agreements are used to limit the Company's exposure to and benefits from interest rate fluctuations on variable rate debt to within a certain range of rates.
The Company has certain interest rate derivative instruments that have been designated as cash flow hedging instruments. Such instruments are those which effectively convert variable interest payments on certain debt instruments into fixed payments. For qualifying hedges, derivative gains and losses are offset against related results on hedged items in the consolidated statement of operations. The Company has formally documented, designated and assessed the effectiveness of transactions that receive hedge accounting. For the three and nine months ended September 30, 2002 and 2001, other expense includes gains of $2.5 million and losses of $2.6 million and gains of $2.1 million and losses of $2.2 million, respectively, which represent cash flow hedge ineffectiveness on interest rate hedge agreements arising from differences between the critical terms of the agreements and the related hedged obligations. Changes in the fair value of interest rate agreements designated as hedging instruments of the variability of cash flows associated with floating-rate debt obligations are reported in accumulated other comprehensive loss on the accompanying consolidated balance sheets. For the nine months ended September 30, 2002 and 2001, a loss of $69.7 million and $41.3 million, respectively, related to derivative instruments designated as cash flow hedges was recorded in accumulated other comprehensive loss and minority interest. The amounts are subsequently reclassified into interest expense as a yield adjustment in the same period in which the related interest on the floating-rate debt obligations affects earnings or losses.
Certain interest rate derivative instruments are not designated as hedges as they do not meet the effectiveness criteria specified by SFAS No. 133. However, management believes such instruments are closely correlated with the respective debt, thus managing associated risk. Interest rate derivative instruments not designated as hedges are marked to fair value with the impact recorded as other income or expense. For the three and nine months ended September 30, 2002, the Company recorded other expense of $78.7 million and $103.2 million, respectively, for changes in the fair values of interest rate derivative instruments not designated as hedges. For the three and nine months ended September 30, 2001, the Company recorded other expense of $70.9 million and $84.2 million (including $23.9 million in the nine months ended September 30, 2001 for the loss on cumulative effect of adopting SFAS No. 133), respectively, for interest rate derivative instruments not designated as hedges.
As of September 30, 2002 and December 31, 2001, the Company had outstanding $3.6 billion and $3.3 billion, and $520.0 million and $520.0 million, respectively, in notional amounts of interest rate swaps and collars, respectively. The notional amounts of interest rate instruments do not represent amounts exchanged by the parties and, thus, are not a measure of exposure to credit loss. The amounts exchanged are determined by reference to the notional amount and the other terms of the contracts.
Accounts payable and accrued expenses consist of the following as of September 30, 2002 and December 31, 2001 (dollars in thousands):
September 30, 2002 December 31, 2001
------------------ ------------------
Accounts payable.................... $ 121,205 $ 290,998
Capital expenditures................ 89,857 192,212
Accrued interest.................... 374,759 242,629
Programming costs................... 170,468 133,748
Accrued general and administrative.. 207,408 183,971
State sales tax payable............. 63,478 52,244
Other accrued expenses.............. 237,911 279,192
------------------ ------------------
$ 1,265,086 $ 1,374,994
================== ==================
Revenues consist of the following for the three and nine months ended September 30, 2002 and 2001 (dollars in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ ------------------------
2002 2001 2002 2001
------------ ----------- ------------ -----------
Analog video................. $ 774,570 $ 730,267 $ 2,306,107 $ 2,045,848
Digital video................ 119,475 86,271 340,748 210,009
Cable modem.................. 97,768 43,917 248,439 101,933
Advertising sales............ 95,874 83,833 245,767 203,988
Other........................ 90,824 99,556 274,197 284,338
----------- ----------- ----------- -----------
$ 1,178,511 $ 1,043,844 $ 3,415,258 $ 2,846,116
=========== =========== =========== ===========
Operating expenses consist of the following for the three and nine months ended September 30, 2002 and 2001 (dollars in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ ------------------------
2002 2001 2002 2001
------------ ----------- ------------ -----------
Analog video programming..... $ 267,143 $ 237,329 $ 794,730 $ 659,542
Digital video................ 41,736 31,161 117,690 75,851
Cable modem.................. 40,807 28,862 114,728 66,948
Advertising sales............ 22,378 17,177 63,006 46,107
Service costs................ 103,762 86,115 285,349 235,956
----------- ----------- ----------- -----------
$ 475,826 $ 400,644 $ 1,375,503 $ 1,084,404
=========== =========== =========== ===========
The Company has various contracts and other arrangements to obtain basic, premium and digital programming from program suppliers that receive compensation typically based on a monthly flat fee per customer. The cost of the right to exhibit network programming under such arrangements is recorded in the month the programming is available for exhibition.
Selling, general and administrative expenses consist of the following for the three and nine months ended September 30, 2002 and 2001 (dollars in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ ------------------------
2002 2001 2002 2001
------------ ----------- ------------ -----------
General and administrative... $ 153,415 $ 141,865 $ 464,243 $ 381,440
Marketing.................... 36,885 18,779 80,746 54,019
----------- ----------- ----------- -----------
$ 190,300 $ 160,644 $ 544,989 $ 435,459
=========== =========== =========== ===========
All operations are held through Charter Holdco and its subsidiaries. Charter Holdco and the majority of these entities are not subject to income tax. Rather, all of the taxable income, gains, losses, deductions and credits of such entities are passed through to the members of Charter Holdco: Charter, Charter Investment, Inc. (Charter Investment) and Vulcan Cable III, Inc. (Vulcan Cable). Charter is responsible for its share of taxable income or loss of Charter Holdco allocated to it in accordance with the Charter Holdco amended and restated limited liability company agreement (Agreement) and partnership tax rules and regulations.
The Agreement provides for certain special allocations of tax profits and tax losses (such profits and losses being determined under the applicable federal income tax rules for determining capital accounts). Pursuant to the Agreement, through the end of 2003, tax losses of Charter Holdco that would otherwise have been allocated to Charter based generally on its percentage ownership of outstanding common membership units will be allocated instead to the membership units held by Vulcan Cable and Charter Investment. The Agreement further provides that, beginning at the time Charter Holdco first generates tax profits, the tax profits that would otherwise have been allocated to Charter based generally on its percentage ownership of outstanding common membership units will instead be allocated to Vulcan Cable and Charter Investment. These special tax profit allocations to Vulcan and Charter Investment will generally continue until the cumulative special tax profit allocations offset the cumulative special tax loss allocations described above. The Agreement generally provides that any additional tax profits are to be allocated proportionately among the members of Charter Holdco based on their ownership of Charter Holdco membership units.
In certain situations, the special tax loss allocations and special tax profit allocations described above could result in Charter having to pay taxes in an amount that is more or less than if Charter Holdco had allocated tax profits and tax losses among its members based generally on the number of common membership units owned by such members. However, management does not anticipate that the special tax loss allocations and special tax profit allocations will result in Charter paying taxes in an amount that is materially different on a present value basis than the taxes that would be payable had tax profits and tax losses been allocated among the members of Charter Holdco based generally on the number of common membership units owned by such members, although there is no assurance that a material difference will not result.
As of September 30, 2002, the Company has deferred income tax liabilities of $1.2 billion, which relate to the Company's acquisition of certain cable businesses. This includes approximately $456.7 million of the deferred income tax liabilities recorded in the consolidated financial statements relate to certain indirect corporate subsidiaries of Charter Holdco, which file separate income tax returns.
Additionally, the Company has deferred tax assets of $1.2 billion, which primarily relate to the excess of cumulative financial statement losses over cumulative tax losses allocated to the Company. The deferred tax assets also include $48.5 million of tax net operating loss carry forwards of which $15.2 million are subject to certain limitations on Charter's ability to utilize. Given the uncertainty surrounding the Company's ability to utilize its deferred tax assets, these items have been offset with a corresponding valuation allowance of $1.2 billion.
During the three and nine months ended September 30, 2001 the Company recorded $3.8 million and $11.3 million of deferred income tax benefit, respectively, primarily related to the deferred tax liabilities of the indirect corporate subsidiaries, which file separate income tax returns, referred to above. For the three and nine months ended September 30, 2002, the Company recorded $15.0 million of deferred income tax expense, primarily related to the change in the deferred tax liabilities related to Charter's investment in Charter Holdco.
Fourteen putative class action lawsuits (the "Federal Class Actions") have been filed against the Company and certain of its former and present officers and directors in various jurisdictions on behalf of all purchasers of the Company's securities during the period from either November 8 or November 9, 1999 through July 17 or July 18, 2002. Unspecified damages are sought by the plaintiffs. In general, the lawsuits allege that the Company utilized misleading accounting practices and failed to disclose these accounting practices and/or issued false and misleading financial statements and press releases concerning the Company's operations and prospects. In October 2002, the Company filed a motion with the Judicial Panel on Multidistrict Litigation to transfer the Federal Class Actions to a single forum. The Company anticipates that the Federal Class Actions will be consolidated into a single class action in a single jurisdiction.
Separately, on September 12, 2002, a shareholders derivative suit (the "Derivative Action") was filed in Missouri state court against the Company and its current directors, as well as its former auditors. The plaintiffs allege that the individual defendants breached their fiduciary duties by failing to establish and maintain adequate internal controls and procedures. Unspecified damages, allegedly on the Company's behalf, are sought by the plaintiffs.
In addition to the Federal Class Actions and the Derivative Action, six putative class action lawsuits have been filed against the Company and certain of its current directors and officers in the Court of Chancery of the State of Delaware (the "Delaware Class Actions"). The Delaware Class Actions are substantively identical and generally allege that the defendants breached their fiduciary duties by participating or acquiescing in a purported and threatened attempt by Defendant Paul Allen to purchase shares and assets of the Company at an unfair price. The lawsuits were brought on behalf of the Company's securities holders as of July 29, 2002, and seek unspecified damages and possible injunctive relief. No such proposed transaction has been presented.
The lawsuits discussed above are each in preliminary stages and no dispositive motions have been filed. The Company intends to vigorously defend the lawsuits.
Since the filing of the first civil class action lawsuit, the Company has received grand jury subpoenas from the United States Attorney's Office for the Eastern District of Missouri. The investigation and subpoenas generally relate to the Company's prior reports with respect to its determination of customers, and to various of its other accounting policies and practices including its capitalization of certain expenses and dealings with certain vendors, including programmers and digital set-top terminal suppliers. The Company has been advised by the U.S. Attorney's Office that no member of the Board of Directors, including the Chief Executive Officer, is a target of the investigation. The Company is actively cooperating with the investigation. On November 4, 2002, the Company received an informal, non-public inquiry from the Staff of the Securities and Exchange Commission concerning its prior reporting of its customers and policies and procedures relating to its disconnection of customers. The Staff requested that the Company voluntarily provide certain documents. The Company intends to cooperate with the SEC Staff and to provide documents in response to the inquiry.
The Company is generally required to indemnify each of the named individual defendants in connection with these matters pursuant to the terms of the Company's bylaws and (where applicable) such individual defendants' employment agreements.
In March 2002, the Federal Communications Commission ruled that Internet access service provided by cable operators was not subject to franchise fees assessed by local franchising authorities. A number of local franchise authorities and Internet service providers have appealed this decision. The matter is expected to be argued in early 2003. As a result of this ruling, the Company has stopped collecting franchise fees for cable modem service.
In addition to the matters set forth above, the Company is also party to other lawsuits and claims that arose in the ordinary course of conducting its business. In the opinion of management, after consulting with legal counsel, and taking into account recorded liabilities, the outcome of these other lawsuits and claims will not have a material adverse effect on the Company's consolidated financial position or results of operations.
The Company has historically accounted for stock-based compensation in accordance with Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations, as permitted by SFAS No. 123, "Accounting for Stock-Based Compensation." On January 1, 2003, the Company will adopt the fair value measurement provisions of SFAS No. 123 under which the Company will recognize compensation expense of a stock-based award to an employee over the vesting period based on the fair value of the award on the grant date. Adoption of these provisions will result in utilizing a preferable accounting method as the consolidated financial statements will present the estimated fair value of stock-based compensation in expense consistently with other forms of compensation and other expense associated with goods and services received for equity instruments. In accordance with SFAS No. 123, the fair value method will be applied only to awards granted or modified after January 1, 2003, whereas awards granted prior to such date will continue to be accounted for under APB No. 25, unless they are modified or settled in cash. Management believes the adoption of these provisions will not have a material impact on the consolidated results of operations or financial position of the Company. The Company had previously announced its intention to adopt SFAS No. 123 beginning July 1, 2002. However, because an exposure draft has been released to amend SFAS No. 123, the Company has postponed the adoption until January 1, 2003. Had the Company adopted SFAS No. 123 as of January 1, 2002, compensation expense for the three and nine months ended September 30, 2002 would have been $5.2 million and $10.4 million, respectively.
PREFERRED EQUITY IN CC VIII, LLC. CC VIII an indirect subsidiary of the Company, issued preferred membership units (collectively, the CC VIII Interest) with a value and an effective liquidation preference of approximately $630 million to certain sellers as part of the Bresnan acquisition in February 2000. The liquidation preference of the CC VIII Interest accretes at 2% annually and is entitled to preferential distributions from available cash and upon liquidation of CC VIII. The CC VIII Interest generally does not share in the profits and losses of CC VIII and is recorded as a minority interest in the Company's financial statements. These holders have the right at their option to exchange the CC VIII Interest for shares of Charter Class A Common Stock. The Company does not have the right to force such an exchange. In connection with the Bresnan acquisition, Mr. Allen granted the holders of the CC VIII Interest the right to sell the CC VIII Interest (or any Charter Class A Common Stock or Charter Holdco membership interests which the current holders might receive upon exchange of the CC VIII Interest prior to transfer to Mr. Allen) to Mr. Allen for approximately $630 million plus 4.5% interest annually from February 2000. In April 2002, in accordance with the put agreement, the holders notified Mr. Allen of their intent to exercise this put right in full, and the parties agreed to consummate the sale in April 2003, although the parties also agreed to negotiate in good faith possible alternatives to the closing. If the sale to Mr. Allen is consummated, Mr. Allen would become the holder of the CC VIII Interest (or, if previously exchanged by the current holders, any Charter Class A Common Stock or a Charter Holdco membership interest issued to the current holders upon such exchange). If the CC VIII Interest is transferred to Mr. Allen, Mr. Allen then generally would be allocated his pro rata share of profits or losses of CC VIII. In the event of a liquidation of CC VIII, Mr. Allen would not be entitled to any priority distributions (except with respect to the 2% accretion, as to which such priority would continue) and Mr. Allen's share of any remaining distributions in liquidation would be equal to the original capital account of approximately $630 million, increased or decreased by Mr. Allen's pro-rata share of CC VIII's profits or losses after the transfer to Mr. Allen.
OXYGEN MEDIA. On July 22, 2002, Charter Holdco entered into a transaction with Oxygen Media, LLC (Oxygen) whereby Charter Holdco agreed to carry programming content from Oxygen and will receive equity and has a warrant to purchase equity in Oxygen Media Corporation (Oxygen Media), the parent of Oxygen. Oxygen provides programming content aimed at the female audience for distribution over the Internet and cable television systems and the Company currently makes it available to approximately 4.4 million of its customers. The term of the Carriage Agreement is retroactive to February 1, 2000, the date of launch of Oxygen programming by Charter Holdco and runs for a period of five years from that date. As the number of customers receiving the Oxygen programming increases, Charter Holdco receives volume discounts. In addition, Oxygen pays Charter Holdco marketing support fees for customers launched after the first year of the term of the Agreement up to an amount of $4 million. The Company has recognized $0.8 million and $1.9 million of revenue related to the marketing support provided for the nine months ended September 30, 2002 and the year ended December 31, 2001, respectively.
The Equity Issuance Agreement grants a subsidiary of Charter Holdco a warrant to purchase 2.4 million shares of common stock of Oxygen Media for an exercise price of $22.00 per share. The term of the warrant expires on the earlier of February 2, 2005, or the date Oxygen Media is acquired. Charter Holdco will also receive unregistered shares of Oxygen Media common stock with a fair market value on the date of issuance of $34.4 million, on or prior to February 2, 2005 with the exact date to be determined by Oxygen Media. Charter Holdco has registration rights for the equity grant and the warrant that are no less favorable than the rights granted to other Oxygen equity holders including Vulcan Programming, Inc., an entity controlled by Mr. Allen. Mr. William Savoy, a director of Charter and Charter Holdco, serves on the board of directors of Oxygen. As of September 30, 2002, through Vulcan Programming, Mr. Allen owns an approximate 31% interest in Oxygen (51% assuming exercise of all warrants held by Vulcan Programming but no exercise of warrants or options by other holders).
CLICK2LEARN. Charter Holdco executed a Software License Agreement with Click2learn, Inc. effective as of June 30, 2002. Since October 1999 Charter Holdco has purchased professional services, software and maintenance from Click2learn, Inc. a company which provides enterprise software for organizations seeking to capture, manage and disseminate knowledge throughout their extended enterprise. As of September 30, 2002, Mr. Allen owned an approximate 27% interest in Click2learn, Inc. including 616,120 shares held of record by Vulcan Ventures, Inc. and 387,096 shares issuable upon exercise of a warrant issued to Vulcan Ventures, Incorporated. Mr. Allen is the sole shareholder of Vulcan Ventures, Inc. and may be deemed to have shared voting and investment power with respect to such shares. Mr. Allen is the founder of Click2learn, Inc. We have paid approximately $280,000 and $21,000 to Click2learn in the nine months ended September 30, 2002 and 2001, respectively.
DIGEO. On September 28, 2002, the Company entered into an amendment to its Broadband Carriage Agreement with Digeo Interactive, LLC, a subsidiary of Digeo, Inc. (Digeo). This amendment supersedes the amendment previously entered into on September 27, 2001, and covers the development of future features to be included on the Basic iTV service provided by Digeo and Digeo's development of an interactive "toolkit" to enable the Company to develop interactive local content. Furthermore, the Company may request that Digeo manage local content for a fee. The amendment provides for the Company to pay for development of the Basic iTV service as well as license fees for customers who receive the service, and for the Company and Digeo to split certain revenues earned from the service.
ACTION SPORTS CABLE NETWORK. On November 5, 2002, the Action Sports Cable Network (Action Sports), which is 100% owned by Mr. Allen, announced that it was discontinuing its business following its failure to obtain an acceptable carriage agreement with AT&T Cable, the cable television provider in Portland, Oregon. Action Sports has not yet announced a termination date of its programming. The Company paid Actions Sports $1.0 million and $0.7 million for rights to carry its programming for the nine months ended September 30, 2002 and 2001, respectively. The Company believes that the failure of this network will not materially affect the business or results of operations of the Company.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
GENERAL
The Company has determined that certain adjustments are required to the consolidated financial statements as of December 31, 2000 and 2001 and for the years then ended that the Company previously filed on Form 10- K. These adjustments were necessary to properly reflect deferred tax liabilities relating to the differences between the financial statement and tax basis of assets acquired in business combinations that existed at the dates of acquisition. The effects of the adjustments for the three and nine months ended September 30, 2001 and as of December 31, 2001 are reflected in this Form 10-Q.
We have engaged KPMG LLP to perform reaudits as of and for the years ended December 31, 2001 and 2000 as a result of the restatement process. We will attempt to conclude these reaudits promptly. All December 31, 2001 balance sheet information contained in this Form 10-Q is considered unaudited until the reaudit is completed and amended consolidated financial statements are filed with the SEC.
Throughout 1999 and 2000, the Company acquired and combined 18 cable businesses and recorded approximately $24 billion in total assets relating to these acquisitions and combinations. The Company has determined that an additional $1.4 billion of franchise costs and $1.2 billion of deferred income tax liability should have been recorded relating to the differences between the financial statement and tax basis of the assets acquired in these transactions that existed at the dates of the acquisitions. The balance of the adjustment will be recorded as $105.1 million of minority interest and $68.9 million of additional paid in capital. Accordingly, the Company will restate previously issued financial statements for the years ended December 31, 2001 and 2000. These adjustments also will result in the Company restating prior periods to record $178.8 million of amortization expense related to periods prior to 2002 as if the additional franchise costs had been recorded at the time of the acquisitions. Additionally, the recording of the franchise cost resulted in a reassessment by management of the transition impairment of franchises with indefinite lives as of January 1, 2002, the date of adoption for SFAS No. 142 by Charter. This reassessment resulted in recognition of impairment at adoption of $82.8 million (approximately $38.5 million after minority interest effects). Accordingly, this adjustment will be recorded by Charter as of January 1, 2002 and has been reflected in the results of operations for the nine months ended September 30, 2002 financial statements.
The adjustments increased the net loss applicable to common stock in the third quarter of 2001 and for the nine months ended September 30, 2001 by $8.9 million, or $.03 per share, and by $25.0 million or $.09 per share, respectively. The adjustments also increased the accumulated deficit of the Company at December 31, 2001 by $54.2 million. The following tables summarize the effects of the adjustments on the December 31, 2001 consolidated balance sheet and the consolidated statements of operations for the three and nine month periods ended September 30, 2001 (dollars in thousands, except per share data).
Consolidated Balance Sheet
As of December 31, 2001
--------------------------
As Previously
Reported Restated
------------ ------------
Franchises, net........................... $ 17,138,774 $ 18,338,776
Total Assets.............................. 24,961,824 26,161,826
Other Long-Term Liabilities............... 341,057 1,494,641
Minority Interest......................... 3,976,791 4,001,615
Additional Paid-in Capital................ 4,952,633 5,028,418
Accumulated Deficit....................... (2,073,527) (2,127,718)
Total Shareholders' Equity................ 2,861,792 2,883,386
Consolidated Statement of Operations
Three Months Ended
September 30, 2001
--------------------------
As Previously
Reported Restated
------------ ------------
Depreciation and Amortization............. $ 775,438 $ 798,417
Loss from Operations...................... (250,813) (273,792)
Income Tax Benefit........................ -- 3,750
Minority Interest......................... 362,611 372,908
Net Loss Applicable to Common Stock....... (317,670) (326,602)
Loss per Common Share..................... (1.08) (1.11)
Consolidated Statement of Operations
Nine Months Ended
September 30, 2001
--------------------------
As Previously
Reported Restated
------------ ------------
Depreciation and Amortization............. $ 2,192,285 $ 2,261,222
Loss from Operations...................... (862,565) (931,502)
Income Tax Benefit........................ -- 11,250
Minority Interest......................... 1,129,357 1,162,056
Net Loss Applicable to Common Stock....... (872,234) (897,222)
Loss per Common Share..................... (3.34) (3.43)
The adjustments had no effect on the Company's cash flow from operations or compliance with debt covenants for the presented periods.
The Company will also restate the financial statements contained in its previously filed March 31, 2002 Form 10-Q and the June 30, 2002 Form 10-Q to reflect the transition impairment loss in 2002 and the effects of the adjustments discussed above.
Throughout the financial statements and footnotes, all amounts presented for the three and nine months ended September 30, 2001 and as of December 31, 2001 have been adjusted to reflect the aforementioned adjustments.
The following table presents various operating statistics as of September 30, 2002 and 2001:
Pro Forma
September 30, September 30,
2002 2001 (a)
----------- ---------------
Video services:
Basic analog video:
Basic homes passed (b)............................ 11,972,600 11,521,500
Basic customers (c) (d) (e)....................... 6,697,900 6,991,700
Penetration of basic homes passed (d) (e) (f)..... 55.9% 60.7%
Digital video:
Digital homes passed (b).......................... 11,492,800 10,366,600
Digital customers (d) (e) (g)..................... 2,527,700 1,951,200
Penetration of digital homes passed (d) (e) (f)... 22.0% 18.8%
Penetration of basic customers (d) (e) (g) (h)..... 37.7% 27.9%
Digital set-top terminals deployed................. 3,537,800 2,611,000
Data services:
Cable modem homes passed (b)......................... 8,973,200 6,479,700
Data customers:
Cable modem customers (e) (i)..................... 1,055,400 507,700
Dial-up customers (e).............................. 15,800 38,200
----------- ---------------
Total data customers (e)........................ 1,071,200 545,900
=========== ===============
Penetration of cable modem homes passed (e) (f)...... 11.8% 7.8%
Revenue Generating Units (j):
Basic customers (c) (d) (e).......................... 6,697,900 6,991,700
Digital customers (e) (g)............................. 2,527,700 1,951,200
Cable modem customers (e) (i)......................... 1,055,400 507,700
Telephony customers (e) (k)........................... 19,700 16,300
----------- ---------------
Total revenue generating units (e)................. 10,300,700 9,466,900
=========== ===============
Customer relationships (l)........................... 6,697,900 6,991,700
(a) The pro forma statistics reflect the acquisition of certain Enstar systems serving approximately 21,600 customers that closed during 2002 and include the transfer of approximately 16,300 telephony customers from AT&T on January 1, 2002 as if such transactions had occurred on September 30, 2001.
(b) Homes passed represents the estimated number of living units, such as single residence homes, apartments and condominium units, passed by the cable distribution network in a given cable system service area to which we offer the service indicated.
(c) As of September 30, 2002 and 2001, basic customers include: 1) approximately 50,300 and 16,800 customers (0.8% and 0.2% of total basic customers), respectively, who pay for cable modem service only and who are also counted as cable modem customers; and 2) approximately 225,100 and 228,200 commercial customers, respectively, who are calculated on an equivalent bulk unit ("EBU") basis. EBU is calculated for a system by dividing the bulk price charged to accounts in a system by the most prevalent price charged to non-bulk residential customers in that system for the comparable tier of service. The EBU method of calculating basic customers is consistent with the methodology used in determining costs paid to programmers and has been consistently applied year over year.
(d) On February 11, 2002, the Company announced that it would disconnect approximately additional 120,000 customers in the first quarter of 2002. This resulted principally from tightened credit and disconnect policies and procedures.
(e) As described on page 57, the United States Attorney's Office is conducting an investigation into certain matters, including the Company's prior practices with respect to its determination of customers. The investigation may provide information that could result in a revision of customer information for 2001 to reflect that certain disconnect requests and non-paying customers were not disconnected in a timely fashion. The Company has initiated company-wide guidelines with respect to voluntary and non-pay disconnects.
(f) Penetration represents the number of customers as a percentage of homes passed.
(g) Digital customers include all households that have one or more digital set-top terminals. Included in digital customers at September 30, 2002 and 2001 are 33,400 and 31,500 customers, respectively, that receive digital service directly through satellite transmission.
(h) Digital penetration of basic customers represents the number of digital customers as a percentage of basic customers.
(i) As of September 30, 2002 and 2001, cable modem customers include approximately 85,500 and 38,000 commercial customers, respectively, who are calculated on an equivalent modem unit ("EMU") basis. EMU is calculated for a system by dividing the aggregate commercial revenue for modem service by the average effective price charged in that system for modem service to residential customers. We have consistently utilized this methodology, as it conforms to our internal practices followed for operating and capital expenditure budgeting.
(j) Revenue generating units include the total of all primary analog video, digital video, cable modem and telephony customers, not counting additional outlets.
(k) Telephony customers include all households purchasing telephone service.
(l) Customer relationships include the number of customers that receive at least one level of service encompassing video, data and telephony services, without regard to which service(s) customers purchase.
ACQUISITIONS
The following table presents information on acquisitions since January 1, 2001:
Purchase Price Net
Including Debt Acquired
Month/Year of Assumed Basic
Acquisition (in millions) Customers
------------- ---------------- -----------
AT&T Broadband Systems......................... 6/01 $ 1,736 551,100
Cable USA...................................... 8/01 100 (a) 30,600
---------------- -----------
Total during 2001............................ 1,836 581,700
---------------- -----------
High-Speed Access.............................. 2/02 78 --
Enstar Limited Partnership Systems............. 4/02 48 21,600
Enstar Income Program II-1, L.P................ 9/02 15 6,400
---------------- -----------
Total during 2002........................... 141 28,000
---------------- -----------
Total..................................... $ 1,977 609,700
================ ===========
On February 28, 2002, CC Systems LLC, a subsidiary of Charter Communications Holding Company, purchased from High Speed Access Corporation the contracts and associated assets, and assumed related liabilities, that serve our customers, including a customer contact center, a network operations center and provisioning software. At the closing, CC Systems paid $77.5 million to High Speed Access and delivered 37,000 shares of High Speed Access Series D convertible preferred stock and all of the warrants to buy High Speed Access common stock owned by Charter Communications Holding Company. In addition, High Speed Access purchased 38,000 shares of its Series D Preferred Stock from Vulcan Ventures Incorporated for $8.0 million. To secure indemnity claims against High Speed Access under the asset purchase agreement, $2.0 million of the purchase price was retained. Charter Communications Holding Company obtained a fairness opinion from a qualified investment-banking firm regarding the valuation of the assets purchased by CC Systems pursuant to the asset purchase agreement. Concurrently with the closing of the transaction, High Speed Access purchased all of its common stock held by Vulcan Ventures Inc., an entity 100% owned by the Chairman and principal shareholder of Charter Communications, Inc., and certain of the agreements between our subsidiaries and High Speed Access were terminated. The results of operations of the acquired assets and assumed liabilities have been included in the consolidated financial statements from the date of acquisition.
In April 2002, Interlink Communications Partners, LLC, Rifkin Acquisition Partners, LLC and Charter Communications Entertainment I, LLC, each an indirect, wholly-owned subsidiary of Charter Communications Holdings, LLC, completed the purchase of certain assets of Enstar Income Program II-2, L.P., Enstar Income Program IV-3, L.P., Enstar Income/Growth Program Six-A, L.P., Enstar Cable of Macoupin County and Enstar IV/PBD Systems Venture, serving in the aggregate approximately 21,600 customers, for a total cash purchase price of $48.3 million. In September 2002, Charter Communications Entertainment I, LLC purchased all of Enstar Income Program II-1, L.P.'s Illinois cable television systems, serving approximately 6,400 customers, for a cash purchase price of $14.7 million. Enstar Communications Corporation, a direct subsidiary of Charter Communications Holding Company, is a general partner of the Enstar limited partnerships, but does not exercise control over them. The results of operations of the acquired assets and assumed liabilities have been included in the consolidated financial statements from their date of acquisition.
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We evaluate our estimates and assumptions on an ongoing basis based on a combination of historical information and various other assumptions that are believed to be reasonable under the particular circumstances. Actual results may differ from these estimates based on different assumptions or conditions. The consolidated financial statements are subject to periodic review by regulatory authorities. This section should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations and Note 2, "Summary of Significant Accounting Policies", in our consolidated financial statements included in our December 31, 2001 Annual Report on Form 10-K.
INVESTMENT IN CABLE PROPERTIES. Our investment in cable properties represents a significant portion of our total assets. Investment in cable properties totaled $25.7 billion and $25.5 billion, representing approximately 95.6% and 97.4% of total assets, at September 30, 2002 and December 31, 2001, respectively. Investment in cable properties includes property, plant and equipment and franchises. Our investment in cable properties has continued to grow over the past several years as we have completed acquisitions of other cable systems and increased capital expenditures to upgrade, rebuild and expand our cable systems. See "Liquidity and Capital Resources - Capital Expenditures" for details of our capital expenditures.
Property, Plant and Equipment. Property, plant and equipment, net, totaled $7.4 billion and $7.1 billion, representing approximately 27.5% and 27.3% of total assets, at September 30, 2002 and December 31, 2001, respectively. Property, plant and equipment are recorded at cost, including all material, labor and certain indirect costs associated with the construction of cable transmission and distribution facilities. Costs associated with initial customer installations, and the additions of network equipment necessary to enable advanced services, are capitalized. The costs of disconnecting service at a customer's dwelling or reconnecting service to a previously installed dwelling are charged to operating expense in the period incurred. Costs for repairs and maintenance are charged to operating expense as incurred, while equipment replacement and betterments, including replacement of drops, are capitalized.
Direct labor originating from field personnel is capitalized based on the specific time devoted to network construction and installation activities. Indirect costs (referred to as "overhead" costs herein) that directly relate to, and add value to, property, plant and equipment are also capitalized via an overhead rate applied to the amount of direct labor capitalized. The overhead rates established are based on a combination of internal company-wide overhead analysis and internal time and motion studies of specific activities. These studies are updated periodically to adjust for changes in facts and circumstances. Overhead costs consist primarily of payroll taxes and other employee benefits. Capitalized internal payroll costs for the three and nine months ended September 30, 2002 were $54.9 million and $172.7 million, respectively, and such costs for the three and nine months ended September 30, 2001 were $58.2 million and $156.0 million, respectively. Related capitalized overhead for the three and nine months ended September 30, 2002 were $47.3 million and $148.1 million, respectively, and such costs for the three and nine months ended September 30, 2001 were $52.4 million and $140.4 million, respectively.
Depreciation expense related to property, plant and equipment totaled $1.5 billion and $2.3 billion, representing approximately 42.9% and 60.5% of total costs and expenses, for the nine months ended September 30, 2002 and 2001, respectively. Depreciation is recorded using the straight-line method over management's estimate of the useful lives of the related assets using the following principal categories, as follows:
|
Cable distribution systems |
|
10-15 years |
|
Customer equipment and installations |
3-5 years |
|
|
Vehicles and equipment |
|
1-5 years |
|
Buildings and leasehold improvements |
|
5-15 years |
|
Furniture and fixtures |
5 years |
Since January 1, 2000, our practice has been to assess the remaining useful lives of certain depreciable assets scheduled for retirement as part of the rebuild and upgrade of our cable distribution systems and modify or shorten the depreciable lives of the assets as appropriate. Based on these assessments, when appropriate, we reduce the estimated useful lives of certain depreciable assets expected to be abandoned as a result of the rebuild and upgrade. We reduced the estimated useful lives of certain depreciable assets by approximately one to three years and as a result, an additional $440.6 million and $406.6 million of depreciation expense was recorded during the nine months ended September 30, 2002 and 2001, respectively. We also periodically evaluate the estimated useful lives used to depreciate our assets and the estimated amount of assets that will be abandoned or have minimal use in the future. While we believe our estimates of useful lives are reasonable, significant differences in actual experience or significant changes in our assumptions may materially affect future depreciation expense.
Franchises. Franchises grant us the right to operate a cable distribution network in a community. Costs incurred to obtain and renew cable franchises are deferred. The value of the franchise rights acquired through the purchase of cable systems represent management's estimate of fair value of the franchise acquired. Franchises totaled $18.3 billion at September 30, 2002 and December 31, 2001, representing approximately 68.1% and 70.1% of total assets, respectively. On January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets." Accordingly, beginning January 1, 2002, all franchises that qualify for indefinite life treatment under SFAS No. 142 are no longer amortized against earnings but instead will be tested for impairment annually, or more frequently as warranted by events or changes in circumstances. During the first quarter of 2002, the Company had an independent appraisal performed to prepare the valuations of its franchises as of January 1, 2002. Franchises were aggregated into essentially inseparable reporting units to conduct the valuations. The appraisal assessed that the fair value of each of the Company's reporting units exceeded their carrying amount at that time. As a result, no impairment charge was initially recorded upon adoption, however, in the third quarter of 2002, the Company recorded the cumulative effect of the change in accounting principle of $38.5 million, net of minority interest, which represents the impairment of certain franchises recorded in connection with the additional $1.4 billion of