1 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 March 31, 1997 ---------------------------- 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 0-18266 ---------------- Falcon Classic Cable Income Properties, L.P. - ------------------------------------------------------------------------------- (Exact name of Registrant as specified in its charter) California 95-4200409 - ------------------------------------------ ----------------------- (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification Number) 10900 Wilshire Boulevard - 15th Floor Los Angeles, California 90024 - ------------------------------------------ ----------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (310) 824-9990 --------------------------- - ------------------------------------------------------------------------------ Former name, former address and former fiscal year, if changed since last report. 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 --- --- 2 PART I - FINANCIAL INFORMATION FALCON CLASSIC CABLE INCOME PROPERTIES, L.P. CONDENSED BALANCE SHEETS ============================================ December 31, March 31, 1996* 1997 ----------- --------- (Unaudited) (Dollars in Thousands) ASSETS: Cash and cash equivalents $ 7,126 $ 6,643 Receivables, less allowance of $31,000 and $39,000 for possible losses 660 572 Prepaid expenses and other assets 1,516 1,237 Property, plant and equipment, less accumulated depreciation and amortization of $19,128,000 and $20,068,000 30,655 30,528 Franchise cost and goodwill, less accumulated amortization of $15,029,000 and $15,697,000 17,409 16,749 Customer lists and other intangible costs, less accumulated amortization of $2,684,000 and $2,790,000 1,968 1,904 -------- -------- $ 59,334 $ 57,633 ======== ======== LIABILITIES AND PARTNERS' EQUITY -------------------------------- LIABILITIES: Notes payable $ 24,300 $ 23,288 Accounts payable 542 219 Accrued expenses 2,509 2,371 Payable to general partner 1,006 440 Customer deposits and prepayments 144 159 -------- -------- TOTAL LIABILITIES 28,501 26,477 -------- -------- COMMITMENTS AND CONTINGENCIES PARTNERS' EQUITY: General partner 401 404 Limited partners 30,654 30,974 Notes receivable from general partner (222) (222) -------- -------- TOTAL PARTNERS' EQUITY 30,833 31,156 -------- -------- $ 59,334 $ 57,633 ======== ======== *As presented in the audited financial statements. See accompanying notes to condensed financial statements. 2 3 FALCON CLASSIC CABLE INCOME PROPERTIES, L.P. CONDENSED STATEMENTS OF OPERATIONS ============================================ Unaudited ------------------------ Three months ended March 31, ------------------------ 1996 1997 -------- -------- (Dollars in thousands except per unit information) REVENUES $ 4,706 $ 5,250 -------- -------- EXPENSES: Service costs 1,550 1,623 General and administrative expenses 633 729 Management fees and reimbursed expenses 376 420 Depreciation and amortization 2,114 1,746 -------- -------- Total Expenses 4,673 4,518 -------- -------- Operating income 33 732 INTEREST EXPENSE, NET (540) (410) -------- -------- NET (LOSS) INCOME $ (507) $ 322 ======== ======== NET (LOSS) INCOME PER LIMITED PARTNERSHIP UNIT $ (6.99) $ 4.44 ======== ======== AVERAGE LIMITED PARTNERSHIP UNITS OUTSTANDING DURING PERIOD 71,879 71,879 ======== ======== See accompanying notes to condensed financial statements. 3 4 FALCON CLASSIC CABLE INCOME PROPERTIES, L.P. STATEMENTS OF CASH FLOWS ============================================ Unaudited --------------------- Three months ended March 31, --------------------- 1996 1997 ------- ------- (Dollars in Thousands) Net cash provided by operating activities $ 1,148 $ 1,425 ------- ------- Cash flows from investing activities: Capital expenditures (651) (845) Increase in intangible assets (14) (50) ------- ------- Net cash used in investing activities (665) (895) ------- ------- Cash flows from financing activities: Repayment of borrowings - (1,013) ------- ------- Increase (decrease) in cash and cash equivalents 483 (483) Cash and cash equivalents at beginning of period 6,137 7,126 ------- ------- Cash and cash equivalents at end of period $ 6,620 $ 6,643 ======= ======= See accompanying notes to condensed financial statements. 4 5 FALCON CLASSIC CABLE INCOME PROPERTIES, L.P. NOTES TO CONDENSED FINANCIAL STATEMENTS ============================================ NOTE 1 - INTERIM FINANCIAL STATEMENTS The interim condensed financial statements for the three months ended March 31, 1997 and 1996 are unaudited. In the opinion of management, such statements reflect all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of the results of such periods. It is suggested that these condensed interim financial statements be read in conjunction with the audited financial statements and notes thereto included in the Partnership's latest Annual Report on Form 10-K. The results of operations for the three months ended March 31, 1997 are not necessarily indicative of the results for the entire year. NOTE 2 - NOTES RECEIVABLE In accordance with the Partnership Agreement, the capital contribution of the General Partner was contributed one-half in cash and one-half in General Partner's notes. The notes are non-interest bearing and are payable on demand of the holder. NOTE 3 - EARNINGS PER EQUIVALENT UNIT Earnings per equivalent limited partnership unit are based on the average number of limited partnership units outstanding during the periods presented. For this purpose, earnings are allocated 99% to the limited partners and 1% to the general partner. NOTE 4 - RECLASSIFICATIONS Certain 1996 amounts have been reclassified to conform to the 1997 presentation. 5 6 FALCON CLASSIC CABLE INCOME PROPERTIES, L.P. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS INTRODUCTION On February 8, 1996, President Clinton signed into law the Telecommunications Act of 1996 (the "1996 Telecom Act"). This statute substantially changed the competitive and regulatory environment for telecommunications providers by significantly amending the Communications Act of 1934, including certain of the rate regulation provisions previously imposed by the Cable Television Consumer Protection and Competition Act of 1992 (the "1992 Cable Act"). Compliance with those rate regulations has had a negative impact on the Partnership's revenues and cash flow. The 1996 Telecom Act provides that certain of the rate regulations will be phased out altogether in 1999. Further, the regulatory environment will continue to change pending, among other things, the outcome of legal challenges and FCC rulemaking and enforcement activity in respect of the 1992 Cable Act and the 1996 Telecom Act. There can be no assurance as to what, if any, further action may be taken by the FCC, Congress or any other regulatory authority or court, or the effect thereof on the Partnership's business. Accordingly, the Partnership's historical financial results as described below are not necessarily indicative of future performance. This Report includes certain forward looking statements regarding, among other things, future results of operations, regulatory requirements, competition, capital needs, the possible sale of assets by the Partnership and general business conditions applicable to the Partnership. Such forward looking statements involve risks and uncertainties including, without limitation, the uncertainty of legislative and regulatory changes and the rapid developments in the competitive environment facing cable television operators such as the Partnership, as discussed more fully elsewhere in this Report. In addition to the information set forth in this Report, reference is made to the Partnership's Annual Report on Form 10-K for the year ended December 31, 1996 and its Current Report on Form 8-K dated February 6, 1997 for additional information regarding such matters and the effect thereof on the Partnership's business. RECENT DEVELOPMENTS Pursuant to the terms of the "Appraisal Process" provided for in the Partnership Agreement, the Partnership may, in the sole discretion of the General Partner, sell individual cable systems and may also sell all or substantially all of the Partnership's assets to the General Partner or its affiliates. Any such sale must be made in cash at the median of appraisals undertaken by three nationally recognized experts in the cable television field. As previously reported, the Partnership commenced the "Appraisal Process" in August 1996 and received the results of the related appraisals in February 1997. The full text of these appraisals has previously been filed with the Securities and Exchange Commission. As of the date of this Report, the General Partner has not made a decision as to whether or not it will further pursue the acquisition of any Partnership assets at this time. Accordingly, there can be no assurance that any such sale of any or all of the Partnership's assets in accordance with the rights of the General Partner and its affiliates under the terms of the Partnership Agreement will be pursued, or if pursued, when and if any such transaction will be consummated. These matters are discussed more fully in the Partnership's Annual Report on Form 10-K for the year ended December 31, 1996 and its Current Reports on Form 8-K dated August 27, 1996, October 17, 1996 and February 6, 1997. Unitholders are urged to review the referenced materials carefully. 6 7 FALCON CLASSIC CABLE INCOME PROPERTIES, L.P. RESULTS OF OPERATIONS The Partnership's revenues increased from $4.7 million to $5.3 million, or by 11.6% for the three months ended March 31, 1997 as compared to the corresponding period in 1996. Of the $544,000 increase, approximately $461,000 was due to increases in regulated service rates implemented during 1996, $100,000 was due to the restructuring of The Disney Channel from a premium channel to a tier channel on July 1, 1996, $55,000 was due to programmer incentives and $51,000 was due to increases in advertising sales. These increases were partially offset by revenue decreases of $123,000, primarily due to reductions in the number of subscriptions for premium cable services. As of March 31, 1997, the Partnership had approximately 47,880 homes subscribing to cable service and 16,592 premium service units. The decrease of 4,802 premium units from March 31, 1996 was due in part to approximately 2,950 Disney premium units that became tier subscriptions under the restructuring discussed above. Service costs remained relatively unchanged at approximately $1.6 million for the three months ended March 31, 1997 as compared to the corresponding period in 1996. Service costs represent costs directly attributable to providing cable services to customers. The $73,000 increase was primarily due to an increase of $155,000 in programming fees charged by program suppliers (including primary satellite fees), which included a $34,000 increase related to the restructuring of The Disney Channel discussed above and an increase of $39,000 in franchise fees. The increases in service costs discussed above were partially offset by a $119,000 increase in capitalized labor, primarily due to upgrading the existing cable television system in Maryland. General and administrative expenses increased from $633,000 to $729,000, or by 15.2%, for the three months ended March 31, 1997 as compared to the corresponding period in 1996. Of the $96,000 increase, $46,000 was due to increases in insurance cost, $10,000 was due to increases in compliance costs associated with re-regulation by the FCC, $10,000 was due to increases in costs associated with marketing activities and $30,000 was due to increases in other expenses. General Partner management fees and reimbursed expenses remained constant as a percent of revenue at 8.0%, and increased from $376,000 to $420,000 for the three months ended March 31, 1997 as compared to the corresponding period in 1996. Depreciation and amortization expenses decreased from $2.1 million to $1.7 million, or by 17.4%, for the three months ended March 31, 1997 as compared to the corresponding period in 1996. The $368,000 decrease was due primarily to certain assets becoming fully amortized in 1996. Operating income increased from $33,000 to $732,000 for the three months ended March 31, 1997 as compared to the corresponding period in 1996. The $699,000 increase in operating income was due primarily to increased revenues and decreases in depreciation and amortization expense as discussed above. Net interest expense, including the effects of interest rate hedging agreements, decreased from $540,000 to $410,000, or by 24.1%, for the three months ended March 31, 1997 as compared to the corresponding period in 1996. The $130,000 decrease was due primarily to lower average debt balances and 7 8 FALCON CLASSIC CABLE INCOME PROPERTIES, L.P. RESULTS OF OPERATIONS (CONCLUDED) lower interest rates. The hedging agreements resulted in higher interest expense of $29,000 and $22,000 for the three months ended March 31, 1997 and 1996, respectively. Due to the factors described above, the Partnership's net loss of $507,000 for the three months ended March 31, 1996 changed to net income of $322,000 for the three months ended March 31, 1997. LIQUIDITY AND CAPITAL RESOURCES The Partnership's primary objective, having invested its net offering proceeds in cable systems, is to distribute to its partners all available cash flow generated from operations and proceeds from the sale of cable systems, if any, after providing for expenses, debt service and capital requirements relating to possible improvement and upgrade of its systems. The Partnership relies upon the availability of cash generated from operations and possible borrowings to fund its ongoing capital requirements. In general, these requirements involve expansion, improvement and upgrade of the Partnership's existing systems. The Partnership has encountered liquidity difficulties due in part to the adverse effects of the 1992 Cable Act and new competitive pressures resulting from both technological advances as well as from the 1996 Telecom Act, which will require that material amounts of capital be invested in the Partnership's systems. As previously reported, in response to the FCC's amended rate regulation rules, distributions to Unitholders were discontinued subsequent to the April 15, 1994 payment in order to preserve cash resources. The Partnership also delayed the majority of its rebuild and upgrade capital expenditure programs that had been scheduled for 1994, 1995, 1996 and 1997 in order to preserve liquidity. The Partnership's access to capital remains severely constrained primarily due to the limitations imposed by the Partnership Agreement. This limitation on indebtedness, which is discussed below, is at odds with the need to increase leverage and to spend approximately $44 million to rebuild and upgrade the Partnership's systems (of which approximately $650,000 is mandated by franchise agreements) and has caused the Partnership to limit its 1997 rebuild and upgrade plans. Current plans are to expend an aggregate of approximately $5 million in 1997 for all capital expenditures, including approximately $1.0 million in upgrades to a portion of one system and $300,000 to upgrade portions of two other systems, which represents the minimum level of expenditures that management believes are necessary, in the short term, to comply with franchise authorities and FCC technical requirements. As a result, the Partnership's systems are significantly less technically advanced than had been expected prior to the implementation of re-regulation. The Partnership believes that the delays in upgrading many of its systems will, under present market conditions, most likely have an adverse effect on the value of those systems compared to systems that have been rebuilt to a higher technical standard. Further, it should be noted that the approximate capital expenditure amounts discussed above are current estimates only and are subject not only to the normal uncertainties of construction projects but also to any changes in materials requirements or design characteristics due to future developments in the underlying technologies. 8 9 FALCON CLASSIC CABLE INCOME PROPERTIES, L.P. LIQUIDITY AND CAPITAL RESOURCES (CONTINUED) On December 29, 1995, the Partnership borrowed $5.6 million under its Bank Credit Agreement because the revolving credit portion of that facility was scheduled to convert to a term loan on December 31, 1995. The Partnership's management believes that the Partnership's anticipated cash resources and cash flow from operations in 1997 will be sufficient to fund its capital expenditure plans (as adjusted) and the required principal payments on its debt of $4.1 million scheduled for 1997. As of March 31, 1997, the amount outstanding under the Partnership's amended Bank Credit Agreement was $23.3 million. As discussed above, the Partnership had no additional borrowings available to it. At March 31, 1997, such borrowings bore interest at an average rate of 7.8% (including the effect of interest rate swap transactions). The Bank Credit Agreement also contains various restrictions relating to, among other things, mergers and acquisitions, investments, capital expenditures, a change in control and the incurrence of additional indebtedness and also requires compliance with certain financial covenants. Management believes that the Partnership was in compliance with all such requirements as of March 31, 1997. The Bank Credit Agreement requires principal repayments of $1.0 million on June 30, 1997, September 30, 1997 and December 31, 1997 and $5.4 million in 1998. The Partnership made its scheduled principal repayment of $1.0 million on March 31, 1997. The Partnership Agreement provides that without the approval of a majority of interests of limited partners, the Partnership may not incur any borrowings unless the amount of such borrowings together with all outstanding borrowings does not exceed 30% of the greater of the aggregate cost or current fair market value of the Partnership's assets as determined by the General Partner. As discussed above, in order to spend the appropriate amount of capital to rebuild and upgrade the Partnership's systems, this provision of the Partnership Agreement would need to be amended to significantly increase the Partnership's leverage because the Partnership's management does not believe that it will be able to fund future rebuild requirements entirely from cash resources and operating cash flow. The Partnership's management agreement with the General Partner requires deferral of the payment of up to 50% of the management fees, without interest, unless Adjusted Operating Cash (as defined) for such month exceeds a 10% annualized return calculated with respect to outstanding Partnership Units. To the extent that Adjusted Operating Cash exceeds such amount, the General Partner may recover previously deferred fees, without interest. In compliance with these provisions, the General Partner received its standard management fee for the three months ended March 31, 1997 and recovered $276,000 in previously deferred management fees. The Partnership Agreement also limits borrowings incurred to make distributions to partners to not more than 10% of Gross Proceeds (as defined) from the public offering of the Units (approximately $7.2 million). As of March 31, 1997, the Partnership had incurred an aggregate of approximately $5.4 million in borrowings to make distributions to partners. The Partnership discontinued distributions subsequent to the April 15, 1994 payments. 9 10 FALCON CLASSIC CABLE INCOME PROPERTIES, L.P. LIQUIDITY AND CAPITAL RESOURCES (CONCLUDED) THREE MONTHS ENDED MARCH 31, 1997 AND 1996 Cash provided by operating activities increased from $1.1 million to $1.4 million, or by $277,000, for the three months ended March 31, 1997 as compared to the corresponding period in 1996. The increase resulted from an increase in net income of $830,000, $368,000 of which resulted from a decrease in non-cash depreciation and amortization; and from a decrease of $185,000 in other operating items (receivables, prepaid expenses and other assets, cable materials, equipment and supplies, payables, accrued expenses and customer deposits and prepayments), which includes the $276,000 decrease in deferred management fees discussed above. Cash used in investing activities increased by $230,000 in the three months ended March 31, 1997 as compared to the corresponding period in 1996, primarily due to an increase in capital expenditures. Cash used by financing activities increased by $1.0 million because of the repayment of debt of $1.0 million on March 31, 1997. Operating income before depreciation and amortization (EBITDA) as a percentage of revenues increased from 45.6% to 47.2% in the three months ended March 31, 1997 as compared to the corresponding period in 1996. The increase was primarily caused by increased revenues, as described above. EBITDA increased from $2.1 million to $2.5 million, or by 15.4%, in the three months ended March 31, 1997 as compared to the corresponding period in 1996. INFLATION Certain of the Partnership's expenses, such as those for wages and benefits, equipment repair and replacement, and billing and marketing generally increase with inflation. However, the Partnership does not believe that its financial results have been, or will be, adversely affected by inflation in a material way. 10 11 PART II. OTHER INFORMATION ITEMS 1-5. Not applicable. ITEM 6. Exhibits and Reports on Form 8-K (a) None (b) The Registrant filed a Form 8-K dated February 6, 1997, in which it reported under Item 5 that the General Partner received summaries of the results of the appraisals from the three independent appraisers. The full text of these appraisals has been filed as Exhibits 10.30 through 10.32 to the Company's Form 10-K for the year ended December 31, 1996. The Registrant filed a Form 8-K dated February 13, 1997, in which it reported under Item 5 that the General Partner had mailed a letter to all limited partners making them aware that an unsolicited offer by Everest Cable Investors, LLC to buy partnership units was, in the opinion of the General Partner, inadequate and advising unitholders of the recommendation of the General Partner that they not accept the offer. The letter also advised unitholders, among other things, that the offer was made without the consent or involvement of the General Partner. 12 SIGNATURES 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. FALCON CLASSIC CABLE INCOME PROPERTIES, L.P. a CALIFORNIA LIMITED PARTNERSHIP -------------------------------- (Registrant) By: Falcon Classic Cable Investors, L.P. Managing General Partner By: Falcon Holding Group, L.P. General Partner By: Falcon Holding Group, Inc. General Partner Date: May 6, 1997 By: /s/ Michael K. Menerey ---------------------------------- Michael K. Menerey, Secretary and Chief Financial Officer