UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2006
Commission file number 0-26677
INSIGHT COMMUNICATIONS COMPANY, INC.
(Exact name of registrant as specified in its charter)
Delaware |
| 13-4053502 |
(State or other jurisdiction of |
| (I.R.S. Employer |
incorporation or organization) |
| Identification No.) |
810 7th Avenue |
|
|
New York, New York |
| 10019 |
(Address of principal executive offices) |
| (Zip code) |
Registrant’s telephone number, including area code: 917-286-2300
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer o Accelerated filer x Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2). Yes o No x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. Not Applicable
The accompanying unaudited consolidated financial statements have been prepared in accordance with the requirements of Form 10-Q and, therefore, do not include all information and footnotes required by accounting principles generally accepted in the United States. However, in our opinion, all adjustments, consisting of normal recurring accruals, necessary for a fair presentation of the results of operations for the relevant periods have been made. Results for the interim periods are not necessarily indicative of the results to be expected for the year. These financial statements should be read in conjunction with the summary of significant accounting policies and the notes to the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2005.
1
INSIGHT COMMUNICATIONS COMPANY, INC.
(dollars in thousands, except share and per share amounts)
|
| September 30, |
| December 31, |
| ||||||
|
| 2006 |
| 2005 |
| ||||||
|
| unaudited |
|
|
| ||||||
Assets |
|
|
|
|
|
|
|
|
| ||
Cash and cash equivalents |
|
| $ | 19,279 |
|
|
| $ | 29,782 |
|
|
Investments |
|
| 6,679 |
|
|
| 5,901 |
|
| ||
Trade accounts receivable, net of allowance for doubtful accounts of $1,169 and $1,079 as of September 30, 2006 and December 31, 2005 |
|
| 26,395 |
|
|
| 27,261 |
|
| ||
Launch funds receivable |
|
| 516 |
|
|
| 974 |
|
| ||
Prepaid expenses and other current assets |
|
| 11,350 |
|
|
| 9,645 |
|
| ||
Total current assets |
|
| 64,219 |
|
|
| 73,563 |
|
| ||
Fixed assets, net |
|
| 1,147,333 |
|
|
| 1,130,705 |
|
| ||
Goodwill |
|
| 72,430 |
|
|
| 72,430 |
|
| ||
Franchise costs |
|
| 2,361,959 |
|
|
| 2,361,959 |
|
| ||
Deferred financing costs, net of accumulated amortization of $28,527 and $24,302 as of September 30, 2006 and December 31, 2005 |
|
| 19,998 |
|
|
| 24,220 |
|
| ||
Other non-current assets |
|
| 2,785 |
|
|
| 2,287 |
|
| ||
Total assets |
|
| $ | 3,668,724 |
|
|
| $ | 3,665,164 |
|
|
Liabilities and stockholders’ equity |
|
|
|
|
|
|
|
|
| ||
Accounts payable |
|
| $ | 39,097 |
|
|
| $ | 42,333 |
|
|
Accrued expenses and other current liabilities |
|
| 43,641 |
|
|
| 45,413 |
|
| ||
Accrued property taxes |
|
| 13,947 |
|
|
| 12,921 |
|
| ||
Accrued programming costs (inclusive of $32,316 and $29,878 due to related parties as of September 30, 2006 and December 31, 2005) |
|
| 47,008 |
|
|
| 43,705 |
|
| ||
Deferred revenue |
|
| 2,152 |
|
|
| 4,978 |
|
| ||
Interest payable |
|
| 51,783 |
|
|
| 20,459 |
|
| ||
Debt—current portion |
|
| 83,500 |
|
|
| 83,500 |
|
| ||
Total current liabilities |
|
| 281,128 |
|
|
| 253,309 |
|
| ||
Deferred revenue |
|
| 874 |
|
|
| 1,499 |
|
| ||
Debt |
|
| 2,687,838 |
|
|
| 2,676,418 |
|
| ||
Other non-current liabilities |
|
| — |
|
|
| 2,382 |
|
| ||
Minority interest |
|
| 244,557 |
|
|
| 251,011 |
|
|
See accompanying notes
2
INSIGHT COMMUNICATIONS COMPANY, INC.
CONSOLIDATED BALANCE SHEETS (Continued)
(dollars in thousands, except share and per share amounts)
|
| September 30, |
| December 31, |
| ||||||
|
| 2006 |
| 2005 |
| ||||||
|
| unaudited |
|
|
| ||||||
Stockholders’ equity: |
|
|
|
|
|
|
|
|
| ||
Voting preferred stock, $.01 par value: |
|
|
|
|
|
|
|
|
| ||
Series A - 1,000,000 shares authorized; 848,945 shares issued and outstanding as of September 30, 2006 and December 31, 2005 |
|
| 8 |
|
|
| 8 |
|
| ||
Series B - 1,000,000 shares authorized; 517,836 shares issued and outstanding as of September 30, 2006 and December 31, 2005 |
|
| 5 |
|
|
| 5 |
|
| ||
Non-voting preferred stock, $.01 par value: |
|
|
|
|
|
|
|
|
| ||
Series C - 15,000,000 shares authorized; 13,364,693 shares issued and outstanding as of September 30, 2006 and December 31, 2005 |
|
| 134 |
|
|
| 134 |
|
| ||
Series D - 50,000,000 shares authorized; 47,015,659 shares issued and outstanding as of September 30, 2006 and December 31, 2005 |
|
| 470 |
|
|
| 470 |
|
| ||
Non-voting common stock, $.01 par value: |
|
|
|
|
|
|
|
|
| ||
Series E - 5,000,000 shares authorized; 3,475,629 and 0 shares issued and outstanding as of September 30, 2006 and December 31, 2005 |
|
| 37 |
|
|
| — |
|
| ||
Series F - 100,000 shares authorized; 93,250 and 0 shares issued and outstanding as of September 30, 2006 and December 31, 2005 |
|
| 1 |
|
|
| — |
|
| ||
Voting common stock, $.01 par value: |
|
|
|
|
|
|
|
|
| ||
Series G - 10,000,000 shares authorized; 0 shares issued and outstanding as of September 30, 2006 and December 31, 2005 |
|
| — |
|
|
| — |
|
| ||
Additional paid-in-capital |
|
| 829,249 |
|
|
| 829,337 |
|
| ||
Accumulated deficit |
|
| (372,641 | ) |
|
| (345,199 | ) |
| ||
Deferred stock compensation |
|
| (2,936 | ) |
|
| (4,210 | ) |
| ||
Total stockholders’ equity |
|
| 454,327 |
|
|
| 480,545 |
|
| ||
Total liabilities and stockholders’ equity |
|
| $ | 3,668,724 |
|
|
| $ | 3,665,164 |
|
|
See accompanying notes
3
INSIGHT COMMUNICATIONS COMPANY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(dollars in thousands)
|
| Three months ended |
| Nine months ended |
| ||||||||
|
| 2006 |
| 2005 |
| 2006 |
| 2005 |
| ||||
Revenue |
| $ | 318,105 |
| $ | 278,986 |
| $ | 931,103 |
| $ | 827,624 |
|
Operating costs and expenses: |
|
|
|
|
|
|
|
|
| ||||
Programming and other operating costs (exclusive of depreciation and amortization) (inclusive of $47,772 and $135,110, and $39,438 and $120,114 of programming expense incurred through related parties for the three and nine months ended September 30, 2006 and 2005) |
| 111,431 |
| 93,514 |
| 333,676 |
| 284,269 |
| ||||
Selling, general and administrative (inclusive of $335 and $1,219, and $3,876 and $7,325 of stock-based compensation for the three and nine months ended September 30, 2006 and 2005) |
| 82,120 |
| 73,340 |
| 243,935 |
| 204,682 |
| ||||
Depreciation and amortization |
| 68,743 |
| 61,054 |
| 200,398 |
| 183,274 |
| ||||
Total operating costs and expenses |
| 262,294 |
| 227,908 |
| 778,009 |
| 672,225 |
| ||||
Operating income |
| 55,811 |
| 51,078 |
| 153,094 |
| 155,399 |
| ||||
Other income (expense): |
|
|
|
|
|
|
|
|
| ||||
Interest expense |
| (65,810 | ) | (57,773 | ) | (188,093 | ) | (168,781 | ) | ||||
Interest income |
| 366 |
| 853 |
| 1,247 |
| 1,876 |
| ||||
Other income (expense) |
| (28 | ) | 834 |
| (78 | ) | 1,505 |
| ||||
Total other expense, net |
| (65,472 | ) | (56,086 | ) | (186,924 | ) | (165,400 | ) | ||||
Loss before minority interest and income taxes |
| (9,661 | ) | (5,008 | ) | (33,830 | ) | (10,001 | ) | ||||
Minority interest income (expense) |
| 1,839 |
| (2,242 | ) | 6,454 |
| (6,069 | ) | ||||
Loss before income taxes |
| (7,822 | ) | (7,250 | ) | (27,376 | ) | (16,070 | ) | ||||
Benefit (provision) for income taxes |
| 94 |
| (125 | ) | (66 | ) | (375 | ) | ||||
Net loss |
| $ | (7,728 | ) | $ | (7,375 | ) | $ | (27,442 | ) | $ | (16,445 | ) |
See accompanying notes
4
INSIGHT COMMUNICATIONS COMPANY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(dollars in thousands)
|
| Nine months ended |
| ||||
|
| 2006 |
| 2005 |
| ||
Operating activities: |
|
|
|
|
| ||
Net loss |
| $ | (27,442 | ) | $ | (16,445 | ) |
Adjustments to reconcile net loss to net cash provided by operating activities: |
|
|
|
|
| ||
Depreciation and amortization |
| 200,398 |
| 183,274 |
| ||
Stock-based compensation |
| 1,219 |
| 7,325 |
| ||
Non-cash consulting expense |
| — |
| 45 |
| ||
Gain on interest rate swaps |
| — |
| (1,684 | ) | ||
Minority interest |
| (6,454 | ) | 6,069 |
| ||
Provision for losses on trade accounts receivable |
| 13,959 |
| 13,196 |
| ||
Contribution of stock to 401(k) Plan |
| — |
| 1,990 |
| ||
Amortization of note discount |
| 6,663 |
| 28,630 |
| ||
Changes in operating assets and liabilities: |
|
|
|
|
| ||
Trade accounts receivable |
| (13,093 | ) | (4,470 | ) | ||
Launch funds receivable |
| 458 |
| 2,232 |
| ||
Prepaid expenses and other assets |
| (2,266 | ) | (7,392 | ) | ||
Accounts payable |
| (3,236 | ) | (9,241 | ) | ||
Interest payable |
| 31,324 |
| 27,488 |
| ||
Accrued expenses and other liabilities |
| (894 | ) | (6,005 | ) | ||
Net cash provided by operating activities |
| 200,636 |
| 225,012 |
| ||
Investing activities: |
|
|
|
|
| ||
Purchase of fixed assets |
| (213,309 | ) | (144,622 | ) | ||
Sale of fixed assets |
| 572 |
| 2,145 |
| ||
Purchase of investments |
| (778 | ) | (1,551 | ) | ||
Sale of investments |
| — |
| 991 |
| ||
Net cash used in investing activities |
| (213,515 | ) | (143,037 | ) | ||
Financing activities: |
|
|
|
|
| ||
Repayment of credit facilities |
| (62,625 | ) | (62,625 | ) | ||
Debt issuance costs |
| — |
| (1,712 | ) | ||
Net proceeds from borrowings under credit facility |
| 65,000 |
| — |
| ||
Other |
| 1 |
| — |
| ||
Net cash provided by (used in) financing activities |
| 2,376 |
| (64,337 | ) | ||
Net increase (decrease) in cash and cash equivalents |
| (10,503 | ) | 17,638 |
| ||
Cash and cash equivalents, beginning of period |
| 29,782 |
| 100,144 |
| ||
Cash and cash equivalents, end of period |
| $ | 19,279 |
| $ | 117,782 |
|
See accompanying notes
5
INSIGHT COMMUNICATIONS COMPANY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Basis of Presentation
Through our wholly owned subsidiary, Insight Communications Company, L.P. (“Insight LP”), we own a 50% interest in Insight Midwest, L.P. (“Insight Midwest”), which through its operating subsidiaries, Insight Communications Midwest, LLC (“Insight Communications Midwest”), Insight Kentucky Partners II, L.P. (“Insight Kentucky”) and Insight Communications of Central Ohio, LLC (“Insight Ohio”), owns and operates cable television systems in Indiana, Kentucky, Ohio, and Illinois which passed approximately 2.5 million homes and served approximately 1.3 million customers as of September 30, 2006.
Insight LP is the general partner of Insight Midwest. Through Insight LP, we manage all of Insight Midwest’s systems.
The accompanying consolidated financial statements include our accounts and those of our wholly owned subsidiaries, Insight LP and Insight Cable Services, LLC. Reclassifications have been made to the prior year’s financial statements to conform to those classifications used in 2006.
2. Responsibility for Interim Financial Statements
Our accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnote disclosures required by accounting principles generally accepted in the United States for complete financial statements.
In our opinion, the consolidated financial statements reflect all adjustments considered necessary for a fair presentation of the consolidated results of operations and financial position for the interim periods presented. All such adjustments are of a normal recurring nature. These unaudited interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes to consolidated financial statements contained in our Annual Report on Form 10-K for the year ended December 31, 2005.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us 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. The results of operations for the three and nine months ended September 30, 2006 are not necessarily indicative of the results to be expected for the year ending December 31, 2006 or any other interim period.
3. Recent Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment, (“SFAS 123R”). SFAS 123R establishes the accounting for transactions in which an entity pays for employee services in share-based payment transactions. SFAS 123R requires companies to recognize the cost of employee services received in exchange for awards of equity instruments, based on the grant date fair value of those awards, in the financial statements. The Company adopted SFAS 123R effective January 1, 2006 using the modified-prospective transition method. Under this method stock-based compensation is recognized for
6
INSIGHT COMMUNICATIONS COMPANY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
3. Recent Accounting Pronouncements (Continued)
awards granted in the period after adoption. Prior year financial statements are not restated. The adoption of this standard did not have a material impact on our consolidated financial statements.
In July 2006, FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109, (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The Company is required to adopt the provisions of FIN 48 during the first fiscal year beginning after December 15, 2006. The Company is currently evaluating the impact of FIN 48 on our consolidated financial statements.
In accordance with SFAS 123R, during the three months ended September 30, 2006, the Company recorded $335,000 of stock-based compensation expense for the vesting of deferred shares and the issuance, in connection with hiring of personnel, of Series F non-voting common stock. For the nine months ended September 30, 2006, the Company recorded $1.2 million of stock-based compensation expense for the vesting of deferred shares and the issuance, in connection with hiring of personnel, of Series E and F non-voting common stock. These expenses are included in selling, general and administrative expense on our consolidated statements of operations.
For the three and nine months ended September 30, 2005, the Company accounted for stock-based compensation under Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”). Compensation cost related to stock awards issued to employees was recorded only if the grant-date market price of the underlying stock exceeded the exercise price. The following table summarizes relevant information as to our reported results under APB 25 (the intrinsic value method of accounting for stock awards), with supplemental information, as if a fair value method had been applied to all awards in accordance with SFAS 123R.
|
| Three Months Ended |
| Nine Months Ended |
| ||||||
|
| 2005 |
| 2005 |
| ||||||
|
| (in thousands) |
| ||||||||
Net loss |
|
| $ | (7,375 | ) |
|
| $ | (16,445 | ) |
|
Stock-based compensation as reported |
|
| 3,876 |
|
|
| 7,325 |
|
| ||
Stock-based compensation determined under fair value based method for all awards, net of tax |
|
| (5,712 | ) |
|
| (12,922 | ) |
| ||
Adjusted net loss |
|
| $ | (9,211 | ) |
|
| $ | (22,042 | ) |
|
Promptu
Promptu (formerly AgileTV Corporation) is a privately owned company that develops voice navigation services for television and mobile devices. On May 11, 2005, we made an additional investment in Promptu by purchasing shares of Promptu’s Series B1 preferred stock and common stock for an
7
INSIGHT COMMUNICATIONS COMPANY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
5. Investments (Continued)
aggregate purchase price of (i) approximately $900,000 in cash and (ii) approximately $300,000 in the form of conversion of an outstanding promissory note. We are accounting for our investment in Promptu under the cost method. As of September 30, 2006 and December 31, 2005, our carrying value in this investment was $1.2 million.
Oxygen Cable, LLC
Oxygen Cable, LLC (“Oxygen”) is an independent cable television network with programming tailored to the interests of women. On July 9, 2002 we entered into a carriage agreement with Oxygen, whereby we agreed to carry programming content from Oxygen. In October 2006, we agreed to extend the term of the carriage agreement through December 31, 2008.
Concurrently with the carriage agreement, we entered into an equity issuance agreement with Oxygen. The agreement called for Oxygen to deliver to us shares having an aggregate fair market value as of December 31, 2005 of $3.8 million, and by December 1, 2006 deliver to us additional shares having an aggregate fair market value as of the December 31, 2005 valuation of $2.0 million. Pursuant to the equity issuance agreement, a portion of the monthly programming fees represent our equity investment in Oxygen. As of September 30, 2006 and December 31, 2005, our carrying value in this investment was $5.5 million and $4.7 million. In October 2006, in connection with the extension of the carriage term, Oxygen issued to us shares of common stock representing a value as of December 31, 2005 of $5.8 million in full satisfaction of its obligation to issue equity to us under the equity issuance agreement.
|
| September 30, |
| December 31, |
| ||||
|
| 2006 |
| 2005 |
| ||||
|
| (in thousands) |
| ||||||
Land, buildings and improvements |
|
| $ | 43,678 |
|
| $ | 41,042 |
|
Cable system equipment |
|
| 2,606,275 |
|
| 2,398,364 |
| ||
Furniture, fixtures and office equipment |
|
| 23,224 |
|
| 21,352 |
| ||
|
|
| 2,673,177 |
|
| 2,460,758 |
| ||
Less: accumulated depreciation and amortization |
|
| (1,525,844 | ) |
| (1,330,053 | ) | ||
|
| $ | 1,147,333 |
|
| $ | 1,130,705 |
|
We recorded depreciation expense of $67.3 million and $196.1 million for the three and nine months ended September 30, 2006 and $59.6 million and $179.2 million for the three and nine months ended September 30, 2005.
8
INSIGHT COMMUNICATIONS COMPANY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
|
| September 30, |
| December 31, |
| ||||||
|
| 2006 |
| 2005 |
| ||||||
|
| (in thousands) |
| ||||||||
Insight Midwest Holdings Credit Facility |
|
| $ | 1,406,625 |
|
|
| $ | 1,404,250 |
|
|
Insight Midwest 93¤4% Senior Notes |
|
| 385,000 |
|
|
| 385,000 |
|
| ||
Insight Midwest 101¤2% Senior Notes |
|
| 630,000 |
|
|
| 630,000 |
|
| ||
Insight Inc. 121¤4% Senior Discount Notes |
|
| 350,000 |
|
|
| 350,000 |
|
| ||
|
|
| 2,771,625 |
|
|
| 2,769,250 |
|
| ||
Net unamortized discount/premium on notes |
|
| (287 | ) |
|
| (6,950 | ) |
| ||
Market value of interest rate swaps |
|
| — |
|
|
| (2,382 | ) |
| ||
Total debt |
|
| $ | 2,771,338 |
|
|
| $ | 2,759,918 |
|
|
Insight Midwest Holdings Credit Facility
Insight Midwest Holdings, LLC, a wholly owned subsidiary of Insight Midwest, holds all of the outstanding equity of each of our operating subsidiaries and serves as borrower under a credit facility. On March 28, 2002, we loaned $100.0 million to Insight Midwest. The loan to Insight Midwest bears annual interest of 9%, compounded semi-annually, has a scheduled maturity date of January 31, 2011 and permits prepayments. Insight Midwest Holdings is permitted under the credit facility to make distributions to Insight Midwest for the purpose of repaying our loan, including accrued interest, provided that there are no defaults existing under the credit facility. In August 2006, Insight Midwest repaid $12.6 million of the loan balance. As of September 30, 2006 and December 31, 2005, the balance of the $100.0 million loan, including accrued interest, was $136.0 million and $139.1 million.
On September 11, 2006 we announced plans to refinance certain indebtedness of Insight Midwest. The refinancing was completed on October 6, 2006. See Subsequent Event Note 12.
Insight Inc. 121¤4% Senior Discount Notes
No cash interest on the discount notes accrued prior to February 15, 2006. Thereafter, cash interest on the discount notes began to accrue and is payable on February 15 and August 15 of each year, commencing with the first such payment which was made on August 15, 2006. The initial accreted value of the discount notes increased until February 15, 2006 such that the accreted value equaled the revised outstanding principal amount of $350.0 million on February 15, 2006.
9
INSIGHT COMMUNICATIONS COMPANY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
7. Debt (Continued)
Debt Principal Payments
As of September 30, 2006, the remaining principal payments required on our debt were as follows (in thousands):
2006 |
| $ | 20,875 |
|
2007 |
| 83,500 |
| |
2008 |
| 104,750 |
| |
2009 |
| 1,582,500 |
| |
2010 |
| 630,000 |
| |
Thereafter |
| 350,000 |
| |
Total |
| $ | 2,771,625 |
|
We enter into derivative instruments, typically interest-rate swap agreements, to modify the interest characteristics of our outstanding debt to either a floating or fixed rate basis. These agreements involve fixed rate interest payments in exchange for floating rate interest receipts, known as cash flow hedges, and floating rate interest payments in exchange for fixed rate interest receipts, known as fair value hedges, over the life of the agreement without an exchange of the underlying principal amount. The differential to be paid or received is accrued as interest rates change and is recognized as an adjustment to interest expense related to the debt. The related amount payable or receivable is included in other non-current liabilities or assets.
Gains and losses related to fair value hedges that are determined to be effective hedges are recorded in the consolidated statements of operations as an adjustment to the swap instrument and an offsetting adjustment to the carrying value of the underlying debt. Gains and losses related to interest rate swaps that are determined not to be effective hedges and do not qualify for hedge accounting are recorded in our consolidated statements of operations as other income or expense.
Fair Value Hedges
In July 2003, we entered into three interest rate swap agreements whereby we swapped fixed rates under a tranche of our 10½% senior notes due in December 2010 for variable rates equal to six-month LIBOR, plus the applicable margin of approximately 8.3%, on $185.0 million notional value of debt. These agreements expired on November 1, 2005. We recorded a gain on these swaps of $872,000 and $1.7 million for the three and nine months ended September 30, 2005, which is included in other income (expense).
In December 2003, we entered into an interest rate swap agreement whereby we swapped fixed rates under a different tranche of our 10½% senior notes due in December 2010 for variable rates equal to six-month LIBOR, plus the applicable margin of approximately 5.9%, on $130.0 million notional value of debt. We terminated this agreement as of September 30, 2006 and the cost of termination was included in interest expense. This swap was determined to be perfectly effective in hedging against fluctuations in the fair value of the underlying debt. As such, changes in the fair value of the underlying debt equally offset changes in the value of the interest rate swap in our consolidated balance sheets. The cost, if terminated, of
10
INSIGHT COMMUNICATIONS COMPANY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
8. Derivative Instruments (Continued)
this swap as of December 31, 2005 was $2.4 million and was recorded in other non-current liabilities and as an adjustment to the carrying value of debt.
As of September 30, 2006 and December 31, 2005 we had $244.6 million and $251.0 million of minority interest recorded in our consolidated balance sheets as temporary equity related to Insight Midwest.
The Insight Midwest partnership was formed in September 1999 to serve as the holding company and a financing vehicle for our cable television system 50/50 joint venture with an indirect subsidiary of AT&T Broadband (now known as Comcast Cable). The results of the partnership are included in our consolidated financial statements since we as general partner effectively control Insight Midwest’s operating and financial decisions. The partnership will continue until October 1, 2011 unless extended or terminated earlier in accordance with the provisions of the Insight Midwest partnership agreement.
Depending on the nature of a dissolution of the partnership, Insight Midwest may be required, in accordance with the partnership agreement, to either distribute to Comcast Cable some of its cable systems and liabilities equal to 50% of the net market value of the partnership or, in the event of a liquidation, an amount in cash equal to 50% of the net proceeds received.
10. Related Party Transactions
We purchase the majority of our programming through affiliates of Comcast Cable. Charges for such programming, including a 11¤2% administrative fee, were $47.8 million and $135.1 million for the three and nine months ended September 30, 2006 and $39.4 million and $120.1 million for the three and nine months ended September 30, 2005. As of September 30, 2006 and December 31, 2005, $32.3 million and $29.9 million of accrued programming costs were due to affiliates of Comcast Cable. We believe that the programming rates charged through these affiliates are lower than those available from independent parties.
11. Commitments and Contingencies
We enter into long-term contracts with third parties who provide us with programming for distribution over our cable television systems. These programming contracts are a significant part of our business and represent a substantial portion of our operating costs. Since future fees under such contracts are based on numerous variables, including number and type of customers, we have not recorded any liabilities with respect to such contracts.
Between March 7 and March 15, 2005, five purported class action lawsuits were filed in the Delaware Court of Chancery naming Insight Communications Company, Inc. and each of its directors as defendants. Three of the lawsuits also named The Carlyle Group as a defendant. The cases were subsequently consolidated under the caption In Re Insight Communications Company, Inc. Shareholders Litigation (Civil
11
INSIGHT COMMUNICATIONS COMPANY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
11. Commitments and Contingencies (Continued)
Action No. 1154-N), and, on April 11, 2005, a Consolidated Amended Complaint (“Complaint”) was filed against each director and The Carlyle Group. The Complaint alleges, among other things, that the defendant directors breached their fiduciary duties to our stockholders in connection with a proposal from Sidney R. Knafel, Michael Willner, together with certain related and other parties, and The Carlyle Group to acquire all of our outstanding, publicly-held Class A common stock. The Complaint also alleges that the proposed transaction violated our Charter and that The Carlyle Group aided and abetted the alleged fiduciary duty breaches. The Complaint seeks the certification of a class of our stockholders; a declaration that the proposed transaction violates our Charter; an injunction prohibiting the defendants from proceeding with the proposed transaction; rescission or other damages in the event the proposed transaction is consummated; an award of costs and disbursements including attorneys’ fees; and other relief.
On July 28, 2005, the parties to the action entered into a memorandum of understanding setting forth the terms of a proposed settlement of the litigation which, among other things, provides that the buyers shall proceed with the merger, subject to the terms and conditions of the merger agreement including the “majority of the minority” stockholder voting condition, and under which the defendants admit to no wrongdoing or fault. The memorandum of understanding contemplates certification of a plaintiff class consisting of all record and beneficial owners of our Class A common stock, other than the buyers, during the period beginning on and including March 6, 2005, through and including the date of the consummation of the merger, a dismissal of all claims with prejudice, and a release in favor of all defendants of any and all claims related to the merger. The proposed settlement is subject to a number of conditions, including consummation of the merger which closed on December 16, 2005, the plaintiffs’ approval of a definitive settlement agreement and final court approval of the settlement.
On May 11, 2006, the parties to the action filed a stipulation of settlement with the court. On May 19, 2006, the court entered a scheduling order setting a hearing on the proposed settlement for July 13, 2006. On or before June 6, 2006, the Notice of Pendency of Class Action, Proposed Settlement of Class Action and Settlement Hearing was mailed to our stockholders. On June 28, 2006, Kim D. Kelly, a former employee and officer, filed an objection to the proposed settlement. On July 13, 2006, the court convened the settlement hearing, and with the agreement of all of the parties to the action, the court adjourned the settlement hearing until September 25, 2006 to permit Ms. Kelly to review the existing discovery materials and conduct additional analysis.
On September 1, 2006, Ms. Kelly filed a supplemental objection to the settlement. On September 25, 2006, the Court convened the settlement hearing, and with the agreement of all of the parties to the action, adjourned the settlement hearing until November 9, 2006. On October 12, 2006, the defendants and plaintiffs filed briefs with accompanying affidavits in support of the settlement. On November 2, 2006, Ms. Kelly filed reply papers in support of her objection. On November 9, 2006, the parties to the action agreed to seek an adjournment of the settlement hearing until a date and time to be determined based on the availability of the parties and the court. We intend to vigorously support the settlement. The outcome of this matter cannot be predicted at this time.
On April 14, 2006, Ms. Kelly filed a petition with the Court, seeking appraisal for the 180,000 shares of Class A common stock she held of record prior to the merger. She also purported to seek recovery with respect to certain options, as well as certain other shares of which she was not the record holder. On May 15, 2006, we filed an answer to the petition, which asserted among other things, that Ms. Kelly was not
12
INSIGHT COMMUNICATIONS COMPANY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
11. Commitments and Contingencies (Continued)
entitled to the appraisal of her options under Delaware law, and that she had not properly sought an appraisal with respect to the additional shares of the company’s stock that she did not hold of record. Ms. Kelly subsequently served discovery requests on the company, to which the company has served responses and objections. We intend to defend this action vigorously. The outcome of this matter cannot be predicted at this time. On August 3, 2006, Ms. Kelly sent our board of directors a claim letter alleging that the company and certain affiliated entities breached certain purported commitments relating to certain equity interests and options that she held. We rejected her alleged claims in a letter dated September 18, 2006.
In April 2005, Acacia Media Technologies Corporation filed a lawsuit against us and others in the United States District Court for the Southern District of New York. The complaint alleges, among other things, infringement of certain United States patents that allegedly relate to systems and methods for transmitting and/or receiving digital audio and video content. The complaint seeks injunctive relief and damages in an unspecified amount. In the event that a court ultimately determines that we infringe on any of the patents, we may be subject to substantial damages, which may include treble damages and/or an injunction that could require us to materially modify certain products and services that we currently offer to subscribers. We believe that the claims are without merit and intend to defend the action vigorously. The final disposition of this claim is not expected to have a material adverse effect on our consolidated financial position but could possibly be material to our consolidated results of operations of any one period. Further, at this time the outcome of the litigation is impossible to predict, and no assurance can be given that any adverse outcome would not be material to our consolidated financial position.
We are subject to various legal proceedings that arise in the ordinary course of business. While it is impossible to determine with certainty the ultimate outcome of these matters, it is our opinion that the resolution of these matters will not have a material adverse affect on our consolidated financial condition.
On October 6, 2006, we completed the financing of $2.445 billion of senior secured credit facilities for Insight Midwest Holdings. The facilities comprise term loans in the amount of $2.185 billion and a $260.0 million revolving credit facility. The proceeds were used to refinance Insight Midwest Holdings’ existing senior credit facilities and to redeem all of Insight Midwest’s 10 ½% Senior Notes due November 1, 2010 and $185.0 million principal amount of Insight Midwest’s 9 ¾% Senior Notes due October 1, 2009.
13
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Cautionary Statement Regarding Forward-Looking Information
This quarterly report on Form 10-Q contains certain forward-looking statements with respect to the financial condition, results of operations, plans, objectives, future performance and business of our company, including, without limitation, statements preceded by, followed by or that include the words “believes,” “expects,” “anticipates,” “estimates” or similar expressions. We believe it is important to communicate management’s expectations to our investors. However, there may be events in the future that we are not able to accurately predict or over which we have no control. The risk factors listed in our Annual Report on Form 10-K for the year ended December 31, 2005, as well as any other cautionary language in this quarterly report, provide examples of risks, uncertainties and events that may cause our actual results to differ materially from the expectations we describe in our forward-looking statements. You should be aware that the occurrence of the events described in these risk factors and elsewhere in this quarterly report could have a material adverse effect on our business, operating results and financial condition. Examples of these risks include:
· All of the services offered by our company face a wide range of competition that could adversely affect our future results of operations;
· We have substantial debt and have significant interest payment requirements, which may adversely affect our ability to obtain financing in the future to finance our operations and our ability to react to changes in our business;
· There is uncertainty surrounding the potential dissolution of our joint venture with a subsidiary of Comcast Corporation;
· The terms of Insight Midwest’s indebtedness limits our ability to access the cash flow of Insight Midwest’s subsidiaries for debt service and any other purpose;
· We have a history of net losses and may not be profitable in the future;
· Our programming costs are substantial, and they are expected to increase; and
· General business conditions, economic uncertainty or slowdown, and the effects of governmental regulation could adversely affect our future results of operations.
We do not undertake any obligation to publicly update or release any revisions to these forward-looking statements to reflect events or circumstances after the date that this quarterly report is filed with the SEC or to reflect the occurrence of unanticipated events, except as required by law.
Our revenues are earned from customer fees for cable television video services including basic, premium, digital and pay-per-view services and ancillary services, such as rental of converters and remote control devices and installations. In addition, we earn revenues from providing high-speed Internet services, selling advertising, providing telephone services and commissions for products sold through home shopping networks.
Some of the principal reasons for our net losses through September 30, 2006 include i) depreciation and amortization associated with capital expenditures for the construction, expansion and maintenance of our systems, and, ii) interest costs on borrowed money. We expect to continue to report net losses for the foreseeable future. We cannot predict what impact, if any, continued losses will have on our ability to finance our operations in the future.
14
The following table is derived from our consolidated financial statements that are included in this report and sets forth certain statement of operations data for our consolidated operations:
|
| Three Months |
| Nine Months |
| ||||||||
|
| 2006 |
| 2005 |
| 2006 |
| 2005 |
| ||||
|
| (in thousands) |
| ||||||||||
Revenue |
| $ | 318,105 |
| $ | 278,986 |
| $ | 931,103 |
| $ | 827,624 |
|
Operating costs and expenses: |
|
|
|
|
|
|
|
|
| ||||
Programming and other operating costs |
| 111,431 |
| 93,514 |
| 333,676 |
| 284,269 |
| ||||
Selling, general and administrative |
| 82,120 |
| 73,340 |
| 243,935 |
| 204,682 |
| ||||
Depreciation and amortization |
| 68,743 |
| 61,054 |
| 200,398 |
| 183,274 |
| ||||
Total operating costs and expenses |
| 262,294 |
| 227,908 |
| 778,009 |
| 672,225 |
| ||||
Operating income |
| 55,811 |
| 51,078 |
| 153,094 |
| 155,399 |
| ||||
Interest expense |
| 65,810 |
| 57,773 |
| 188,093 |
| 168,781 |
| ||||
Minority interest income (expense) |
| 1,839 |
| (2,242 | ) | 6,454 |
| (6,069 | ) | ||||
Net loss |
| (7,728 | ) | (7,375 | ) | (27,442 | ) | (16,445 | ) | ||||
Net cash provided by operating activities |
| 67,304 |
| 81,785 |
| 200,636 |
| 225,012 |
| ||||
Net cash used in investing activities |
| 71,736 |
| 50,100 |
| 213,515 |
| 143,037 |
| ||||
Net cash used in (provided by) financing activities |
| (19,125 | ) | 22,587 |
| (2,376 | ) | 64,337 |
| ||||
Capital expenditures |
| 71,544 |
| 51,109 |
| 213,309 |
| 144,622 |
| ||||
Use of Adjusted Operating Income before Depreciation and Amortization and Free Cash Flow
We utilize Adjusted Operating Income before Depreciation and Amortization, (defined as operating income before depreciation, amortization and non-cash stock-based compensation) among other measures, to evaluate the performance of our businesses. Adjusted Operating Income before Depreciation and Amortization is considered an important indicator of the operational strength of our businesses and is a component of our annual compensation programs. In addition, our debt agreements use Adjusted Operating Income before Depreciation and Amortization, adjusted for certain non-recurring items, in our leverage and other covenant calculations. We also use this measure to determine how we will allocate resources and capital. Our management finds this measure helpful because it captures all of the revenue and ongoing operating expenses of our businesses and therefore provides a means to directly evaluate the ability of our business operations to generate returns and to compare operating capabilities across our businesses. This measure is also used by equity and fixed income research analysts in their reports to investors evaluating our businesses and other companies in the cable television industry. We believe Adjusted Operating Income before Depreciation and Amortization is useful to investors because it enables them to assess our performance in a manner similar to the methods used by our management and provides a measure that can be used to analyze, value and compare companies in the cable television industry, which may have different depreciation, amortization and stock-based compensation policies.
A limitation of Adjusted Operating Income before Depreciation and Amortization, however, is that it does not reflect the periodic costs of certain capitalized tangible and intangible assets used in generating revenues in our businesses. Management evaluates the costs of such tangible and intangible assets through other financial measures such as capital expenditures, investment spending and Free Cash Flow. Management also evaluates the costs of capitalized tangible and intangible assets by analyzing returns provided on the capital dollars deployed. Another limitation of Adjusted Operating Income before Depreciation and Amortization is that it does not reflect income net of interest expense, which is a significant expense for us because of the substantial debt we incurred to acquire cable television systems and finance capital expenditures to upgrade our cable network. Management evaluates the impact of interest expense through measures including interest expense, Free Cash Flow, the returns analysis discussed above and debt service covenant ratios under our credit facility.
15
Free Cash Flow is net cash provided by operating activities (as defined by accounting principles generally accepted in the United States) less capital expenditures. Free Cash Flow is considered to be an important indicator of our liquidity, including our ability to repay indebtedness. We believe Free Cash Flow is useful for investors because it enables them to assess our ability to service our debt and to fund continued growth with internally generated funds in a manner similar to the methods used by our management, and provides a measure that can be used to analyze, value and compare companies in the cable television industry.
Both Adjusted Operating Income before Depreciation and Amortization and Free Cash Flow should be considered in addition to, not as a substitute for, Operating Income, Net Income and various cash flow measures (e.g., Net Cash Provided by Operating Activities), as well as other measures of financial performance and liquidity reported in accordance with accounting principles generally accepted in the United States.
Reconciliation of Net Loss to Adjusted Operating Income before Depreciation and Amortization
The following table reconciles Net Loss to Adjusted Operating Income before Depreciation and Amortization. In addition, the table provides the components from Net Loss to Operating Income.
|
| Three Months |
| Nine Months |
| ||||||||
|
| 2006 |
| 2005 |
| 2006 |
| 2005 |
| ||||
|
| (in thousands) |
| ||||||||||
Net loss |
| $ | (7,728 | ) | $ | (7,375 | ) | $ | (27,442 | ) | $ | (16,445 | ) |
(Benefit) provision for income taxes |
| (94 | ) | 125 |
| 66 |
| 375 |
| ||||
Loss before income taxes |
| (7,822 | ) | (7,250 | ) | (27,376 | ) | (16,070 | ) | ||||
Minority interest income (expense) |
| (1,839 | ) | 2,242 |
| (6,454 | ) | 6,069 |
| ||||
Loss before minority interest and income taxes |
| (9,661 | ) | (5,008 | ) | (33,830 | ) | (10,001 | ) | ||||
Other (income) expense: |
|
|
|
|
|
|
|
|
| ||||
Other |
| 28 |
| (834 | ) | 78 |
| (1,505 | ) | ||||
Interest income |
| (366 | ) | (853 | ) | (1,247 | ) | (1,876 | ) | ||||
Interest expense |
| 65,810 |
| 57,773 |
| 188,093 |
| 168,781 |
| ||||
Total other expense, net |
| 65,472 |
| 56,086 |
| 186,924 |
| 165,400 |
| ||||
Operating income |
| 55,811 |
| 51,078 |
| 153,094 |
| 155,399 |
| ||||
Depreciation and amortization |
| 68,743 |
| 61,054 |
| 200,398 |
| 183,274 |
| ||||
Stock-based compensation |
| 335 |
| 3,876 |
| 1,219 |
| 7,325 |
| ||||
Adjusted Operating Income before Depreciation and Amortization |
| $ | 124,889 |
| $ | 116,008 |
| $ | 354,711 |
| $ | 345,998 |
|
16
Reconciliation of Net Cash Provided by Operating Activities to Free Cash Flow
The following table provides a reconciliation from net cash provided by operating activities to Free Cash Flow. In addition, the table provides the components from net cash provided by operating activities to operating income for purposes of the discussions that follow.
|
| Three Months |
| Nine Months |
| ||||||||
|
| 2006 |
| 2005 |
| 2006 |
| 2005 |
| ||||
|
| (in thousands) |
| ||||||||||
Operating income |
| $ | 55,811 |
| $ | 51,078 |
| $ | 153,094 |
| $ | 155,399 |
|
Depreciation and amortization |
| 68,743 |
| 61,054 |
| 200,398 |
| 183,274 |
| ||||
Stock-based compensation |
| 335 |
| 3,876 |
| 1,219 |
| 7,325 |
| ||||
Adjusted Operating Income before Depreciation and Amortization |
| 124,889 |
| 116,008 |
| 354,711 |
| 345,998 |
| ||||
Changes in working capital accounts(1) |
| (6,918 | ) | (13,713 | ) | (3,246 | ) | (8,136 | ) | ||||
Cash paid for interest |
| (50,603 | ) | (20,480 | ) | (150,074 | ) | (112,598 | ) | ||||
Cash paid for taxes |
| (64 | ) | (30 | ) | (755 | ) | (252 | ) | ||||
Net cash provided by operating activities |
| 67,304 |
| 81,785 |
| 200,636 |
| 225,012 |
| ||||
Capital expenditures |
| (71,544 | ) | (51,109 | ) | (213,309 | ) | (144,622 | ) | ||||
Free Cash Flow |
| $ | (4,240 | ) | $ | 30,676 |
| $ | (12,673 | ) | $ | 80,390 |
|
(1) Changes in working capital accounts are based on the net cash changes in current assets and current liabilities, excluding charges related to interest and taxes and other non-cash expenses.
Three Months Ended September 30, 2006 Compared to Three Months Ended September 30, 2005
Revenue for the three months ended September 30, 2006 totaled $318.1million, an increase of 14% over the prior year, due primarily to customer gains in all services, as well as video rate increases. High-speed Internet service revenue increased 22% over the prior year, which was attributable to an increased customer base and was partially offset by lower average revenue per customer due to promotional discounts. We added a net 44,800 high-speed Internet customers during the quarter to end at 579,300 customers.
Basic cable service revenue increased 8% due to an increased customer base and video rate increases, partially offset by promotional discounts. In addition, digital service revenue increased 28% over the prior year primarily due to an increased customer base. We added a net 22,500 digital customers during the quarter to end at 597,700 customers. Other revenue also increased as a result of a settlement of a fiber lease dispute.
We have been increasing our customer growth and retention efforts by increasing spending on sales and marketing efforts, emphasizing bundling and enhancing and differentiating our video services by providing video-on-demand, high definition television and digital video recorders. We are also continuing to focus on improving customer satisfaction through higher service levels and increased customer education of product offerings.
17
Revenue by service offering was as follows for the three months ended September 30 (dollars in thousands):
|
| Revenue by Service Offering |
|
| ||||||||||||||||||||||
|
| Three Months |
| % of |
| Three Months |
| % of |
|
|
| % Change |
|
| ||||||||||||
Basic |
|
| $ | 159,677 |
|
|
| 50.2 | % |
|
| $ | 148,393 |
|
|
| 53.2 | % |
|
|
|
| 7.6 | % |
| |
High-Speed Internet |
|
| 60,402 |
|
|
| 19.0 | % |
|
| 49,677 |
|
|
| 17.8 | % |
|
|
|
| 21.6 | % |
| |||
Digital |
|
| 34,979 |
|
|
| 11.0 | % |
|
| 27,300 |
|
|
| 9.8 | % |
|
|
|
| 28.1 | % |
| |||
Advertising |
|
| 20,024 |
|
|
| 6.3 | % |
|
| 18,416 |
|
|
| 6.6 | % |
|
|
|
| 8.7 | % |
| |||
Premium |
|
| 13,891 |
|
|
| 4.4 | % |
|
| 13,215 |
|
|
| 4.7 | % |
|
|
|
| 5.1 | % |
| |||
Telephone |
|
| 13,249 |
|
|
| 4.2 | % |
|
| 9,020 |
|
|
| 3.2 | % |
|
|
|
| 46.9 | % |
| |||
Franchise fees |
|
| 7,496 |
|
|
| 2.3 | % |
|
| 7,681 |
|
|
| 2.8 | % |
|
|
|
| -2.4 | % |
| |||
Other |
|
| 8,387 |
|
|
| 2.6 | % |
|
| 5,284 |
|
|
| 1.9 | % |
|
|
|
| 58.7 | % |
| |||
Total |
|
| $ | 318,105 |
|
|
| 100.0 | % |
|
| $ | 278,986 |
|
|
| 100.0 | % |
|
|
|
| 14.0 | % |
|
Total Customer Relationships were 1,395,400 as of September 30, 2006, an increase of 61,200 from 1,334,200 as of September 30, 2005. Total Customer Relationships represent the number of customers who receive one or more of our products (i.e., basic cable, high-speed Internet or telephone) without regard to which product they purchase. In the three months ending September 30, 2006, we added 92,400 total Revenue Generating Units (“RGUs”), which represent the sum of basic, digital, high-speed Internet and telephone customers, and as of September 30, 2006, had 2,608,700 RGUs, an increase of 14% from September 30, 2005. RGUs by category were as follows (in thousands):
|
| September 30, 2006 |
| September 30, 2005 |
| ||||
Basic |
|
| 1,318.8 |
|
|
| 1,271.0 |
|
|
Digital |
|
| 597.7 |
|
|
| 489.9 |
|
|
High-Speed Internet |
|
| 579.3 |
|
|
| 439.2 |
|
|
Telephone |
|
| 112.9 |
|
|
| 80.9 |
|
|
Total RGUs |
|
| 2,608.7 |
|
|
| 2,281.0 |
|
|
Average monthly revenue per basic customer was $80.90 for the three months ended September 30, 2006 compared to $73.57 for the three months ended September 30, 2005. This primarily reflects the continued growth of high-speed Internet and digital product offerings in all markets, as well as video rate increases and one-time revenue from the settlement of a fiber lease dispute.
Programming and other operating costs increased $17.9 million, or 19%. Increases in customers, the addition of new programming content and substantial increases in programming rates were significant drivers of the cost increase for the three months ended September 30, 2006. For the three months ended September 30, 2005, our programming costs reflected certain programming credits and a one-time settlement for a disputed claim with a vendor. These credits resulted from favorable resolution of pricing negotiations related to certain prior period programming costs that were accrued at a higher rate than the amount actually paid. Programming credits for the three months ended September 30, 2006, were significantly lower, causing our overall programming cost increases to be greater. Direct operating costs decreased due to a decrease in our high-speed Internet service costs as we finalized the transition of our Internet services in-house and realized both the cost savings and operational benefits of this investment partially offset by increases in telephone cost of sales as we continue to invest and roll out this product. Other operating costs increased primarily as a result of increases in technical salaries for new and existing employees; increases in repair, maintenance and warranty costs; an increase in taxes due to a change in the tax law in Kentucky; and an increase in outside installation labor due to increased customer activity.
18
Selling, general and administrative expenses increased $8.8 million, or 12%, primarily due to increased payroll, payroll related costs and temporary help associated with an increase in the number of employees and salary increases for existing employees. The increase in the number of employees represents investments in direct sales, customer care and information technology personnel to continue to upgrade and enhance our product offerings and increase customer satisfaction. A portion of these information technology personnel increases were directly related to the transition of our Internet services in-house. Marketing expenses increased over the prior year to support the continued rollout of high-speed Internet, digital and telephone products, and to grow our core video customer base. Customer billing, collection fees and bad debt expense increased due to the increase in our customer base.
Depreciation and amortization expense increased $7.7 million, or 13%, primarily as a result of an increased level of capital expenditures through September 30, 2006. These expenditures were primarily for purchases of customer premise equipment, installation materials, capitalized labor, headend equipment, network extensions and network capacity and bandwidth increases, all of which we consider necessary in order to continue to maintain and grow our customer base and expand our service offerings. Partially offsetting this increase was a decrease in depreciation expense related to certain assets that have become fully depreciated since September 30, 2005.
As a result of the factors discussed above, Adjusted Operating Income before Depreciation and Amortization increased $8.9 million to $124.9 million, an increase of 8% over the prior year’s third quarter.
Interest expense increased $8.0 million, or 14%, due to:
· higher interest rates, which averaged 9.1% for the three months ended September 30, 2006, as compared to 8.3% for the three months ended September 30, 2005;
· the termination of our interest rate swap agreement during the three months ended September 30, 2006; and
· additional interest expense on the now fully accreted 12 ¼% Senior Discount Notes.
Nine Months Ended September 30, 2006 Compared to Nine Months Ended September 30, 2005
Revenue for the nine months ended September 30, 2006 totaled $931.1 million, an increase of 13% over the prior year, due primarily to customer gains in all services, as well as video rate increases. High-speed Internet service revenue increased 27% over the prior year, which was attributable to an increased customer base and was partially offset by lower average revenue per customer due to promotional discounts. We added a net 108,900 high-speed Internet customers during the nine months ended September 30, 2006 to end at 579,300 customers.
Basic cable service revenue increased 7% due to an increased customer base and video rate increases, partially offset by promotional discounts. We added a net 37,200 basic customers during the nine months ended September 30, 2006 to end at 1,318,800 customers. In addition, digital service revenue increased 23% over the prior year primarily due to an increased customer base. We added a net 78,900 digital customers during the nine months ended September 30, 2006 to end at 597,700 customers.
19
Revenue by service offering was as follows for the nine months ended September (dollars in thousands):
|
| Revenue by Service Offering |
|
| ||||||||||||||||||
|
| Nine Months Ended |
| % of |
| Nine Months Ended |
| % of |
| % Change | ||||||||||||
Basic |
|
| $ | 478,212 |
|
|
| 51.4 | % |
|
| $ | 446,096 |
|
|
| 53.9 | % |
|
| 7.2 | % |
High-Speed Internet |
|
| 175,515 |
|
|
| 18.9 | % |
|
| 138,108 |
|
|
| 16.7 | % |
|
| 27.1 | % | ||
Digital |
|
| 101,009 |
|
|
| 10.8 | % |
|
| 81,899 |
|
|
| 9.9 | % |
|
| 23.3 | % | ||
Advertising |
|
| 57,741 |
|
|
| 6.2 | % |
|
| 55,153 |
|
|
| 6.7 | % |
|
| 4.7 | % | ||
Premium |
|
| 41,137 |
|
|
| 4.4 | % |
|
| 41,305 |
|
|
| 5.0 | % |
|
| -0.4 | % | ||
Telephone |
|
| 37,132 |
|
|
| 4.0 | % |
|
| 25,139 |
|
|
| 3.0 | % |
|
| 47.7 | % | ||
Franchise fees |
|
| 22,234 |
|
|
| 2.4 | % |
|
| 22,884 |
|
|
| 2.8 | % |
|
| -2.8 | % | ||
Other |
|
| 18,123 |
|
|
| 1.9 | % |
|
| 17,040 |
|
|
| 2.0 | % |
|
| 6.4 | % | ||
Total |
|
| $ | 931,103 |
|
|
| 100.0 | % |
|
| $ | 827,624 |
|
|
| 100.0 | % |
|
| 12.5 | % |
Average monthly revenue per basic customer was $79.43 for the nine months ended September 30, 2006 compared to $72.52 for the nine months ended September 30, 2005. This primarily reflects the continued growth of high-speed Internet and digital product offerings in all markets, as well as video rate increases.
Programming and other operating costs increased $49.4 million, or 17%. Increases in customers, the addition of new programming content and substantial increases in programming rates were significant drivers of the cost increase for the nine months ended September 30, 2006. For the nine months ended September 30, 2005, our programming costs reflected certain programming credits and a one-time settlement for a disputed claim with a vendor. These credits resulted from favorable resolution of pricing negotiations related to certain prior period programming costs that were accrued at a higher rate than the amount actually paid. Programming credits for the nine months ended September 30, 2006, were significantly lower, causing our overall programming cost increases to be greater. In addition, direct operating costs increased due to an increase in our high-speed Internet service costs and telephone cost of sales. These increases are primarily attributable to the growth in our high-speed Internet and telephone customer base and the payment of contractually obligated and other one-time transition costs to bring Internet services in-house. Other operating costs increased primarily as a result of increases in repair, maintenance and warranty costs; increases in gasoline prices for our vehicle fleet; an increase in taxes due to a change in the tax law in Kentucky; an increase in utility related expenses; and an increase in outside installation labor due to increased customer installation and disconnect activity.
Selling, general and administrative expenses increased $39.3 million, or 19%, primarily due to increased payroll, payroll related costs and temporary help associated with an increase in the number of employees and salary increases for existing employees. Marketing expenses increased over the prior year to support the continued rollout of high-speed Internet, digital and telephone products, and to grow our core video customer base. Customer billing, collection fees and bad debt expense increased due to the increase in our customer base. Professional fees also increased due to increased legal activity for the nine months ended September 30, 2006.
Depreciation and amortization expense increased $17.1 million, or 9%, primarily as a result of an increased level of capital expenditures through September 30, 2006. These expenditures were primarily for purchases of customer premise equipment, installation materials, capitalized labor, headend equipment, network extensions and network capacity and bandwidth increases, all of which we consider necessary in order to continue to maintain and grow our customer base and expand our service offerings. Partially offsetting this increase was a decrease in depreciation expense related to certain assets that have become fully depreciated since September 30, 2005.
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As a result of the factors discussed above, Adjusted Operating Income before Depreciation and Amortization increased $8.7 million to $354.7 million, an increase of 3% over the nine months ended September 30, 2005.
Interest expense increased $19.3 million, or 11%, due to:
· higher interest rates, which averaged 8.9% for the nine months ended September 30, 2006, as compared to 8.1% for the nine months ended September 30, 2005;
· the termination of our interest rate swap agreement during the nine months ended September 30, 2006; and
· additional interest expense on the now fully accreted 12¼% Senior Discount Notes.
Liquidity and Capital Resources
Our business requires cash for operations, debt service and capital expenditures. The cable television business has substantial ongoing capital requirements for the construction, expansion and maintenance of its broadband networks and provision of new services. In the past, expenditures have been made for various purposes, including the upgrade of the existing cable network, and will continue to be made for network extensions, network capacity and bandwidth increases, installation of new services, customer premise equipment (e.g., set-top boxes), deployment of new product and service offerings, and, to a lesser extent, network upgrades. Historically, we have been able to meet our cash requirements with cash flow from operations, borrowings under our credit facilities and issuances of private and public debt and equity.
Cash provided by operations for the nine months ended September 30, 2006 and 2005 was $200.6 million and $225.0 million. The decrease was primarily attributable to the effect of the initial cash interest payment on the 12¼% Senior Discount Notes partially offset by the timing of cash receipts and payments related to our working capital accounts.
Cash used in investing activities for the nine months ended September 30, 2006 and 2005 was $213.5 million and $143.0 million. The increase primarily was due to increases in capital expenditures. For the nine months ended September 30, 2006 and 2005, Insight spent $213.3 million and $144.6 million in capital expenditures. These expenditures principally constituted purchases of customer premise equipment, capitalized labor, installation materials, headend equipment, network capacity and bandwidth increases and system upgrades and rebuilds, all of which are necessary to maintain Insight’s existing network, grow its customer base and expand its service offerings.
Cash provided by financing activities for the nine months ended September 30, 2006 was $2.4 million compared to $64.3 million of cash used in financing activities for the nine months ended September 30, 2005. The decrease was due to $65.0 million in net proceeds from borrowings under our credit facility for the nine months ended September 30, 2006.
Free Cash Flow for the nine months ended September 30, 2006 totaled ($12.7) million, compared to $80.4 million for the nine months ended September 30, 2005. This decrease in Free Cash Flow of $93.1 million was primarily driven by the following:
· A $68.7 million increase in capital expenditures; and
· A $37.5 million increase in cash interest expense paid primarily driven by the initial cash interest payment on the 12¼% Senior Discount Notes and an increase in interest rates.
These uses of cash were offset by:
· An $8.7 million increase in Adjusted Operating Income and Depreciation and Amortization; and
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· A $4.9 million decrease in the use of Free Cash Flow over the same period in the prior year from changes in working capital accounts.
We believe that the Insight Midwest Holdings credit facility, cash on-hand and our cash flow from operations are sufficient to support our current operating plan. On October 6, 2006, Insight Midwest Holdings completed the financing of $2.445 billion of senior secured credit facilities. The facilities comprise term loans in the amount of $2.185 billion and a $260.0 million revolving credit facility. The proceeds were used to refinance Insight Midwest Holdings’ existing senior credit facilities and to redeem all of Insight Midwest’s 10½% Senior Notes due November 1, 2010 and $185.0 million principal amount of Insight Midwest’s 9¾% Senior Notes due October 1, 2009. This financing will reduce Insight’s interest expense and near term debt amortizations. As of November 8, 2006, $110.3 million of the $260.0 million revolving credit facility was drawn (including $9.3 million in letters of credit) and Insight had the ability to draw upon $149.7 million of unused availability to fund any shortfall resulting from the inability of Insight Midwest’s cash from operations to fund its capital expenditures, meet its debt service requirements or otherwise fund its operations. Insight expects to use any available Free Cash Flow to repay its indebtedness.
We have a substantial amount of debt. Our high level of debt could have important consequences for you. Our investments in our operating subsidiaries, including Insight Midwest, constitute substantially all of our operating assets. Consequently, our subsidiaries conduct all of our consolidated operations and own substantially all of our operating assets. Our principal source of cash we need to pay our obligations and to repay the principal amount of our debt obligations is the cash that our subsidiaries generate from their operations and their borrowings. Our subsidiaries are not obligated to make funds available to us and are restricted by the terms of their indebtedness from doing so. Because of such restrictions, our ability to access the cash flow of our subsidiaries may be contingent upon our ability to refinance the debt of our subsidiaries. As of September 30, 2006 we were in compliance with all covenants under our credit agreement.
The following table summarizes our contractual obligations and commitments, excluding interest and commitments for programming, as of September 30, 2006 (in thousands):
|
| Contractual Obligations |
| |||||||||
|
| Long-Term |
| Operating |
| Total |
| |||||
2006 |
| $ | 20,875 |
|
| $ | 1,328 |
|
| $ | 22,203 |
|
2007 |
| 83,500 |
|
| 4,176 |
|
| 87,676 |
| |||
2008 |
| 104,750 |
|
| 3,554 |
|
| 108,304 |
| |||
2009 |
| 1,582,500 |
|
| 2,546 |
|
| 1,585,046 |
| |||
2010 |
| 630,000 |
|
| 667 |
|
| 630,667 |
| |||
Thereafter |
| 350,000 |
|
| 1,433 |
|
| 351,433 |
| |||
Total cash obligations |
| $ | 2,771,625 |
|
| $ | 13,704 |
|
| $ | 2,785,329 |
|
Item 3. Quantitative and Qualitative Disclosure About Market Risk
Our revolving credit and term loan agreements bear interest at floating rates. Accordingly, we are exposed to potential losses related to changes in interest rates. In order to manage our exposure to interest rate risk, we enter into derivative financial instruments, typically interest rate swaps. The counter-parties to our swap agreements are major financial institutions. We do not enter into derivatives or other financial instruments for trading or speculative purposes.
The aggregate fair market value and aggregate carrying value of our 9¾% and 10½% senior notes and 12¼% senior discount notes was $1.4 billion as of September 30, 2006. The fair market value of our credit facility borrowings approximates its carrying value as the credit facility borrowings bear interest at floating
22
rates of interest. As of December 31, 2005, the cost, if terminated, of our interest rate swap agreement was $2.4 million and was reflected in our financial statements as an other non-current liability.
Item 4. Controls and Procedures
Our management carried out an evaluation, with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as of September 30, 2006. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that (i) our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the rules and forms of the Securities and Exchange Commission, and (ii) our disclosure controls and procedures were designed to ensure that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934 is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
There has not been any change in our internal control over financial reporting in connection with the evaluation required by Rule 13a-15(d) or 15d-15(d) under the Exchange Act that occurred during the quarter ended September 30, 2006 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
23
See Note 11 in Item 1 of PART I, Notes to Consolidated Financial Statements.
There have been no material changes in our risk factors from those disclosed in our annual report on Form 10-K for the year ended December 31, 2005.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
During the three months ended September 30, 2006, we issued 3,705 shares of Series F Non-voting common stock to certain of our employees. The issuances of non-voting common stock were not registered under the Securities Act of 1933 because such issuances were offered and sold in transactions not involving a public offering, and therefore exempt from registration under the Securities Act of 1933 pursuant to Section 4(2).
Termination of a Material Definitive Agreement
As previously reported, on October 6, 2006, notices of redemption were delivered to the holders of the 101¤2% Senior Notes due 2010 (“101¤2% notes”) and the 93¤4% Senior Notes due 2009 (“93¤4% notes”) originally issued by Insight Midwest and Insight Capital, Inc. (together, the “Issuers”), in accordance with the terms and conditions of the 101¤2% notes and the 93¤4% notes. On November 7, 2006, in accordance with the notices of redemption, the Issuers redeemed all $630 million outstanding principal amount of the 101¤2% notes at a redemption price of 103.5% of the principal amount, plus accrued and unpaid interest, and $185 million principal amount of the 93¤4% notes at a redemption price of 101.625% of the principal amount redeemed, plus accrued and unpaid interest. The aggregate redemption price, including the redemption premium and accrued but unpaid interest, of $843 million was funded with Insight Midwest Holdings credit facilities and cash on hand.
As of November 7, 2006, following the redemption, the 101¤2% notes ceased to be issued and outstanding. The 93¤4% notes were redeemed on a pro rata basis, and Insight Midwest will continue to make scheduled interest payments on the remaining outstanding $200 million aggregate principal amount of 93¤4% notes in accordance with, and otherwise comply with, the indenture governing the 93¤4% notes.
Exhibits: |
|
| ||
| 31.1 |
|
| Rule 13a-14(a)/15d-14(a) Certifications of the Chief Executive Officer of Insight Communications Company, Inc. |
| 31.2 |
|
| Rule 13a-14(a)/15d-14(a) Certifications of the Chief Financial Officer of Insight Communications Company, Inc. |
| 32 |
|
| Section 1350 Certifications |
24
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: November 9, 2006 |
| INSIGHT COMMUNICATIONS COMPANY, INC. | |
|
| By: /s/ JOHN ABBOT |
|
|
| John Abbot | |
|
| Executive Vice President and Chief Financial Officer | |
|
| (Principal Financial Officer) |
25