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November 15, 1999
CLASSIC COMMUNICATIONS INC (CLSC)
Quarterly Report (SEC form 10-Q)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
The following discussion provides additional information regarding the financial condition and results of operations of Classic Communications, Inc. ("CCI") for the nine months ended September 30, 1999 and 1998. This discussion should be read in conjunction with CCI's "Management's Discussion and Analysis of Financial Condition and Results of Operations" for the fiscal year ended December 31, 1998 and the six-month period ended June 30, 1999 contained in CCI's Form S-1 Registration Statement dated October 19, 1999. Since its inception, CCI has completed multiple acquisitions and divestitures of cable systems. As a result, management believes that period-to-period comparisons of CCI's financial results to date are not necessarily meaningful and should not be relied upon as an indication of future performance. In addition, the financial condition and operating results of CCI could differ materially from those discussed herein and its current business plans could be altered in response to market conditions and other factors beyond CCI's control.
The statements, other than statements of historical fact, included in this Report are forward-looking statements. These statements include, but are not limited to:
- statements regarding CCI's plans for future acquisitions;
- statements regarding integration of CCI's cable systems and future acquired systems;
- statements regarding CCI's planned capital expenditures and system upgrades;
- statements regarding the offering of video and internet access on CCI's systems; and
- statements regarding CCI's preparations for the year 2000 date change.
Forward-looking statements generally can also be identified by the use of forward-looking terminology such as "may," "will," "expect," "intend," "estimate," "anticipate," "plan," "seek," or "believe." CCI believes that the expectations reflected in such forward-looking statements are accurate. However, CCI cannot assure you that such expectations will occur. CCI's actual future performance could differ materially from such statements. Factors that could cause such or contribute to such differences include, but are not limited to:
- the uncertainties and/or potential delays associated with respect to integrating Buford and Star and future acquisitions;
- CCI's ability to acquire additional cable systems on favorable terms;
- the passage of legislation or court decisions adversely affecting the cable industry;
- CCI's ability to repay or refinance outstanding indebtedness;
- the timing, actual cost and allocation of CCI's capital expenditures and system upgrades;
- CCI's potential need for additional capital;
- competition in the cable industry;
- the advent of new technology; and
Investors should not unduly rely on these forward-looking statements, which speak only as of the date of this Report. Except as required by law, CCI is not obligated to publicly release any revisions to these forward-looking statements to reflect events or circumstances occurring after the date of this Report or to reflect the occurrence of unanticipated events. Important factors that could cause CCI's actual results to differ materially from its expectations are discussed in this Report. All subsequent written and oral forward-looking statements attributable to CCI, or persons acting on its behalf, are expressly qualified in their entirety by the statements in this Report.
All percentage amounts and ratios were calculated using the underlying data in thousands. Operating results for the three and nine month periods ended September 30, 1999, are not necessarily indicative of the results that may be expected for the full fiscal year.
Results of Operations
REVENUES. Revenues increased $22.0 million, or 44%, for the nine months ended September 30, 1999, as compared to the corresponding prior year period. Basic revenues increased by $7.5 million due to increased subscribers of approximately 28,000 in July 1998 and 170,000 in July 1999 and basic rate increases. The increase in subscribers was due to the acquisition of systems from Cable One in July 1998 and the acquisition of Buford Group, Inc. in July 1999. In addition, there was a rate increase of approximately 7% affecting approximately two-thirds of our customers in February 1999 which resulted in an increase in basic revenues per subscriber of 7% from $27.74 to $29.69 period to period. Classic Cable has historically increased rates in February in order to offset increases in operating costs such as programming which occur primarily in January of each year.
OPERATING EXPENSES. Operating expenses increased $28.9 million, or 55%, for the nine months ended September 30, 1999, as compared to the corresponding prior year period. Programming expenses increased $6.4 million due to the continued escalation in rates charged by programming vendors as well as an increase in the subscriber base over the same period in 1998. Plant and operating and general and administrative expenses increased $5.1 million, or 36%, as a result of the additional costs associated with the systems acquired in 1998 and 1999. Corporate overhead increased $6.4 million primarily due to $6.6 million of acquisition related compensation expenses incurred in connection with the Buford acquisition. Depreciation and amortization expense for the nine months ended September 30, 1999 was $32.3 million, an increase of $10.6 million over the same period in 1998. The increase represents the effect of acquisitions and capital expenditures.
OTHER INCOME AND EXPENSES. Interest expense increased $10.7 million, or 63%, for the nine months ended September 30, 1999, as compared to the corresponding prior year period. This increase is primarily the result of the debt issued in conjunction with the July 1999 and 1998 acquisitions and subsequent refinancing of debt.
INCOME TAX BENEFIT. The income tax benefit decreased $1.7 million for the nine months ended September 30, 1999, as compared to the corresponding prior year period. No tax benefit was recognized in 1999. The effective tax rates for the nine months ended September 30, 1999 and September 30, 1998 differ from the statutory rates primarily due to an increase in the valuation allowance on deferred tax assets.
NET LOSS. As a result of the above described fluctuations in CCI's results of operations and extraordinary losses recognized in connection with the July 1998 and 1999 refinancing of debt, the net loss of $43.0 million for the nine months ended September 30, 1999 increased by $20.4 million, as compared to the net loss of $22.5 million for the corresponding prior year period.
Liquidity and Capital Resources
Operating income before depreciation and amortization or "operating cash flow" as commonly referred to in the cable communications business, was $20.0 million and $23.7 million for the nine months ended September 30, 1999 and 1998, respectively. Operating cash flow less the impact of non-cash operating charges and cash charges related to acquisition and financing transactions was $31.1 million and $20.7 million for the nine months ended September 30, 1999 and 1998, respectively. Operating cash flow is a measure of a company's ability to generate cash to service its obligations, including debt service obligations, and to finance capital and other expenditures. In part due to the capital intensive nature of the cable communications business and the resulting significant level of non-cash depreciation and amortization expense, operating cash flow is frequently used as one of the basics for comparing businesses in the cable communications industry, although our measure of operating cash flow may not be comparable to similarly titled measures of other companies. Operating cash flow is the primary basis used by our management to measure the operating performance of our business. Operating cash flow does not purport to represent net income or net cash provided by operating activities, as those terms are defined under generally accepted accounting principles, and should not be considered as an alternative to measurements as an indicator of our performance.
For the nine months ended September 30, 1999 and 1998, CCI's capital expenditures, other than those related to acquisitions, were approximately $16.0 million and $7.7 million, respectively. Capital expenditures include expansion and improvements of existing cable properties, plant and equipment upgrades, as well as cable line drops, line plant extensions and installations of service to new subscribers.
In July 1999, Classic Cable issued $150.0 million of 9.375% Senior Subordinated Notes due 2009. Concurrently with the offering, Classic Cable entered into the 1999 Credit Agreement. The proceeds from these transactions and a sale of CCI's stock were approximately $425.0 million and were used to (a) fund the acquisition of Buford Group, Inc., (b) repay the 1998 Credit Agreement and (c) pay fees and expenses of these transactions. The 1999 Credit Agreement consists of (a) a $75.0 million revolving credit facility which matures in 2007, (b) a $75.0 million Term A loan facility which matures in 2007, (c) a $100.0 million Term B loan facility which matures in 2008, and (d) a $100.0 million Term C loan facility which matures in 2008. Mandatory payments commence in 2001. Interest is based upon either a LIBOR rate plus an applicable margin or, at Classic Cable's option, a base rate plus an applicable margin. The Term C loan facility was utilized in September 1999 to fund the partial redemption of $86.0 million of the 2008 subordinated notes.
CCI has debt service requirements increasing from approximately $40 million a year to $54 million over the next eight years. During the next four fiscal years, CCI anticipates capital expenditures averaging approximately $50 million a year. Debt covenants dictate that Classic Cable maintain certain ratios related to debt balances and operating results in addition to limiting the amount that can be used for capital expenditures. Funds to support Classic Cable's operations and pay the anticipated debt service and capital expenditure requirements are anticipated to be primarily generated from its operating activities and from additional financing activities. On September 30, 1999, we had $75.0 million available under Classic Cable's line of credit, subject to some limitations.
The 1999 Credit Agreement of Classic Cable is collateralized by essentially all of the assets of Classic Cable. CCI has no operations of its own. Consequently, it will rely on dividends and cash flow of Classic Cable to meet its debt service obligations. The terms of the Credit Agreement restrict certain activities of Classic Cable, including the incurrence of additional indebtedness and the payment of certain dividends. Accordingly, substantially all the assets and operations of Classic Cable are restricted as to transfer to CCI and may not be available for dividends and/or debt service of CCI.
Management believes that CCI has sufficient resources from cash provided from operations and available borrowings to support its operations and capital requirements for at least the next 12 months. There can be no assurance, however, that Classic Cable's business will generate sufficient cash flow from operations, that currently anticipated cost savings and operating improvements will be realized on schedule or that future borrowings will be available to CCI under Classic Cable's credit facility in an amount sufficient to enable CCI to pay its indebtedness or to fund its other liquidity needs. CCI may need to refinance all or a portion of its indebtedness on or before maturity. There can be no assurance that CCI will be able to refinance any of its indebtedness, including Classic Cable's credit facility and its outstanding notes, on commercially reasonable terms or at all.
Certain of CCI's expenses, such as programming, wages and benefits, equipment repair and maintenance, billing and marketing are subject to inflation. However, because changes in costs are generally passed through to subscribers, these changes historically have not had a material adverse effect on CCI's results of operations.
YEAR 2000 COMPLIANCE
Through 1999, most large companies will be facing a potentially serious business problem because many software applications and computer equipment developed in the past may not properly recognize calendar dates beginning in the year 2000. This problem could cause computers to either shut down or provide incorrect data.
These problems are expected to increase in frequency and severity as the year 2000 approaches. This issue impacts our owned or licensed computer systems and equipment used in connection with internal operations, including:
- information processing and financial reporting systems;
- customer billing systems;
- customer service systems;
- telecommunication transmission and reception systems; and
- facility systems
CCI also relies directly or indirectly, in the regular course of business, on the proper operation and compatibility of third party systems. The year 2000 problem could cause these systems to fail or become incompatible with its systems.
The failure or loss of compatibility among systems could cause material disruptions, including the inability to process transactions, generate invoices, or to respond to requests for service. CCI could also face similar disruptions if the year 2000 problem causes general widespread problems or an economic crisis. CCI cannot now estimate the extent of these potential disruptions on its results of operations, liquidity or financial condition.
Through the redeployment of internal resources and the selective engagement of outside consultants, CCI is addressing the year 2000 problem with respect to its internal operations in three stages:
- conducting an inventory and evaluation of its systems, components, and other significant infrastructure to identify those elements that it reasonably believes could be expected to be affected by the year 2000 problem. This stage has been completed.
- remediation or replacing equipment that, based upon such inventory and evaluation, CCI believes may fail to operate properly in the year 2000. This stage has been completed.
- testing of the remediation and replacement conducted in stage two. This stage is substantially complete, with further testing to be conducted up to and through December 31, 1999.
To date, costs incurred that were directly related to addressing the year 2000 problem have not been material. CCI does not expect that the total cost of its year 2000 remediation will be material.
Much of CCI's assessment efforts have involved, and depend upon, inquiries to third party service providers, suppliers and vendors of various parts or components of its systems. CCI has obtained certifications from third party service providers, suppliers and vendors as to the readiness of mission critical elements. Certain of these parties have certified the readiness of their products but will not certify their operability within its fully integrated systems. CCI cannot assure you that these technologies of third parties, on which it relies, will be year 2000 ready or timely converted into year 2000 compliant systems compatible with its systems. CCI has, however, evaluated the potential impact of third party and/or integration failure on its systems in connection with the development of its contingency plans.
CCI's year 2000 plan calls for appropriate contingency planning for its at-risk business functions. As part of its normal operations, contingency plans are in place to minimize disruption of service to customers and other critical business functions, including guidelines for informing the appropriate personnel in order to accelerate restoration of service.
CCI has negotiated certain contractual rights relating to the year 2000 problem in the Star asset purchase agreement. CCI has included acquired cable television systems in its year 2000 compliance efforts. CCI is monitoring the remediation process for the systems it is acquiring to ensure completion of remediation in a timely manner. CCI has found that these companies are following a three stage process similar to that outlined above and are on a similar time line for completion. CCI is not currently aware of any likely material system failures relating to the year 2000 affecting the acquired systems.
CCI believes its efforts have significantly reduced its level of uncertainty about the year 2000 problem and, in particular, about the year 2000 compliance and readiness of its material vendors. However, no assurance can be given that year 2000 compliance can be achieved without costs that might affect future financial results or cause reported financial information not to be necessarily indicative of future operating results or future financial condition.
Factors Affecting CCI's Business and Prospects
There are numerous factors that affect CCI's business and the results of its operations. These factors include changes in laws and regulations; changes in the competitive environment; changes in technology; franchise related matters; market conditions that may adversely affect the availability of debt and equity financing for working capital, capital expenditures or other purposes; and other general economic conditions.
Item 3. Quantitative and Qualitative Disclosure About Market Risk
Classic Cable's credit facility bears interest at floating rates. Accordingly, its earnings are affected by changes in short-term interest rates. Classic Cable does not enter into derivatives or other financial instruments for trading or speculative purposes. However, the credit facility does require that 50% of Classic Cable's outstanding debt be effectively subject to a fixed rate. If Classic Cable has non-fixed rate debt in a principal amount in excess of its current senior subordinated indebtedness, as set forth in the credit facility, then Classic Cable must enter into interest rate hedges and/or other arrangements which are designed solely to protect against fluctuations in interest rates. These arrangements would be required only with respect to the portion of Classic Cable's debt in excess of its senior subordinated indebtedness to the extent necessary to raise the aggregate amount of Classic Cable's fixed rate debt to 50% of its outstanding debt.
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