ITEM 1.
BUSINESS
Overview
Grande’s primary business is providing a bundled package of cable television (“video”), telephone (“voice”), and broadband Internet (“HSD”) and other services to residential and small and medium sized business customers in Texas. We provide these services in seven markets in the state of Texas using local broadband networks that we constructed. We refer to the homes and businesses that our network is capable of providing services to as “marketable homes passed”. As of December 31, 2007, we had the ability to market services to 340,058 distinct homes and businesses over our networks and had 145,675 residential and business customers. Our operating revenues were $189.9 million in 2006 compared to $197.1 million for 2007.
Grande was founded in October 1999 and was funded with $232 million of initial equity capital to pursue a retail strategy of constructing broadband networks in order to offer bundled video, voice and HSD services to customers. Operating revenues from bundled services were $146.1 million in 2006 compared to $155.0 million for 2007.
We believe that an important measure of our growth potential is the number of marketable homes passed by our networks and the marketable homes we are able to pass in the future in the markets in which we currently operate. Marketable homes passed are the number of residential and business units, such as single family residential homes, apartments and condominium units, passed by our networks, other than those we believe are covered by exclusive arrangements with other providers of competing services. Since 2001, we have grown our marketable homes passed through the construction of our networks. The expansion of our networks has, in turn, allowed us to pursue a retail strategy of offering bundled video, voice and HSD services to residential and business customers. We have derived an increasing percentage of our revenues from our bundled services and we expect this trend to continue. Because of our local networks and existing fixed infrastructure in the markets in which we currently operate, we believe we can continue to grow our business without incurring the significant capital investment required to launch operations in new markets.
In addition, we have leveraged our retail metro network build-out with the 2003 acquisition of a long haul fiber optic network, primarily located in Texas, to allow us to provide broadband transport services to medium and large enterprises and communications carriers. Operating revenues for broadband transport services were $8.6 million in 2006 compared to $9.4 million for 2007.
In July 2000, when our network construction was still in a very early stage, we acquired Thrifty Call, Inc. (“Thrifty Call”), which had an established telephone and data network that served as the platform for the provisioning of residential voice and HSD services and that still provides network services to medium and large enterprises and communications carriers in the wholesale market. Operating revenues for network services were $35.2 million in 2006 compared to $32.7 million for 2007.
Our network services are primarily provided using our existing infrastructure and personnel with minimal incremental operating costs and capital expenditures for maintenance. By leveraging our brand, communications infrastructure, voice and data volume, and personnel that predominately support our core retail business and its products, we have gained efficiencies of scale by offering telecommunications and HSD products into wholesale markets.
On January 18, 2008, we issued a press release announcing that our board of directors has authorized the Company to explore all of its strategic alternatives to enhance shareholder value. The board of directors will work with the Company’s management team and its legal and financial advisors to evaluate the Company’s available alternatives. We have engaged Waller Capital Partners LLC to assist us in exploring strategic alternatives. There can be no assurance that the exploration of strategic alternatives will result in the Company adopting or approving any strategic alternative. We undertake no obligation to make any further announcements regarding the exploration of strategic alternatives unless and until a final decision is made.
Grande Competitive Advantages
We believe we have been able to grow our customer base because of the following competitive advantages:
•
Competitively superior networks. We provide our services over our newly constructed, fully integrated, high-speed, high capacity networks. In 2005, we began taking fiber optic cable direct to our customers’ homes on new network passings in Austin and San Antonio with a technology known as fiber-to-the-home (“FTTH”). On all passings constructed prior to our launch of FTTH, our networks deploy fiber optic cable to nodes that can serve from 24 to 450 marketable homes passed, depending on network configuration. Our networks generally utilize an 860Mhz signal, which can be upgraded to 1Ghz. Our networks are designed to have sufficient capacity to meet the growing demand for high bandwidth cable television, telephone and Internet services while providing additional capacity to enable us to offer planned and future products. The architecture of our networks allows us to offer superior services, such as dedicated Internet products at high bandwidth rates that we believe are superior to the shared bandwidth Internet products offered by our cable competitors. We already offer high definition television, digital video recording, and interactive television. Our networks are positioned to deliver new services, such as video on-demand cable television, switched digital, and other high bandwidth applications without requiring a significant additional capital investment.
•
Flexible product offerings, attractively bundled and priced. We are able to deliver a wide range of products that allow our customers to select the services that meet their specific needs and preferences: from bundled product offerings that include over 300 channels, including product enhancements such as digital video recorders (“DVRs”) and high-definition television programming (“HDTV”), local and long distance voice services, and a full suite of HSD products with speeds from 384Kbps to 12.0Mbps (up to 15.0Mbps in the Company’s FTTH passings). We believe we can offer a competitively priced package to virtually any marketable home passed by our networks. Because of operating efficiencies that result from providing multiple services to one customer, we are able to provide our customers additional savings when they purchase products as part of a bundle of two or more services. We believe that our ability to provide a single consolidated bill for multiple services is also an attractive feature for our customers.
•
Strong local brand and customer service. We have chosen to serve customers in seven attractive and growing markets in Texas: Austin/San Marcos, San Antonio, suburban northwest Dallas, Waco, Corpus Christi, Midland/Odessa and, to a lesser extent, Houston. In each of these markets, we have established a strong local presence that we believe has positioned Grande as the hometown company, despite the fact that we are not the incumbent service provider in any of our markets. Our customer service and technical representatives, as well as our sales representatives, installation technicians and other employees who interact with our customers, know our markets and products, and are part of our customer-focused culture. We operate a virtual customer phone center system, with centers in Austin and San Marcos, that allows us to offer customer care 24 hours a day, seven days a week in an efficient, cost-effective manner. We believe our hometown brand, combined with local customer service and support, enables us to appeal to residential and business customers in our markets, as well as to local universities, utilities, hospitals and other institutions.
The Grande Strategy
We seek to take advantage of our market position by executing the following operating strategy:
•
Increase customer penetration in markets with demonstrated demand and operating metrics. We believe that each of our existing markets has demonstrated strong consumer demand and favorable operating metrics. As of December 31, 2007, we had 145,675 customers taking an average of over two connections each. We have proven our ability to take market share from our competitors over time in the communities that we serve. We had a 6% growth in residential and business customers from 137,542 as of December 31, 2006 to 145,675 as of December 31, 2007. We believe that there is opportunity to further penetrate our existing markets, particularly in our newer passings.
•
Expand commercial business offering over our retail footprint. We have extensive local deep fiber networks in each of our markets (excluding Houston) that enable us to pursue our commercial business. We have leveraged our local brand, network, and telecommunications infrastructure to grow this offering by 18.2% to $15.3 million in revenue during 2007. We offer our commercial customers cable television, telephone, and broadband Intranet services at competitive rates. Because of our expansive and fiber rich local networks, we believe we can cost effectively grow this business without requiring significant additional capital investment. Our commercial business is part of our overall bundled services business.
•
Leverage our infrastructure by serving broader telecommunications market. In addition to our primary business of offering bundled services to residential and business customers, we also offer broadband transport services and network services to medium and large enterprises and communications carriers. These services are primarily provided using our existing infrastructure and personnel with minimal incremental operating costs and capital expenditures for maintenance. By leveraging our brand, communications infrastructure, voice and data volume, and personnel that predominately support our core retail business and its products; we have gained efficiencies of scale by offering telecommunications and HSD products into broader telecommunications markets.
Services
Bundled Services
We provide video, voice, HSD and other services to our residential and business customers. We are able to deliver a wide range of products that allow our existing and potential residential and business customers to select the services that meet their specific needs and preferences, from products on an individual basis to bundled product offerings. Our bundled packages offer the convenience and cost-savings of having one bill and one company providing the services. We believe we were the first company in many of our markets to offer one-stop shopping for video, voice and HSD services to residential and business customers. We price our products competitively in each of our target markets. When customers purchase our products as part of a bundle of two or more services, they benefit from additional savings.
Our bundled services encompass a broad range of services provided on an individual basis or through a bundled product offering. These services include:
•
Video. We offer a wide variety of video programming and services. In addition to basic and digital video services, the Company offers numerous add-on services, such as pay-per-view, premium movie channels, digital video recorders and HDTV. Grande also offers interactive features, such as video games and local source guides. As of December 31, 2007, we provided video services to 99,453 connections. On average, during 2007, each of our video connections generated $55.28 in monthly revenues.
Our video offerings include:
•
Basic Cable. Our basic cable offering consists of approximately 25 analog channels, which generally consists of local broadcast television, local community programming (including governmental, public and education), limited satellite-delivered or non-broadcast channels.
•
Expanded Cable. Includes Basic Cable plus approximately 55 additional channels (approximately 80 total), including ESPN, Disney, CNN, Comedy Central and MTV.
•
Digital Cable. Our digital cable offering consists of our expanded cable offering plus approximately 220 digital cable channels for a total of over 300 channels. Digital service includes an interactive program guide with features such as games and local guides and 48 channels of digital music. In addition, we have tailored our digital cable programming to include a large number of Spanish language channels to appeal to the large Spanish-speaking population in our markets. We offer this target-specific content in tiers. Digital service also includes advanced services such as Grande News & Info on Demand. Grande’s digital package includes access to multi-cast premium channels such as HBO, Showtime, Cinemax, and Starz! as well as specialty programming tiers featuring Spanish programming, sports, high-definition, and movie content. Digital Cable TV subscribers must have a digital set-top box to use the service.
•
High-Definition Television. HDTV is offered to all digital cable subscribers. HDTV is a digital television service that displays enhanced picture quality that surpasses standard analog and digital television images. We currently offer 25 channels of HDTV programming.
•
Premium Movie Channels. These 31 additional channels provide commercial-free movies, foreign language programming and other programming including HBO, Cinemax, Showtime, The Movie Channel, Starz! and Encore, as well as others.
•
Pay-Per-View. Premium content, such as movies, sports and concerts that are offered on a commercial-free basis for additional fees.
•
Digital Video Recorder. For an additional fee, Grande offers digital set-top boxes that allow customers to digitally record television programs and watch them on their own schedule. In addition to recording and replay, DVRs also allow customers to pause and rewind live programming. Grande offers dual-tuner DVRs that allow customers to record programs while watching other channels.
•
Voice. We offer a variety of local and long distance calling plans as well as numerous advanced calling features. Grande’s voice plans generally include unlimited local calling, free calls to existing Grande customers, directory listing service options and bundles of local and long distance calling with a variety of calling features. Grande’s voice plans offer consumers superior service and value compared to other offerings in the market. As of December 31, 2007, we provided service to 114,303 telephone connections. On average, during 2007, each of our telephone connections generated $40.43 in monthly revenues, including local and long-distance service.
Our voice offerings include:
•
Local Service. Our local telephone services include standard dial tone access, 911 access, operator services and directory assistance, all over a powered network affording greater reliability. In addition, we offer a wide range of custom call services, including call waiting, call forwarding, call return, caller blocker, anonymous call rejection, auto redial, speed dial, three-way calling, priority-call and voice mail, each of which may be activated or deactivated by a customer, usually by dialing a simple activation code.
•
Long Distance. Our long-distance services include traditional switched and dedicated long distance, toll-free calling, international, calling card and operator services. We offer our customers an option of a flat rate for long-distance calls all day, every day, with no minimum monthly usage fees, and several prepaid long distance plans by which the customer pays a monthly fee for a pre-determined number of long distance minutes and a flat rate for any additional minutes. We also offer flat rate direct-dial international calling with no additional fees, surcharges or minimum call times per call. Our customers also may purchase 800 number calling services and calling card services. We believe our long-distance telephone services are competitively priced. We offer our retail customers, as part of their subscription to our services, “free Grande-to-Grande,” which means there are no long-distance charges for calls between two of our phone subscribers in different markets.
•
HSD and Other. As of December 31, 2007, we had 95,125 HSD and other service connections. On average, during 2007, each of our HSD and other connections generated $31.88 in monthly revenues. HSD and other services include:
•
HSD Service. We provide our HSD customers with a full suite of high-speed broadband Internet products through our networks, with speeds up to 12Mbps download (15Mbps to our FTTH customers) for residential customers. We offer multiple tiers of high-speed broadband access, including dedicated access and tiered bandwidth, with Ethernet speeds up to 100Mbps, to business customers. We also offer DSL and low-price dial-up Internet access, but most of our residential and business customers take advantage of the wide bandwidth and high data speeds available on our broadband networks. Our HSD customers have a choice of services with different download and upload speeds for different monthly charges. Grande HSD service provides unlimited dedicated access to the Internet without dialing in or logging on to a network and without a dedicated telephone line. Our higher speed service offers superior speeds to DSL and, we believe, appeals to the more sophisticated broadband Internet user. We also provide to our customers a specific number of free e-mail accounts and personal Web space. Customers have the option to purchase or rent a cable modem from us or purchase it directly from a retailer. We believe businesses and sophisticated users continue to require faster Internet access and more bandwidth as content is becoming more robust, and we intend to offer products that will meet that demand using our high capacity networks. We also offer web premiums, such as Internet security, sports and news, and family applications.
•
Security Solutions. We discontinued actively marketing our security product in 2006. However, we continue to provide service to our existing customer base. Through our wireless security product, we installed leading wireless security systems in private residences. We use a third party for 24 hours a day, 7 days a week monitoring, and our trained technical staff is licensed by the Private Security Board under the Texas Department of Public Safety.
Broadband Transport Services
We offer access to our metro area and long-haul fiber networks in 16 cities in Texas, as well as in Tulsa and Oklahoma City, Oklahoma, Little Rock, Arkansas and Shreveport, Louisiana and provide our broadband transport customers with a full range of network-related services. The Grande network provides intercity long haul transport services between 20 cities in Texas, Oklahoma, Arkansas and Louisiana with collocation facilities in 15 of those cities. These services can include dark fiber leases and indefeasible rights of use, custom network construction or lateral builds and access to the networks at various wavelengths. We also provide private line services to enterprises, carriers and Internet service providers which allow the customer to connect multiple sites through dedicated point-to-point circuits, which carry voice and data traffic at high-speeds. A metro area network is a high-speed data intra-city network, usually including a fiber optic ring that links multiple locations within a city. Each of our metro area networks connects to most carrier points of presence, major incumbent local exchange carriers, or ILECs, and competitive local exchange carriers, or CLECs, central offices, hotels, central and suburban business centers, data centers and co-location facilities in these areas. We also provide equipment co-location services that permit Internet service providers to collocate modems, routers or network servers with our network equipment.
Network Services
We offer network services to other communications service providers and carriers. Our wholesale network services encompass a broad range of voice telephony products including domestic and international terminations, originating and terminating local access and national directory assistance. In addition, Grande provides wholesale data services ranging from dial up to Gigabit Ethernet Internet access. All of these services are provided using primarily the same personnel and network infrastructure that we use to provide voice and HSD services to our retail customers. This allows us to leverage our existing resources and expertise to generate incremental revenues and cash flow, which we believe has allowed us to support the early development of our core retail services while amortizing the cost of our networks over a larger revenue base. Since our networks pass or interconnect with these larger enterprises and carriers anyway, our goal has been to serve these customers and earn a return from every mile of network.
Our wholesale network services primarily include:
•
Carrier Voice. These services consist of our transmission services to carriers and other telecommunications companies. This primarily involves our selling access to and transporting minutes for long-distance telephone companies for intrastate, interstate and international long-distance traffic terminations.
•
Data Services. We provide services to Internet service providers, which we call our managed modem services that allow the Internet service provider to deliver dial-up Internet service to customers in areas where our network is located. We provide the modems, offer dial-up and a variety of related services, including server hosting, direct access between our networks and the network of the Internet service provider, a customer-maintained user database, and end-user technical support services. We also offer various other data services, such as VoIP terminations, inbound local calling and toll-free calling. A portion of our data revenue is derived from reciprocal compensation, and the latest FCC order (described more thoroughly below under the caption “Regulation of Telecommunications Services”) regarding this revenue stream negatively impacted our revenue beginning in the latter half of 2005.
•
Managed Services. We provide telephone services, as well as the infrastructure needed to offer local telephone service, to competitive local exchange carriers. This enables the carriers to offer telephone services to their customers using our networks, including a local dial tone, local telephone features, long-distance switching and calling cards. We also provide access to a comprehensive national directory assistance service, which includes local and long-distance directory assistance for listings in the United States. We also provide equipment co-location services that permit Internet service providers to collocate modems, routers or network servers with our network equipment.
Marketing and Sales
Our sales and marketing efforts focus on building loyalty with our customers and acquiring new customers along our existing network footprint. We emphasize the convenience, savings and improved service that can be obtained by subscribing to bundled services.
Marketing
In each of our markets, we have established a strong community presence that we believe has positioned Grande as the hometown company, despite the fact that we are not an incumbent service provider in any of our markets. We believe our hometown image enables us to appeal to residential customers and small businesses in our markets as well as to local universities, utilities, hospitals and other institutions. A key part of our marketing strategy has been to support local community organizations by sponsoring and participating in local charitable events and other community activities. Our employees run our Passion and Commitment Investment Club, which supports community organizations that provide food, shelter, clothing and healthcare to persons in need in our markets, has made significant donations to non-profit organizations across our markets in Texas and has been recognized with numerous local and state-wide awards for its’ community service. We believe that our employees’ community participation directly supports our direct sales force by creating a strong local brand to which we believe potential customers are receptive. We believe that this helps us to penetrate our target markets where the acquisition of new customers is typically dependent upon customers switching to our services from their existing providers. We had a 6% growth in residential and business customers from 137,542 as of December 31, 2006 to 145,675 as of December 31, 2007.
We focus our marketing efforts on areas served by our networks through such means as direct mail campaigns, outdoor space advertising, local event sponsorship and media where we have more local scale. In newly constructed network areas, we will undertake an extensive marketing campaign prior to activation of our services, beginning with direct mailings and door-hangers. In established areas, we focus on marketing additional services to those customers who have previously subscribed to one or two of our products. For example, we run Grande television advertisements on our own cable system which emphasize our voice and HSD products that are available as part of a bundle. In both new and established areas, we will, to a lesser extent, use traditional advertising outlets, such as television, radio and local newspaper advertising, to reach potential customers.
Sales
We have separate sales teams in each of our markets dedicated to residential, multiple family dwelling units (“MDUs”), and commercial customers. Each of these sales teams reports to separate sales management that is responsible for all of the sales in a particular product area. We also have a separate sales team dedicated to broadband transport and network services.
A standard residential sales team consists of direct sales, outbound and inbound call center sales, counter sales and support personnel. A typical commercial sales team consists of account executives and specialized business installation coordinators. Our MDU sales team has developed relationships with owners and management of the MDU properties in our target markets, which enables us to gain access to new customers as soon as they move into their unit. Our network services sales team focuses on making direct contact with communications providers principally via sales calls, trade shows and our sales team’s existing industry relationships. Our call center sales team handles substantially all incoming and outgoing sales calls.
Our sales teams are cross-trained on all our products to support our bundling strategy. Our sales teams are compensated based on both revenues and connections and are therefore motivated to sell more than one product to each customer. However, our sales force is highly incentivized to sell the right services to a particular customer without overselling. Our sales personnel do not get credit for selling products that are later cancelled within a certain number of months after the start of service. We believe that by providing the appropriate level of services to each customer, we are more likely to retain that customer, which reduces our overall customer turnover rate.
In addition, we have different strategies for marketing to customers in newly constructed network areas and to customers in established network areas. In new areas, prior to activation of our services, we target customers with door-to-door solicitations and outbound telemarketing as part of an extensive marketing campaign in the area. In established areas, we assign territories to individual direct sales representatives, allowing them to adjust sales techniques to fit the profile of different buyers in particular areas. We have also established relationships with certain strategic partners, such as local grocery stores, to market through certain products and services.
We work to gain customer referrals for additional sales by focusing on service and customer satisfaction. We have implemented several retention and customer referral tactics, including customer newsletters, personalized e-mail communications and loyalty programs. These programs are designed to increase loyalty, retention and up-sell among our current base of customers.
Customer Care, Billing and Installation
Customer Care
We believe that the combination of bundled communications services on our own networks and quality customer care are key drivers to effectively compete in the residential and business markets. We believe that the quality of service and responsiveness differentiates us from many of our competitors. We provide customer service 24 hours a day, seven days a week. Our representatives are cross-trained to handle customer service transactions for all of our products. We operate a virtual customer phone center system, with centers in Austin and San Marcos, that handle all customer service transactions other than network trouble calls, which we handle through our technical service center also located in San Marcos. In addition, we provide our business customers with a local customer service representative, which we believe improves our responsiveness to customer needs and distinguishes our products in the market. We believe it is a competitive advantage to provide our customers with the convenience of a single point of contact for all customer service issues for our video, voice and HSD services and is consistent with our bundling strategy.
We monitor our networks 24 hours a day, seven days a week through our network operations and control center (“NOCC”) located in San Marcos. Typically, our NOCC allows us to detect problems before or as soon as any service interruption occurs. We strive to resolve service delivery problems prior to customer awareness of any service interruptions.
Billing
We have invested significant resources in outsourced integrated provisioning and billing systems that we believe are sufficiently scalable to support a full build-out in our existing markets and beyond for our retail customer base. This system greatly enhances our ability to address customer billing issues and also enables us to send a single bill to our customers for video, voice and HSD services. We have separate billing platforms for enterprise, broadband transport and network services that we also believe meet our business needs for accuracy and flexibility.
Installation
Within each market, we have a single group of installers who install the equipment for all our of our video, voice, and HSD offerings. This creates operating efficiencies for us by reducing the number of necessary installation personnel and allowing us to make one trip to the customer premises at the commencement of service. Our dispatch, order taking and installation management processes are coordinated for increased efficiency. We believe that this integrated and streamlined installation process creates a positive experience for Grande’s customers.
Industry
In recent years, regulatory developments have led to changes and increased competition, both intra-modal and inter-modal, in the communications industry. The Telecommunications Act of 1996 and its implementation through Federal Communications Commission (“FCC”) regulations have broken down barriers between providers of different types of communications services. Companies that were effectively limited to providing one telecommunications service can now provide additional services with fewer regulatory restrictions or requirements.
We believe the industry is moving more towards an environment of inter-modal competition where both the cable television providers and the local telephone providers, and to some extent wireless service providers, will be competing head to head for local telephone, long distance, cable television or other video, and high speed data service. Advances in technology have furthered convergence in the industry by enabling delivery of cable television or video services, telephone services and broadband Internet services over different types of networks and making the delivery of more than one service over one broadband network, whether wireless or wireline, feasible and economical. The cable companies have introduced telephone services via Voice over Internet Protocol (“VoIP”) to residential customers, and the local telephone providers are investing large amounts of capital into new networks to offer television or video service using IP-enabled technologies in addition to their existing telephone and DSL services. Verizon Communications Inc. (“Verizon”) is constructing fiber-to-the-home networks and AT&T Inc. (“AT&T”) has begun serving customers via a fiber-to-the-curb network, in an effort to sell television over IP. Separately, advances in technology are enabling providers of wireless service to accommodate the transmission of video and other broadband applications.
Additionally, consolidation is continuing in the industry. Verizon purchased MCI Inc. in January 2006, and SBC Communications Inc. acquired AT&T in November 2005 and BellSouth Corporation in December 2006 and has adopted the AT&T name. We believe this consolidation trend will continue for the foreseeable future. As in the past, we will have to compete against companies that have significant competitive advantages over us, including more years of experience, greater resources, significant mass marketing capabilities and broader name recognition.
We also anticipate having to compete with the growing availability of wireless high-speed Internet access, or Wi-Fi service, principally when offered by municipal authorities or authorized third parties in a particular geographic region. Wi-Fi services, particularly when combined with VoIP or other advanced IP-based applications, can enable users to communicate by phone, access the Internet, or engage in other broadband activities, typically at a minimal flat-rate charge. The development and deployment of municipal Wi-Fi networks is still at an early stage, and it is difficult to predict the extent to which it will affect the provision of similar services by commercial companies such as ours.
We believe as the market continues to converge across product and market segments, communications providers will have to distinguish themselves from competitors by offering: high quality products, services, and applications across all service types; better pricing that reflects some of the operational efficiencies; and convenience to the customer in the form of a single bill and unified customer support. We believe that our ability to provide a tailored package of bundled services developed from a wide range of service options at competitive prices over one network system with a regional focus on Texas has been a key factor in enabling us to penetrate our markets.
Markets
The following table sets forth, in each of our markets, the marketable homes we pass as of December 31, 2007.
Competition
The broadband communications industry is highly competitive. We compete primarily on the basis of the price, availability, reliability, variety, quality of our offerings, our people, and on the quality of our customer service. Our ability to compete effectively depends on our ability to maintain high-quality services at prices generally equal to or below those charged by our competitors. Price competition in the retail services and broadband transport services markets generally has been intense and is expected to continue, although cable rates increase annually and AT&T recently raised its DSL rates.
We are not the first provider of any of our three principal bundled services in any of our markets. We compete with numerous other companies that have provided services for longer periods of time in each of our markets, and we often have to convince people to switch from other companies to Grande. Some of our competitors have significant competitive advantages over us, such as more years of experience, greater resources, significant mass marketing capabilities and broader name recognition. Our primary competitors include:
•
for video services: Time Warner Cable, Cable One Inc. (“Cable One”), Suddenlink Communications, Comcast Corporation (“Comcast”), Charter Communications Inc. (“Charter Communications”), DIRECTV Holdings LLC (“DIRECTV”), DISH Network Corporation (“DISH Network”), AT&T, Verizon and others;
•
for HSD services: AT&T, Time Warner Cable, Time Warner Telecom, Verizon, Comcast, Charter Communications, Cable One, Suddenlink Communications, CenturyTel Inc. (“CenturyTel”), Direct-PC and others;
•
for long-distance telephone services: AT&T, Verizon, Sprint, Time Warner Cable, Time Warner Telecom, Suddenlink Communications (VoIP), Vonage Holdings Corp (“Vonage”) (VoIP) and others;
•
for local telephone services: AT&T, Verizon, CenturyTel, Birch Telecom Inc. (“Birch Telecom”), Time Warner Cable, Time Warner Telecom, Suddenlink Communications (VoIP), Vonage (VoIP) and others.
Advances in communications technology as well as changes in the marketplace and the regulatory and legislative environment are constantly occurring. In certain areas of our markets, for example in Austin, we compete for local and long distance services against the VoIP offerings of Vonage and Time Warner Cable. In addition, the continuing trend toward business combinations and alliances in the telecommunications industry will create significant new competitors. As a result of these business combinations and the introduction of VoIP offerings, we anticipate that the competitive environment will become increasingly intense. In addition to terrestrial competition, we continue to see consumers choose to eliminate a second line, their long distance, and/or their primary landline and use wireless telephone service instead. This dynamic is more prevalent in younger, more transient households such as MDUs in which students or young adults tend to move every twelve to eighteen months. Advances in technology also are leading to changes in video distribution platforms, making downloadable, on-demand video content accessible in both traditional wireline and new wireless mobile viewing devices. These and other developments are requiring traditional communications providers such as us to regularly rethink the model for successfully marketing and providing video, voice and HSD content and services to consumers.
Bundled Services
We believe that, among our existing competitors, incumbent cable providers, ILECs, CLECs and satellite television providers represent our primary competitors in the delivery of a bundle of two or more video, voice and HSD services. Presently, Time Warner Cable and AT&T routinely offer a combination of two or more of these services in our markets. In some of our markets, these companies also are offering all three services. We expect the remaining ILECs and incumbent cable providers that do not yet offer more than one service to begin to offer combinations of these services in the near future, and we expect that some providers will bundle these services with a fourth product, wireless service. The introduction of bundled service offerings by our competitors could have a significant adverse impact on our ability to market our bundled services to customers, especially in areas where we currently are the only company offering bundles of these services.
•
Video. Our video service competes with the incumbent cable television provider in all of our markets except in certain private-development subdivisions and MDUs where we currently are the only cable provider. The incumbent cable providers in our markets, such as Time Warner Cable in Austin, San Antonio, Corpus Christi and Waco; Cable One in Odessa; Suddenlink Communications in Midland and Austin; and Comcast in northwest Dallas, have significantly greater resources and operating history than we do. We also compete with satellite television providers such as DIRECTV, as well as other cable television providers, broadcast television stations and wireless cable services. We face additional competition from private satellite master antenna television systems that serve condominiums, apartment and office complexes and private residential developments, and these systems generally are free of any regulation by state or local government authorities.
Legislative and regulatory developments may lead to additional competition in the cable and video market. The Cable Television Consumer Protection and Competition Act of 1992 contains provisions, which the FCC has implemented through regulations, to enhance the ability of competitors to cable to purchase and make available to consumers certain satellite-delivered cable programming at competitive costs. The Telecommunications Act of 1996 eliminated many of the restrictions on local telephone companies that offer cable programming, and we may face increased competition from such companies. Major local telephone companies such as Verizon and AT&T now provide cable television or similar video services to homes and may compete with us to the extent they modify or overbuild their networks to sell these services to the same homes we serve now or will serve in the future. AT&T, for example, has launched an Internet Protocol-based video service to some of its customers in Texas. Verizon has been overbuilding its own network and extending it into greenfield communities, which require the construction of new local loops, through a FTTH architecture (known commercially as FIOS) to enable the delivery of its cable service. Verizon already has launched its cable service in north Texas, and it currently passes approximately 3% of the homes in our service region. Verizon also offers IP-enabled video offerings.
We obtain our cable programming by entering into arrangements or contracts with cable programming suppliers. Currently, a programming supplier that delivers its programming terrestrially (as opposed to by satellite) may be able to enter into an exclusive arrangement with one of our cable competitors for the delivery of certain programming, creating a competitive disadvantage for us by restricting our access to that programming. This generally involves local and regional programming, such as news and sporting events.
Some of our competitors may purchase programming at more advantageous rates due to their size and the availability of volume discounts. We purchase a large portion of our programming using the services of a national cooperative that seeks to obtain more favorable pricing on behalf of smaller cable providers nationwide.
The FCC and Congress have adopted laws and policies that today provide, and may in the future provide, in some cases a more favorable operating environment for new and existing technologies that may compete with our various video distribution systems. These technologies today include, among others, direct broadcast satellite service in which signals are transmitted by satellite to receiving facilities located on customer premises. In the future, these technologies could include, among others, video distribution systems that provide service to mobile phones or other hand-held devices.
•
Voice. Our principal competitor for local services is the incumbent carrier in the particular market, which is AT&T in a large majority of our market areas. Incumbent carriers enjoy substantial competitive advantages arising from their historical monopoly position in the local telephone market, including pre-existing customer relationships with all or virtually all end-users. We also face competition from alternative service providers, including competitive providers and other CLECs, many of which already have established local operations in our markets. Cable service providers have also entered the voice communication market in some of our service areas. Time Warner Cable and Suddenlink Communications, for example, are offering a VoIP telephony product in their service areas, some of which overlap with ours. Other VoIP providers such as Vonage and Skype have also entered the telephony market.
We expect to continue to face significant competition for long-distance telephone services from incumbent long-distance providers such as AT&T, Verizon and Sprint, which together account for the majority of all U.S. long-distance revenues. The major long-distance service providers benefit from established market share, both in traditional direct-dial services as well as in prepaid and dial-around products, and from established trade names through nationwide advertising. We regard our long-distance service as a complementary service rather than a principal source of revenues. However, certain incumbents, including AT&T, Verizon and Sprint, also view their long-distance service in a similar way and are able to offer local services in their markets using their existing network. Additional new threats may present themselves if incumbent carriers continue to acquire or merge with other large providers of telecommunications services. The AT&T and Verizon acquisitions and others like them could provide incumbent carriers with additional, considerable competitive resources, particularly in the market for long distance, broadband transport and network services, thereby strengthening their market position and their ability to compete with us.
We also face competition in the local and long-distance telephone market from wireless carriers. We believe that the assumption that wireless telephone service is viewed primarily, although not entirely, by consumers as a supplement to, and not a replacement for, traditional wireline telephone service is under increasing pressure. Wireless service generally is more expensive than traditional telephone service and is priced on a usage-sensitive basis. However, the rate differential between wireless and traditional telephone service has begun to decline and is expected to decline further and lead to more competition between providers of wireline and wireless telephone services. Expansion of IP technology in the wireless industry will be expected to further narrow the historic price differential. Although customers generally continue to subscribe to their landline telephone service, wireless service may become an even bigger threat to the traditional telephone market as usage rates for wireless service continue to decline and “buckets” of nationwide wireless telephone minutes are offered for flat monthly rates. We also believe that younger consumers are beginning to view wireless as a substitute, rather than a supplement to terrestrial wireline services.
We also increasingly face competition from businesses, including incumbent cable providers, offering long-distance services through VoIP. These businesses could enjoy a significant cost advantage because, at this time, they generally do not pay carrier access charges although interconnect VoIP providers are now required to pay federal universal service fees. As explained more fully below under the caption “-Legislation and Regulation,” the regulatory status of VoIP service continues to be considered by the FCC, various states and reviewing courts; and while the FCC has made some preliminary determinations about VoIP already, a number of important regulatory issues have not yet been resolved fully. The conclusions reached by federal and state agencies and courts largely will determine the viability and profitability of VoIP service, and, possibly, the success of our competitors offering this service. Currently, AT&T, Time Warner Cable, Suddenlink Communications, Cable One, Comcast and Vonage each provide a VoIP offering in certain of our market areas.
•
HSD Services. The Internet access market is extremely competitive and highly fragmented. Providing broadband Internet services is a rapidly growing business and competition is increasing in each of our markets. Some of our competitors benefit from stronger name recognition and greater resources, experience and marketing capabilities. For HSD services, we compete primarily with AT&T, Time Warner Cable, Verizon, Suddenlink Communications, Cable One, Comcast, Charter Communications, CenturyTel, Direct-PC, Earthlink and STIC.NET. Other competitors include traditional dial-up Internet service providers, providers of satellite-based Internet services, other local and long-distance telephone companies and cable television companies. We also expect to compete with providers of wireless high-speed Internet access, or Wi-Fi service, principally when offered by municipal authorities or authorized third parties in a particular geographic region. New technologies, such as Access Broadband over Power Line, continue to emerge as well.
Many companies provide individuals and businesses with direct access to the Internet and a variety of supporting services. In addition, many companies such as Microsoft Corporation and AOL offer online services consisting of access to closed, proprietary information networks with services similar to those available on the Internet, in addition to direct access to the Internet. These companies generally offer broadband Internet services over telephone lines using computer modems. Some of these Internet service providers also offer high-speed integrated services using digital network connections, cable modems or DSL connections to the Internet, and their focus on delivering high-speed services is expected to increase. Cable television companies also have entered the high-speed Internet access market using cable modems and broadband facilities.
Broadband Transport Services
We have a wide range of competitors in the provisioning of broadband transport services. We generally compete with communications companies that have fiber in the markets where we have our metro and long-haul facilities.
Network Services
We have a wide range of competitors in the provisioning of network services. We compete with virtually all communications companies that own their own network equipment.
Legislation and Regulation
The cable television industry is primarily regulated by the FCC and local governments, although in Texas, Grande currently is subject only to state rather than local government franchising requirements. Telecommunications services are regulated by the FCC and state public utility commissions, including the Public Utility Commission of Texas (PUCT). Internet service, including high-speed access to the Internet, generally is not subject to significant regulation although this may change in the future. Legislative and regulatory proposals under consideration by Congress, federal agencies and the Texas legislature may materially affect the provision, cost and profitability of video, voice and HSD services. Set forth below is a brief summary of significant federal laws and regulations affecting the growth and operation of the cable television and telecommunications industries and a description of certain state and local laws.
Regulation of Cable Services
Federal Regulation of Cable Services
The FCC, the principal federal regulatory agency with jurisdiction over cable television, has promulgated regulations covering many aspects of cable television operations pursuant to federal laws governing cable television. The FCC may enforce its regulations through the imposition of fines, the issuance of cease and desist orders and/or the imposition of other administrative sanctions, such as the revocation of FCC licenses, permits and authorization. A brief summary of certain federal regulations follows.
Rate Regulation. The Cable Television Consumer Protection and Competition Act of 1992 authorized rate regulation for certain cable communications services and equipment in communities where the cable operator is not subject to effective competition. Pursuant to the Telecommunications Act of 1996, as of April 1, 1999, only the basic tier of cable television service, which does not include the expanded basic tier of cable television service, and equipment used to receive the basic tier of cable television service remain subject to rate regulation. Basic rates of operators not subject to effective competition are subject to limited regulation by local franchising authorities that choose to regulate these rates.
The Cable Television Consumer Protection and Competition Act of 1992 requires local franchising authorities that choose to regulate basic service rates to certify with the FCC before regulating such rates. The FCC’s rate regulations do not apply where a cable operator demonstrates that it is subject to effective competition. The Company meets the FCC definition of effective competition in the areas that we currently serve. To the extent that any municipality attempts to regulate our basic rates or equipment, we believe we could demonstrate to the FCC that our systems all face effective competition and, therefore, should not be subject to rate regulation. Further, in Texas, Grande’s cable service operates under a state-issued franchise and is not subject to separate regulation of rates by municipalities.
Carriage of Broadcast Television Signals. The Cable Television Consumer Protection and Competition Act of 1992 established broadcast signal carriage requirements. These requirements allow commercial television broadcast stations that are local to a cable system to elect every three years whether to require the cable system to carry the station (“must-carry”) or whether to require the cable system to negotiate for consent to carry the station (“retransmission consent”). The most recent must-carry/retransmission consent elections were made in December 2005. Stations generally are considered local to a cable system where the system is located in the station’s Nielsen designated market area. Cable systems must obtain retransmission consent for the carriage of all distant commercial broadcast stations, except for certain superstations, which are commercial satellite-delivered independent stations such as WGN. We carry some stations pursuant to retransmission consent agreements.
Local non-commercial television stations also are given mandatory carriage rights, subject to certain exceptions, within a limited radius. Non-commercial stations are not given the option to negotiate for retransmission consent.
The FCC has adopted rules for the carriage of digital broadcast signals, but has declined to adopt rules that would require cable systems to carry both the analog and digital signals of television stations entitled to must-carry rights during those stations’ transition to full digital operations. The FCC also has declined to adopt rules that would require cable television systems to carry more than a single programming stream from any particular television broadcaster that has converted to a digital format. If these decisions are modified in the future and “dual carriage” and “multicasting” requirements are adopted, we, like other cable operators, may have to discontinue or forego the opportunity to transmit other channels of programming due to the capacity of our systems. The Chairman of the FCC as well as some members of Congress have also recently stated that they believe the FCC should consider whether consumers should be permitted to purchase channels individually on an a-la-carte basis. The cable industry is strongly opposed to this suggestion. If it were adopted, it could materially and adversely impact the financial condition of all cable companies, including Grande.
As the marketplace for the programming and distribution of broadcast television evolves, so too may our rights and obligations as a provider of cable service, particularly in connection with the programming we purchase from broadcast television networks and other programmers. For instance, when the FCC consented to the purchase of DIRECTV by News Corp., the owner of the Fox television network, making News Corp. a vertically-integrated broadcast television network and nationwide multi-channel video programming distributor, the FCC did so subject to certain conditions. Some of these conditions could affect our ability to carry or purchase programming. For instance, with respect to News Corp.’s Fox television network:
•
Cable operators may submit disputes with a News Corp. broadcast television station over the terms and conditions of a retransmission consent negotiation to commercial arbitration. While the arbitration is pending, the News Corp. station may not deny its continued carriage as long as it is not a first time request for carriage. An aggrieved cable operator may seek review of an arbitrator’s decision by the FCC.
•
A cable operator with fewer than 400,000 total subscribers may appoint a bargaining agent to bargain collectively on its behalf in negotiating with News Corp.’s broadcast television stations for retransmission consent.
Nonduplication of Network Programming. Cable television systems that have 1,000 or more subscribers must, upon the appropriate request of a local television station, delete or “black out” the simultaneous or non-simultaneous network programming of a distant same-network station when the local station has contracted for such programming on an exclusive basis.
Deletion of Syndicated Programming. Cable television systems that have 1,000 or more subscribers must, upon the appropriate request of a local television station, delete or “black out” the simultaneous or non-simultaneous syndicated programming of a distant station when the local station has contracted for such programming on an exclusive basis.
Registration Procedures and Reporting Requirements. Prior to commencing operation in a particular community, all cable television systems must file a registration statement with the FCC listing the broadcast signals they will carry and certain other information. Additionally, cable operators periodically are required to file various informational reports with the FCC.
Exclusive Service Agreements with MDUs. In November 2007, the FCC issued an order prohibiting exclusive cable service arrangements between MDUs and cable providers. The order, which applies to all such agreements, existing and future, was intended to bring more choice and competitive pricing for cable services to MDU residents. AT&T and Verizon would be allowed to provide competing video service to all MDUs, if the order is upheld in the courts. Several legal actions to challenge the order have been filed, focusing primarily on the retroactive application of the prohibition to existing contracts, and resolution in the judicial system will take many months if not years. The Fifth Circuit Court of Appeals has denied a request to stay the effect of the FCC’s order pending appeal. Since Grande has exclusive cable service agreements with several MDUs, its market share in those properties could significantly drop if the order is upheld and other video/cable providers enter the properties. On the other hand, Grande is prevented from competing in even more MDU properties that have exclusive agreements with the incumbent cable provider, so it is also possible that Grande would be able to acquire additional cable subscribers in these properties if the order is upheld. The limiting factor in such a scenario would be availability of the capital required to extend Grande’s network into the MDUs and the ability to successfully compete against companies that have significant competitive advantages over us, including more years of experience, greater resources, significant mass marketing capabilities and broader name recognition.
Technical Requirements. Historically, the FCC has imposed technical standards applicable to the cable channels on which broadcast stations are carried and has prohibited franchising authorities from adopting standards which were in conflict with or more restrictive than those established by the FCC. The FCC has applied its standards to all classes of channels that carry downstream National Television System Committee video programming. The FCC also has adopted standards applicable to cable television systems, including Grande, using frequencies in certain bands in order to prevent harmful interference with aeronautical navigation and safety radio services and also has established limits on cable system signal leakage. Operators are required to conduct tests and to file with the FCC results of those cumulative leakage-testing measurements. Operators that fail to make this filing or exceed the FCC’s allowable cumulative leakage index risk being prohibited from operating in those frequency bands and risk incurring monetary fines or other sanctions.
The Cable Television Consumer Protection and Competition Act of 1992 requires the FCC to update periodically its technical standards. Pursuant to the Telecommunications Act of 1996, the FCC adopted regulations to assure compatibility among televisions, VCRs and cable systems, leaving all features, functions, protocols and other product and service options for selection through open competition in the market. The Telecommunications Act of 1996 also prohibits states or franchising authorities from prohibiting, conditioning or restricting a cable system’s use of any type of subscriber equipment or transmission technology. The FCC also has adopted technical standards in connection with cable systems’ carriage of digital television signals.
Franchise Authority. The Cable Communications Policy Act of 1984 affirmed the right of franchising authorities to award franchises within their jurisdictions and prohibited non-grandfathered cable systems from operating without a franchise in such jurisdictions. The Cable Television Consumer Protection and Competition Act of 1992 encouraged competition with existing cable systems in several areas, including by:
•
allowing municipalities to operate their own cable systems without franchises;
•
preventing franchising authorities from granting exclusive franchises or from unreasonably refusing to award additional franchises covering an existing cable system’s service area; and
•
prohibiting, with limited exceptions, the common ownership of cable systems and co-located multi-channel multipoint distribution or satellite master antenna television systems, which prohibition is limited by the Telecommunications Act of 1996 to cases in which the cable operator is not subject to effective competition.
The Telecommunications Act of 1996 exempted telecommunications services provided by a cable operator or its affiliate from cable franchise requirements, although municipalities retain authority, subject to state law, to regulate the manner in which a cable operator uses public rights-of-way to provide telecommunications services.
Franchising authorities also may not require a cable operator to provide telecommunications service or facilities, other than institutional networks, as a condition of a franchise grant, renewal, or transfer. Similarly, franchise authorities may not impose any conditions on the provision of such service.
The State of Texas passed a law in late 2005 allowing cable operators to file for a state-issued certificate of franchise authority (SICFA) for the provision of cable television and video services in any service area footprint within the state of Texas rather than negotiate with each individual municipality for such a right. On October 25, 2005, the Public Utility Commission of Texas (PUCT) approved Grande’s application for a SICFA to provide cable television service in twenty-seven municipalities and in eleven unincorporated areas of Texas. When Grande’s SICFA was approved, all of Grande’s municipal cable television franchises were terminated. Since that time, Grande has applied for and had approved amendments to the SICFA adding to and modifying the footprint of its service areas.
Under its SICFA, Grande makes quarterly franchise fee payments to the Texas Comptroller for the benefit of each municipality in which it provides cable television service in the amount of five percent of gross cable service revenues, and Grande reports its subscriber count in each municipality. In cities where the incumbent cable TV provider is still subject to a municipal franchise, the municipalities then notify Grande of its quarterly Public, Educational and Government (PEG) obligation based on Grande’s share of total subscribers multiplied by the total PEG contribution that the incumbent cable TV provider made in the quarter. In cities where the incumbent provider’s municipal franchise has expired and the incumbent has obtained a SICFA, Grande and the incumbent pay the city a PEG fee equal to one percent of their gross cable service revenues, or at the city’s option, a flat per subscriber monthly fee that was required by the city before the incumbent’s franchise expired. Grande also continues to provide free cable television service to public facilities and INet fiber connectivity to cities that were in place when the SICFA was approved. Under the SICFA, Grande continues to provide carriage of all PEG channels that were carried prior to October 25, 2005, and all municipalities retain control and police powers over their public rights of way.
Congress separately is considering legislation that would create a national framework for the issuance of cable television franchises. Various proposals for national franchises have been introduced and are pending. Although these proposals would not likely affect our operations given our regional focus, a national franchise law could enable our competitors, principally AT&T and Verizon, who are planning to deploy cable television or other video services in multiple jurisdictions within their large service areas, to enter the market for video services more quickly, much like they can today in Texas under their SICFA. This, in turn, could enhance their ability to compete against us in our markets.
Franchise Transfer. The Telecommunications Act of 1996 repealed most of the anti-trafficking restrictions imposed by the Cable Television Consumer Protection and Competition Act of 1992, which prevented a cable operator from selling or transferring ownership of a cable system within 36 months of acquisition. However, a local franchise nevertheless may require the prior approval of the franchising authority for a transfer or sale. The Cable Television Consumer Protection and Competition Act of 1992 requires franchising authorities to act on a franchise transfer request within 120 days after receipt of all information required by FCC regulations and the franchising authority. Approval is deemed granted if the franchising authority fails to act within such period. It is uncertain at this time whether any of the national franchising proposals being considered in Congress would affect such franchise transfer issues.
Program Access and Exclusivity. The Cable Television Consumer Protection and Competition Act of 1992 and the FCC’s rules generally prohibit cable operators and vertically-integrated satellite programmers from entering into agreements that have the purpose or effect of preventing or substantially hindering the ability of multi-channel video programming distributors from providing satellite programming to their subscribers. The rules specifically prohibit vertically integrated cable operators from entering into exclusive distribution agreements with satellite programmers in which they have an attributable interest. The rules were set to expire in October 2007, but were extended by the FCC to October 2012.
The program access rules currently do not restrict a vertically integrated cable operator from offering terrestrially delivered programming on an exclusive basis. If vertically integrated competitors obtain exclusive programming agreements, they may gain competitive advantages that adversely affect the ability to grow our business.
The FCC’s Order consenting to the DIRECTV-News Corp. merger prohibits News Corp. from offering any existing or future national and regional programming services on an exclusive or discriminatory basis. News Corp. also is prohibited from unduly or improperly influencing any of its affiliated programming services in the sale of programming to unaffiliated cable operators. Additionally, as noted above, News Corp. is subject to certain conditions regarding its ownership of numerous regional sports programming networks.
Channel Set-Asides. The Cable Communications Policy Act of 1984 permits local franchising authorities to require cable operators to set aside certain channels for PEG access programming. It also requires cable television systems with 36 or more activated channels to designate a portion of their channel capacity for commercial leased access by unaffiliated third parties. The Cable Television Consumer Protection and Competition Act of 1992 requires leased access rates to be set according to a FCC-prescribed formula.
Ownership. The Telecommunications Act of 1996 eliminated the Cable Communications Policy Act of 1984’s general prohibition on the provision of video programming by local exchange carriers to customers within their local exchange telephone service areas. Under the Telecommunications Act of 1996, local exchange carriers may, subject to certain restrictions described below, provide video programming by radio-based systems, common carrier systems, open video systems, or cable systems, subject to regulations applicable to each type of service. Technological developments are expected to enable local exchange carriers to provide video programming over broadband connections to the Internet as well. The degree to which such carriers must comply with the rules governing cable systems, including franchising requirements, has not yet been addressed by regulators.
The Telecommunications Act of 1996 prohibits a local telephone company or its affiliate from acquiring more than a 10% financial or management interest in any cable operator providing cable television service in its telephone service area. It also prohibits a cable operator or its affiliate from acquiring more than a 10% financial or management interest in any local telephone company providing telephone service in its franchise area. A local telephone company and cable operator whose telephone service area and cable franchise area are in the same market may not enter into a joint venture to provide telecommunications services or video programming. There are exceptions to these limitations for rural facilities, very small cable systems and small local telephone companies in non-urban areas, and such restrictions do not apply to local exchange carriers that were not providing local telephone service prior to January 1, 1993.
Internet Access via Cable Modem. The FCC has determined in the Cable Modem Access NOPR that cable modem service is an information service and thus is not subject to local regulation as a cable service and thus is not subject to the payment of franchise fees. This regulatory classification has been upheld by the Supreme Court.
Pole Attachments. The Telecommunications Act of 1996 requires utilities, defined to include all local exchange telephone companies and public utilities except those owned by municipalities and co-ops, to provide cable operators and telecommunications carriers with nondiscriminatory access to poles, ducts, conduit and rights-of-way. The right to mandatory access is beneficial to facilities-based providers such as Grande. The Telecommunications Act of 1996 also establishes principles to govern the pricing of such access. Telecommunications providers are charged a higher rate than cable operators for pole attachments. Companies that provide both cable and telecommunications services over the same facilities, such as us, may be required to pay the higher telecommunications rate; but the Supreme Court has confirmed that commingling high-speed Internet access with cable or telecommunications attachments does not change the pole attachment rate. At this time, we believe the rental rate at which utility pole owners can charge cable operators offering VoIP services is unclear.
Inside Wiring of Multiple Dwelling Units. The FCC has adopted rules to promote competition among multichannel video program distributors in multiple family dwelling units, or MDUs. The rules provide generally that, in cases where the program distributor owns the wiring inside an MDU but has no right of access to the premises, the MDU owner may give the program distributor notice that it intends to permit another program distributor to provide service there. The program distributor then must elect whether to remove the inside wiring, sell the inside wiring to the MDU owner at a price not to exceed the replacement cost of the wire on a per-foot basis or abandon the inside wiring.
Privacy. The Cable Communications Policy Act of 1984 imposes a number of restrictions on the manner in which cable system operators can collect and disclose data about individual system customers. The statute also requires that the system operator periodically provide all customers with written information about its policies regarding the collection and handling of data about customers, their privacy rights under federal law and their enforcement rights. In the event that a cable operator is found to have violated the customer privacy provisions of the Cable Communications Policy Act of 1984, it could be required to pay damages, attorneys’ fees and other costs. Under the Cable Television Consumer Protection and Competition Act of 1992, the privacy requirements were strengthened to require that cable operators take such actions as are necessary to prevent unauthorized access to personally identifiable information. Congress and the FCC are considering, and in the future may again consider, additional restrictions intended to safeguard consumer privacy. The extent to which these laws and regulations, if promulgated, will affect our cable television operations is not clear at this time.
Copyright. Cable television systems are subject to federal compulsory copyright licensing covering carriage of broadcast signals. In exchange for making semi-annual payments to a federal copyright royalty pool and meeting certain other obligations, cable operators obtain a statutory license to retransmit broadcast signals. The amount of the royalty payment varies, depending on the amount of system revenues from certain sources, the number of distant signals carried and the location of the cable system with respect to over-the-air television stations. Adjustments in copyright royalty rates are made through an arbitration process supervised by the U.S. Copyright Office.
Various bills have been introduced in Congress in the past several years that would eliminate or modify the cable television compulsory license. Without the compulsory license, cable operators might need to negotiate rights from the copyright owners for each program carried on each broadcast station retransmitted by the cable system.
Internet Service Providers. A number of Internet service providers have requested that the FCC and state and local officials adopt rules requiring cable operators to provide unaffiliated Internet service providers with direct access to the operators’ broadband facilities on the same terms as the operator makes those facilities available to affiliated Internet service providers. To date, the FCC has rejected these equal access proposals, but a number of local franchising authorities outside our service territory have in the past sought to impose this type of requirement on cable operators and may try to do so again in the future. Some cable operators, including Grande, have agreed to open their systems to competing Internet service providers or have been required to do so as a condition of a merger. The FCC has more recently indicated that such requirements may no longer be necessary so long as consumers are able to have unrestricted access to alternative providers once the consumer accesses the Internet.
Regulatory Fees and Other Matters. The FCC requires payment of annual regulatory fees by the various industries it regulates, including the cable television industry. Fees are also assessed for other FCC licenses often used by cable television operators, including licenses for business radio, cable television relay systems and earth stations.
FCC regulations also address:
•
political advertising;
•
local sports programming;
•
restrictions on origination and cablecasting by cable system operators;
•
application of the rules governing political broadcasts;
•
customer service standards;
•
limitations on advertising contained in non-broadcast children’s programming; and
•
closed captioning.
Regulation of Telecommunications Services
Our telecommunications services are subject to varying degrees of federal, state and local regulation. Pursuant to the Communications Act of 1934, as amended by the Telecommunications Act of 1996, the FCC generally exercises jurisdiction over the facilities of, and the services offered by, telecommunications carriers that provide interstate or international communications services. State regulatory authorities generally retain jurisdiction over the same facilities and other services to the extent that they are used to provide intrastate and local communications services.
Federal Regulation of Telecommunications Services
Tariffs and Licensing. The Company is classified as a non-dominant long distance carrier and as a competitive local exchange carrier by the FCC. The FCC requires non-dominant long distance companies to detariff interstate long distance domestic and international services. The FCC also permits competitive local exchange carriers to either (1) detariff the interstate access services that they sell to long distance companies or (2) maintain tariffs but comply with certain rate caps. Prior to detariffing, we filed tariffs with the FCC to govern our relationship with most long-distance customers and companies. The detariffing process requires us to, among other things, post the rates, terms, and conditions formerly in our tariffs on our website instead of filing them at the FCC. Because detariffing precludes us from filing our tariffs at the FCC, we may no longer be subject to the “filed rate doctrine,” which stands for the proposition that the tariff controls all contractual disputes between a carrier and its customers. This may expose us to certain legal liabilities and costs as we can no longer rely on this doctrine to settle disputes with customers. The FCC still requires companies such as us to obtain licenses under Section 214 of the Communications Act of 1934, as amended, to provide international long-distance calling service. We hold such international authority from the FCC.
Interconnection. The Telecommunications Act of 1996 establishes local telephone competition as a national policy. This Act preempts laws that prohibit competition for local telephone services and establishes uniform requirements and standards for local network interconnection, unbundling and resale. Interconnection, unbundling and resale standards were developed initially by the FCC and have been, and will continue to be, implemented by both the FCC and the states in numerous proceedings.
In August 1996, the FCC adopted a wide-ranging decision regarding the interconnection obligations of local telephone carriers. This Interconnection Order specified, among other things, which network elements (and combinations of elements) incumbent carriers must unbundle and provide to competitive carriers on a nondiscriminatory basis. The FCC’s initial list of network elements and combinations was affirmed by the Supreme Court, but has since been subject to further review by the FCC and, after several rounds of review by the courts, has been pared significantly. In June 2006, the D.C. Circuit approved the FCC’s fourth attempt to implement the unbundling provisions of the Telecommunications Act of 1996. Changes to the list of network elements and combinations have had, and may continue to have, a significant impact on the industry and, to a lesser extent, the Company.
The FCC’s Interconnection Order also established pricing principles, for use by the states, to determine rates for unbundled network elements and discounts. These pricing principles also are undergoing further review by the FCC and may change, which could have a significant impact on the industry and on the Company.
The Telecommunications Act of 1996 requires incumbent local telephone carriers to enter into mutual compensation arrangements with other local telephone companies for transport and termination of local calls on each other’s networks. In the past, most state public utility commissions ruled that traffic to Internet service providers is covered by this requirement. Thus, carriers that counted traffic-generating Internet service providers as customers benefited from such reciprocal compensation arrangements. In April 2001, the FCC changed the compensation mechanism for traffic exchanged between telecommunications carriers that is destined for Internet service providers. In doing so, the FCC prescribed a new rate structure for such traffic and prescribed gradually reduced caps for its compensation. In October 2004, the FCC adopted an order that forbears from enforcing certain portions of its 2001 ISP-Bound Traffic Order. Under the 2001 order, the amount of ISP-bound traffic eligible for compensation was capped at 120% of eligible traffic for the first quarter of 2001 annualized; and no compensation for ISP-bound traffic was permitted for new markets entered after April 2001. The FCC has now determined that it is no longer in the public interest to apply these rules. Reciprocal compensation revenue is an element of data services revenue, and the FCC order impacted us negatively, causing a decrease in revenue beginning in the latter half of 2005. There are several open issues related to reciprocal compensation, and there is a potential that this revenue stream could further decrease based on future FCC rulings.
The FCC launched a new proceeding intended to examine comprehensively the “intercarrier compensation” rates paid among carriers for exchanging various categories of traffic, including but not limited to local calls. Several proposals for how the FCC’s intercarrier compensation rules should be structured also have been submitted to the FCC by industry groups and coalitions. We cannot predict how the FCC will act in response to these proposals, or, more generally, in connection with its intercarrier compensation proceeding. FCC rulings in this area will affect a large number of carriers and could have a significant impact on the industry and the Company.
The FCC has also initiated an investigation of IP-Enabled Services intended to provide comprehensive guidance on the appropriate regulatory treatment of a broad array of services, including VoIP. The outcome of both the Intercarrier Compensation and IP-Enabled Service dockets could have a material impact on our business. We are not able to predict what that outcome may be or when such orders might be issued.
Additional Requirements. The FCC imposes additional obligations on all telecommunications carriers, including obligations to:
•
interconnect with other carriers and not to install equipment that cannot be connected with the facilities of other carriers;
•
ensure that their services are accessible and usable by persons with disabilities;
•
comply with verification procedures in connection with changing a customer’s carrier;
•
pay annual regulatory fees to the FCC; and
•
contribute to the Telecommunications Relay Services Fund, as well as funds to support universal service, telephone numbering administration and local number portability.
Forbearance. The Telecommunications Act of 1996 permits the FCC to forbear from requiring telecommunications carriers to comply with certain regulations. Specifically, the Act permits the FCC to forbear from applying statutory provisions or regulations if the FCC determines that:
•
enforcement is not necessary to protect consumers;
•
a carrier’s terms are reasonable and nondiscriminatory;
•
forbearance is in the public interest; and
•
forbearance will promote competition.
The FCC has exempted certain carriers from reporting requirements pursuant to this provision of the Telecommunications Act of 1996. The FCC may take similar action in the future to reduce or eliminate other requirements. Such actions could free us from regulatory burdens but also might increase the pricing and general flexibility of our competitors.
Collocation. The FCC has adopted rules designed to improve competitor access to incumbent local telephone carriers’ collocation space and to reduce the delays and costs associated with collocation, but we cannot be sure that these rules will not change or otherwise inure to the advantage of incumbent carriers in the future.
Multiunit Premise Access. In June 2007, the FCC released an order clarifying that incumbent local exchange carriers are required to provide direct access at the terminal block to permit a competitor’s technician to cross connect in order to access the incumbent’s sub-loop to reach end user customers at multiunit premises. The ruling is based on an incumbent local exchange carriers’ statutory obligation to permit interconnection at “any technically feasible point.” As a result of this clarification, Grande may have opportunities to access multiunit premises in a more direct and less costly manner assuming capital is available to extend its network facilities to reach the minimum point of entry at these properties. The FCC recently issued an order prohibiting exclusive telecommunications contracts in residential multi-tenant environments and prohibiting enforcement of pre-existing agreements between carriers and building owners. This decision will have no impact on Grande because Texas PUC regulations already prohibited such exclusive arrangements.
Broadband Services. Section 706 of the Telecommunications Act of 1996 requires the FCC to encourage the deployment of advanced telecommunications capabilities to all Americans through the promotion of local telecommunications competition. The FCC had in the past taken steps to facilitate competitors’ access to lines connecting customer premises to the operator for purposes of digital subscriber line deployment. But the FCC more recently has declined to take similar steps in connection with more advanced, newly constructed transmission facilities such as fiber-to-the-home. In the TRRO proceeding, the FCC held that incumbent local exchange carriers such as AT&T need not make available to unaffiliated carriers access to most high-capacity local loops and transport facilities; and the FCC has more recently determined that facilities-based wireline broadband services such as DSL are “information services” and thus are subject to minimal regulation. Separately, Congress has periodically considered initiatives proposing to deregulate the advanced services offerings of incumbent carriers. If one of these initiatives becomes law, or if the FCC’s rulings are upheld on appeal, the use of incumbent carrier facilities for the deployment of competing high-capacity services by carriers such as Grande may be adversely affected. This, however, is not a material part of our business since we typically provide these services over our own network. Relying upon definitions in the Communications Assistance for Law Enforcement Act (CALEA) rather than the Telecommunications Act of 1996, the FCC now requires broadband networks to cooperate with law enforcement as required by CALEA.
Voice-over-Internet Protocol. VoIP is an application that manages the delivery of voice information across data networks, including the Internet, using Internet Protocol. VoIP sends voice information in digital form using discrete packets that are routed in the same manner as data packets. VoIP is widely viewed as a more cost-effective, feature-rich alternative to traditional circuit-switched telephone service. Because VoIP can be deployed by carriers in various capacities, and because it is widely considered a next-generation communication service, its regulatory classification-and, thus, its long-term revenue potential-is unclear. Several petitions seeking guidance on the regulatory classification of VoIP service have been filed at the FCC, and the FCC has resolved only a few of them, either through the issuance of narrowly-tailored declaratory rulings or through broader regulatory pronouncements, depending on the issue.
In one case, the FCC held that a computer-to-computer VoIP application provided by Pulver.com is an unregulated information service, in part because it does not include a transmission component, offers computing capabilities, and is free to its users. In another case, the FCC reached a different conclusion, holding that AT&T’s use of VoIP to transmit the long-haul portion of certain calls constitutes a telecommunications service, thus subjecting it to regulation, because the calls use ordinary customer premises equipment with no enhanced functionality, originate and terminate on the public switched telephone network, and undergo no net protocol conversion and provide no enhanced functionality to end users. In a third case, the FCC ruled that certain prepaid calling card services are telecommunications services rather than information services. An earlier case, which involved the VoIP application of Vonage, the FCC preempted the authority of the State of Minnesota (and presumably all other states) and ruled that Vonage’s VoIP application, and others like it, was an interstate service subject only to Federal regulation, thus preempting the authority of the Minnesota commission to require Vonage to obtain state certification. The FCC, however, refused to speak beyond prior rulings involving enhanced services as to whether Vonage’s VoIP application is a telecommunications service or an information service, thus leaving open the question of the extent to which the service might be regulated. The Eighth Circuit Court of Appeals in March 2007 denied several petitions seeking review of the FCC’s decision to classify Vonage’s VoIP application as interstate rather than intrastate in nature.
On a broader level, the FCC has held that providers of interconnected VoIP service must provide law enforcement officials with access to their networks pursuant to CALEA and, separately, that providers of interconnected VoIP service also must comply with specific E-911 and other requirements to enable their customers to access public safety officials. The FCC has also ruled as noted above that interconnected VoIP providers must contribute to the federal universal service fund.
The FCC separately has initiated a more generic proceeding, the IP-Enabled Services NOPR to address the many other regulatory issues raised by the development and growth of IP services, including VoIP service and also including the extent to which the governance of VoIP will reside at the Federal level. The FCC has expressly reserved the right to reconsider some of its earlier rulings in the generic proceeding.
Grande filed its own petition at the FCC seeking a declaratory ruling regarding the proper treatment of traffic terminated to end users of interconnected ILECs through CLECs like Grande, which traffic wholesale customers of Grande have certified as originating in VoIP format. The petition asks the FCC to rule that a CLEC properly may rely on its customer’s self-certification; that the ILECs, receiving certified traffic over local interconnection trunks from the CLEC, are to treat the traffic as local traffic for intercarrier compensation purposes and may not assess access charges against certified traffic unless the Commission decides otherwise in the IP-Enabled Services or Intercarrier Compensation Rulemakings or in another proceeding. This petition is still pending, and we cannot predict how or when it might be decided. In addition, two forbearance petitions relating to the treatment of VoIP traffic for purposes of intercarrier compensation were filed in 2007 by other companies. These petitions are pending and we cannot predict how or when they might be decided. Future rulings in connection with VoIP likely will have a significant impact on us, our competitors and the communications industry.
Consumer Privacy. The Communications Act and the FCC’s rules specify the circumstances under which carriers can share consumer call data, or Customer Proprietary Network Information (CPNI), with their affiliates and unrelated third parties. Congress and the FCC are in the process of reviewing these rules and may adopt further restrictions to further prevent the disclosure of CPNI and related information by carriers. This could affect our ability, and the ability of our competitors, to market services.
State Regulation of Telecommunications Services
Traditionally, states have exercised jurisdiction over intrastate telecommunications services, and the Telecommunications Act of 1996 largely upholds that traditional state authority. The Telecommunications Act of 1996 does place limits on state authority to the extent necessary to advance competition in the telecommunications industry; for example, the statute contains provisions that prohibit states and localities from adopting or imposing any legal requirement that may prohibit, or have the effect of prohibiting, market entry by new providers of interstate or intrastate telecommunications services. The FCC is required to preempt any such state or local requirement to the extent necessary to enforce the Telecommunications Act of 1996’s open market entry requirements. States and localities may, however, continue to regulate the provision of intrastate telecommunications services and require carriers to obtain certificates or licenses before providing service.
We are certified as a CLEC in Arkansas, Florida, Georgia, Indiana, Oklahoma and Texas and as an interexchange service provider (IXC) in Arkansas, Florida, Georgia, Indiana, North Carolina, Oklahoma, Washington and Texas. If we expand to provide similar telecommunications services in new states, we will likely be required to obtain certificates of authority to operate and be subject to ongoing regulatory requirements in those states as well.
Although we are authorized to provide telecommunications services in several states, the majority of our telecommunications end user customers are located in Texas. Since 1995, Texas law has provided a regulatory framework for competitive carriers such as us to provide telecommunications services in the State. A major revision to the State’s telecommunications law was adopted by the Texas Legislature in 2005. These amendments to PURA require the PUCT to deregulate markets that meet certain standards and to consider deregulating certain other markets. The PUCT was also directed to undertake several important studies including whether Universal Service Funds should be continued or whether the program should be changed. The amendments also included additional competitive market safeguards. Like the Federal Telecommunications Act of 1996, Texas law is intended to promote competition in the local exchange market, as well as in the intrastate interexchange market. The PUCT is responsible for an evolving regulation of these markets, and the PUCT plays a key role in promulgating rules and policies and by arbitrating interconnection agreements between carriers in the local market. For example, the PUCT has adopted substantive rules that permit any competing carrier to install its own telecommunications equipment at an MDU or commercial property in order to provide telecommunications services to a requesting tenant. The PUCT also has adopted substantive rules prohibiting exclusive arrangements to provide telecommunications services at multiple dwelling units (MDUs) and at commercial properties. The rules, policies and decisions of the PUCT are influenced by a variety of factors, and future regulatory and legislative developments in the State could have a significant impact on us.
Among the PUCT’s regulatory responsibilities is the review of AT&T’s performance in its provision of wholesale telecommunications services to competitive carriers such as us through a comprehensive set of performance measurements and a performance remedy plan. This performance remedy plan is in the interconnection agreement between Grande and AT&T and requires AT&T to pay certain fines when it fails to meet its prescribed performance benchmarks. Although the performance remedy plan is intended to provide AT&T with incentive to provide timely wholesale service to competitive carriers on a nondiscriminatory basis, AT&T holds considerable market power in Texas and may be able to use that market power to the detriment of the competitive telecommunications market, and, in turn, carriers such as us.
Telecommunications carriers in Texas are subject to numerous state policies, the application of which could affect our business. These policies include, but are not limited to, the Texas Universal Service Fund, broadband initiatives such as the state’s DSL and advanced services in rural areas initiatives, and the Texas Infrastructure Fund, the fee for which was originally intended to promote the deployment of equipment and infrastructure for distance learning library information sharing programs and telemedicine services. Telecommunications carriers also are subject to various consumer protection regulations, such as prohibitions relating to slamming (changing an end user’s service provider without appropriate authorization), cramming (adding charges to an end user’s account without appropriate authorization) and telemarketing. All carriers are required to comply with a Code of Conduct for marketing, which has been adopted by the PUCT. Grande must comply with these and other regulations or risk significant fines and penalties.
SB 5 also contained an amendment to PURA, which requires municipally-owned utilities, which are exempt from the federal pole attachment laws, to equalize pole attachment fees as between telecom and cable service providers. This is intended to eliminate any artificial competitive advantage that might arise from the nature of the wires platform. This is a significant benefit to Grande since Grande’s two largest markets are served by municipally-owned utilities.
Texas has long been involved in both federal and state initiatives relating to homeland security, defense and disaster recovery. These initiatives sometimes require telecommunications carriers to, among other things, maintain certain network security procedures and monitoring systems. The growing emphasis on homeland security at the federal and state level and the recent experience with hurricane disasters on the Gulf Coast may cause us to incur unforeseen expenses relating to the security and protection of telecommunications networks.
Local Regulation
Occasionally, we are required to obtain street use and construction permits to install and expand our interactive broadband network using state, city, county or municipal rights-of-way. The Telecommunications Act of 1996 and recently adopted Chapter 66 of PURA require municipalities to manage public rights-of-way in a competitively neutral and non-discriminatory manner.
Employees
As of December 31, 2007, we had 831 full-time employees, other than temporary employees. None of our employees are subject to collective bargaining agreements. We believe that our relations with our employees are good.
WHERE YOU CAN FIND MORE INFORMATION
We file annual, quarterly and special reports, and other information with the SEC, in accordance with the Exchange Act. You may read and copy any document we file with the SEC at the following public reference room:
Public Reference Room
100 F Street, N.E.
Room
Washington, D.C. 20549
1-800-SEC-0330
Please call the SEC at 1-800-SEC-0330 for further information about the public reference room. Our reports and other information filed with the SEC are also available to the public over the Internet at the SEC’s world wide web site at http://www.sec.gov.
ITEM 1A.
ITEM 1A.
RISK FACTORS
RISKS RELATING TO OUR BUSINESS
We have a history of net losses and may not be profitable in the future.
As of December 31, 2007, we had an accumulated deficit of $440.8 million. We expect to continue to incur net losses in the future. Our ability to generate profits and positive cash flow from operating activities will depend in large part on our ability to increase our revenues to offset the costs of operating our network and providing services. If we cannot achieve operating profitability or positive cash flow from operating activities, our business, financial condition and operating results will be adversely affected.
We may require additional funding to cover the costs to grow the business or to cover shortfalls or unforeseen changes, for which funding may not be available.
When we expand our networks within our existing markets, introduce new products or services or enter new markets, we project the capital expenditures that will be required based in part on the amount of time necessary to complete the construction of the networks or the introduction of the services and the difficulty of such projects. We may need more funds to cover the costs associated with delays or difficulties in connection with the build-out, maintenance or technical upgrades of our networks or for other unanticipated reasons. Such financing, if necessary, may not be available on favorable terms or at all. If we cannot obtain additional funds when needed or if cash flow from operations is less than expected, our business and financial condition may be adversely affected.
Changes in demand for our services could harm our business.
We could be affected by changes in demand for the services we provide in our markets. Our plan could be unsuccessful due to:
•
competition, especially from incumbent telephone and cable providers, which offer bundled services and from new technologies such as VoIP service;
•
pricing;
•
regulatory uncertainties;
•
downturns in economic conditions in our markets;
•
operating and technical difficulties; or
•
unsuccessful sales and marketing.
Any downturn in demand for our services will harm our business and our prospects for growth and profitability.
Competition from other cable television, telephone and broadband Internet service providers could have an adverse effect on our growth and revenues.
We are not the first provider of any of our three principal bundled services in any of our markets. We compete with numerous other companies that have long-standing customer relationships with the residents in these markets, and we typically have to convince people to switch from other companies to Grande. Some of our competitors have significant competitive advantages over us, including greater experience, resources, marketing capabilities and name recognition.
•
for video services: Time Warner Cable, Cable One, Suddenlink Communications, Comcast, Charter Communications, DIRECTV, EchoStar Communications (DISH Network), AT&T, Verizon and others;
•
for HSD services: AT&T, Time Warner Cable, Time Warner Telecom, Verizon, Comcast, Charter Communications, Cable One, Suddenlink Communications, CenturyTel, Direct-PC and others;
•
for long-distance telephone services: AT&T, Verizon, Sprint, Time Warner Cable, Time Warner Telecom, Suddenlink Communications (VoIP), Vonage (VoIP) and others;
•
for local telephone services: AT&T, Verizon, CenturyTel, Birch Telecom, Time Warner Cable, Time Warner Telecom, Suddenlink Communications (VoIP), Vonage (VoIP) and others.
As the incumbent local telephone company, and a major provider of long-distance telephone services, AT&T is a particularly strong competitor in telephone and data services and competes for video services as well. With respect to cable television services, Time Warner Cable is the incumbent provider in the majority of our markets. Several of these competitors offer more than one service, such as telephone companies and cable providers offering broadband Internet services. A few have begun to offer all three services; in particular, Time Warner Cable and other cable operators have begun providing digital phone services through VoIP technology. We expect AT&T and Verizon, which are upgrading their networks and providing video services, to be able to provide all three services as well and each also control a nationwide wireless service provider. We can expect that competition at MDUs also will increase if the FCC’s November 2007 order prohibiting exclusive cable service arrangements between MDUs and cable providers is upheld in the courts. We also compete with wireless telephone carriers for both local and long distance services. Many of our competitors are larger than we are, and we anticipate that the trend toward business combinations and alliances in the telecommunications industry will continue, making some of our competitors even larger. We expect these business combinations and the level of competition to continue to increase in the future. If we fail to compete successfully in our markets and grow our customer base, our business and financial condition will be harmed.
Restrictive covenants under our indebtedness may limit our ability to grow and operate our business.
The indenture governing our 14% senior secured notes due April 1, 2011 (“senior notes”), by and between Grande and U.S. Bank National Association, as Indenture Trustee, dated March 23, 2004, contains, among other things, covenants imposing significant financial and operating restrictions on our business. These restrictions may affect our ability to manage and operate our business, may limit our ability to take advantage of potential business opportunities as they arise and may adversely affect the conduct or management of our current business. These restrictions limit our ability to, among other things:
•
incur additional indebtedness, issue disqualified capital stock (as defined in the Indenture) and, in the case of our restricted subsidiaries, issue preferred stock;
•
create liens on our assets;
•
pay dividends on, redeem or repurchase our capital stock or make other restricted payments;
•
make investments in other companies;
•
enter into transactions with affiliates;
•
enter into sale and leaseback transactions;
•
sell or make dispositions of assets;
•
place restrictions on the ability of our restricted subsidiaries to pay dividends or make other payments to us;
•
engage in certain business activities;
•
merge or consolidate with other entities; and
•
spend growth capital in the event our cash falls below $20 million.
These limitations may affect our ability to finance our future operations or to engage in other business activities that may be in our best interest. Also, since we are a holding company with no assets other than our ownership of our subsidiary, we will be dependent on the receipt of funds from our subsidiary to pay the interest and principal on the senior notes, and these limitations could adversely affect our ability to make such payment on the senior notes.
The amount of debt we have could harm our business.
As of December 31, 2007, we had approximately $208.7 million of indebtedness and capital lease obligations outstanding, including the carrying value of our senior notes of $188.0 million, all of which was secured. Further, the Indenture allows us to incur additional indebtedness under certain circumstances. Our significant indebtedness could adversely affect our business in a number of ways, including the risks that:
•
we will use a substantial portion of our cash flow from operations to pay principal and interest on our debt, thereby reducing the funds available for acquisitions, working capital, capital expenditures and other general corporate purposes;
•
our degree of leverage may limit our ability to obtain additional capital, through equity offerings or debt financings, for working capital expenditures or refinancing of indebtedness;
•
our degree of leverage limits our ability to withstand competitive pressure and reduces our flexibility in responding to changes in business and economic conditions; and
•
our degree of leverage may hinder our ability to adjust rapidly to changing market conditions and could make us more vulnerable to downturns in the economy or in our industry.
If we cannot generate sufficient cash flow from operations to meet our obligations, we may be forced to reduce or delay capital expenditures, sell assets, restructure our debt, or seek additional equity capital. We cannot assure you that these remedies would be available or satisfactory. Our cash flow from operations will be affected by prevailing economic conditions, financial, business and other factors, which may be beyond our control.
The costs associated with the provision of our services may increase and we may not be able to pass any cost increases on to our customers.
In recent years, the cable industry has experienced increases in the cost of programming, which is one of the most significant costs of operating a cable system, and we expect these increases to continue. Because we have a relatively small base of subscribers, we cannot obtain programming costs comparable to those of the larger cable providers with which we compete despite using the services of a national cooperative that seeks to obtain better pricing on behalf of smaller cable providers nationwide. We may also see increases over time in other costs, such as the fees we pay utility companies for space on their utility poles. If we are unable to pass any programming or other cost increases on to our customers, our results of operations could be adversely affected.
Future technologies and capital deployment from competitors may hurt our business or increase our cost of operations.
The development of future technologies may result in new competition in one or more of the services we offer. Other developments may give our competitors a cost advantage or other features we cannot readily match, or require us to make expensive and time-consuming upgrades to our networks to remain competitive. In addition, we may select one technology or one technology provider over another, while our competitors may select different technologies or providers. If we do not choose the technology that turns out to be the most efficient, economic or appealing to customers, our business could be adversely affected.
Failure to maintain existing state cable television franchises could adversely affect our ability to grow our business.
We provide video service over our networks generally pursuant to a statewide cable franchise in Texas. Our ability to grow our business depends on the terms of our cable franchise, including payment obligations. Litigation over the constitutionality of the Texas statewide franchise law is pending. In early September 2005, the Texas Cable and Telecommunications Association, or TCTA, filed a lawsuit in U.S. District Court, Western District of Texas, Austin division, to challenge the legislation passed allowing for a state cable franchise and implementing a transition process to end the need for individual municipal franchises. The lawsuit contends that the new state law discriminates against incumbent cable operators in violation of the U.S. and Texas Constitutions, discriminates against incumbent cable operators in violation of the Federal Communications Act, violates the federal prohibition on exclusive franchises, and violates the Cable Act prohibition against redlining. In September 2006, U.S. Federal District Judge Yeakel dismissed TCTA’s complaint against the PUC commissioners and the governor, without prejudice. TCTA subsequently filed an appeal of the dismissal in the Fifth Circuit Court of Appeals. The Fifth Circuit granted the appeal, overturned the dismissal of TCTA’s challenge and remanded the case to the district court for further proceedings. Both AT&T and Verizon filed petitions for rehearing, which remain pending at the Fifth Circuit Court of Appeals. We cannot predict the outcome of the litigation. Several outcomes are possible which could raise various levels of uncertainty about the nature of franchise authority. Certain outcomes could harm our business.
Our cable franchises are required by federal law to be non-exclusive. Our market areas currently are served by at least one incumbent provider. In addition, under federal law, municipal entities can operate cable television systems without franchises. New competitors in our existing markets or changes to franchise terms could adversely affect our business and financial condition.
If we are not able to manage our growth, our business will be harmed.
Our ability to grow will depend, in part, upon our ability to:
•
successfully implement our strategy for offering bundled broadband services;
•
construct network facilities;
•
market our services;
•
obtain and maintain on favorable terms any required government authorizations and interconnection agreements;
•
secure any needed financing; and
•
hire and retain qualified personnel.
In addition, as we increase our service offerings and expand within our targeted markets, we will have additional demands on our customer support, sales and marketing, administrative resources and network infrastructure. If we cannot effectively manage our growth, our business and results of operations will be harmed.
Our business could be hurt in the event of a network outage.
Our success depends on the efficient and uninterrupted operation of our communications services. Our networks are attached to poles and other structures in our service areas. A natural disaster, including tornado, hurricane, flood or other natural catastrophe, or things unforeseen as our network gets older in one of these areas could damage our networks, interrupt our service and harm our business in the affected area.
We could be hurt by future regulation of our industry.
Legislation and implementing regulations in the telecommunications and cable areas continue to be quite complex, and regulation of carrier and Internet services may increase. Future actions by the United States Congress, the FCC, the Federal Trade Commission, state legislatures, state utility commissions, local municipalities and other regulators may adversely impact our business. For example, if a regulation or interpretative ruling increases the costs associated with a particular service, such as an increase in the cost of terminating telecommunications traffic, our business may be adversely impacted. Additionally, if the FCC order prohibiting exclusive cable service arrangements between MDUs and cable providers were upheld in the courts, our competitors, some of who have significant competitive advantages over us, would be allowed to provide competing video service to all MDUs.
Expanding into additional markets, either through internal growth or acquisitions, will require additional funding and numerous approvals.
Although currently we do not intend to enter any new markets, we may expand into other attractive markets if the right opportunities arise. However, expansion into additional markets will require significant additional capital, as well as numerous authorizations and approvals, which could include franchises, construction permits, pole attachment agreements, interconnection agreements and others. Expansion markets may not have the same economics or operating metrics as we have experienced in our existing markets, and may involve more difficult competitive situations or other hurdles.
RISKS RELATING TO OUR SENIOR NOTES
Rights of holders of the senior notes in the collateral may be adversely affected by the failure to create or perfect security interests in certain collateral on a timely basis or at all, or by the failure of our existing subsidiary or any future subsidiary guarantors to guarantee the senior notes.
We have agreed to secure the senior notes and the guarantees by granting first priority liens on substantially all of our property and our existing subsidiary’s and any future subsidiary guarantor’s property, subject to certain exceptions, and to take other steps to assist in perfecting the security interests granted in the collateral. Certain property will be excluded from the collateral secured for the benefit of the noteholders.
Not all of the security interests in the collateral attached on the issue date of the outstanding senior notes. If we or our subsidiary guarantor or future subsidiary guarantors were to become subject to a bankruptcy proceeding, any liens recorded or perfected after the issue date would face a greater risk of being invalidated than if they had been recorded or perfected on the issue date. Liens recorded or perfected after the issue date, may be treated under bankruptcy law as if they were delivered to secure previously existing indebtedness. In bankruptcy proceedings commenced within 90 days of lien perfection, a lien given to secure previously existing debt is materially more likely to be avoided as a preference by the bankruptcy court than if delivered and promptly recorded on the issue date. Accordingly, if we or our subsidiary guarantor or any future subsidiary guarantor were to file for bankruptcy protection and the liens had been perfected less than 90 days before commencement of such bankruptcy proceeding, the liens securing the senior notes may be especially subject to challenge as a result of having been delivered after the issue date. To the extent that such challenge succeeded, senior noteholders would lose the benefit of the security that the collateral was intended to provide. In the unlikely event that a senior noteholder is determined to be an “insider” of Grande Communications Holdings, Inc., the preference look-back period is one year, rather than 90 days, for the purposes of the risks described in this paragraph.
Because certain of the outstanding senior notes were issued with original issue discount, U.S. holders of such senior notes will be required to include such discount in gross income for U.S. federal income tax purposes before such amounts are received in cash.
Certain of the outstanding senior notes were issued at a discount from their stated principal amount. As a result, the discount on such senior notes is subject to the special tax rules applicable to original issue discount. Under these rules, the original issue discount generally must be included in the gross income of U.S. holders for U.S. federal income tax purposes in advance of the receipt of the cash payments on the senior notes to which such income is attributable.
Due to events that are beyond our control, we may not be able to generate sufficient cash flow to make interest payments under the senior notes.
Our ability to make payments on and to refinance our indebtedness, including the senior notes, and to fund planned capital expenditures will depend on our ability to generate cash in the future. This, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. We cannot provide any assurances that our business will generate sufficient cash flow from operations or that future borrowings will be available to us in an amount sufficient to enable us to pay our indebtedness or to fund our other liquidity needs. A significant reduction in operating cash flow would likely increase the need for alternative sources of liquidity. If we are unable to generate sufficient cash flow to make payments on the senior notes or our other indebtedness, we will have to pursue one or more alternatives, such as reducing or delaying capital expenditures, refinancing the senior notes or such other indebtedness, selling assets or raising equity. We cannot provide any assurances that any of these alternatives could be accomplished on satisfactory terms or that they would yield sufficient funds to repay the senior notes and our other indebtedness.
If a change of control occurs, we may not have sufficient funds to repurchase senior notes.
Upon specified change of control events, senior noteholders may require us to repurchase all or a portion of their senior notes. However, if a change of control occurs, we may not be able to pay the price for all of the senior notes submitted for repurchase. Future credit agreements or other agreements relating to debt may contain provisions prohibiting us from purchasing any senior notes until we have repaid all of such debt. We may not be able to secure the consent of such future lenders to repurchase the senior notes or refinance the borrowings that prohibit us from repurchasing the senior notes. In addition, certain significant corporate events would not constitute a change of control under the indenture for the senior notes.
We depend upon dividends from our subsidiary to meet our debt service obligations.
Grande Communications Holdings, Inc. is a holding company and conducts all of its operations through a subsidiary. Our ability to meet our debt service obligations depends upon our receipt of dividends from our subsidiary. Subject to the restrictions contained in the indenture governing the senior notes and our other outstanding debt, future borrowings by our subsidiary could contain restrictions or prohibitions on the payment of dividends by our subsidiary to us. In addition, under applicable law, our existing subsidiary and any future subsidiary guarantors could be limited in the amounts that they are permitted to pay us as dividends on their capital stock.
Federal and state statutes may allow courts to void or subordinate guarantees.
The senior notes will be guaranteed by our existing subsidiary and certain of our future subsidiary guarantors, if any. If a bankruptcy case or lawsuit is initiated with respect to a guarantor, the debt represented by the guarantee entered into by that guarantor may be reviewed under federal bankruptcy law and comparable provisions of state fraudulent transfer laws. Under these laws, a guarantee could be voided, or claims in respect of a guarantee could be subordinated to certain obligations of a guarantor, if, among other things, such guarantor, at the time it entered into the guarantee, received less than fair consideration for entering into the guarantee and either it was insolvent or rendered insolvent by reason of entering into the guarantee, it was engaged in a business or transaction for which the guarantor’s remaining assets constituted unreasonably small capital or it intended to incur, or believed that it would incur, debts or contingent liabilities beyond its ability to pay such debts or contingent liabilities as they became due. If one or more of the guarantees is voided, holders of the senior notes would be solely creditors of ours and of the guarantors that have validly guaranteed the senior notes; if one or more guarantees is subordinated, the other creditors of such guarantor would be entitled to be paid in full before any payment could be made on the senior notes. We cannot assure senior noteholders that after providing for all prior claims there would be sufficient guarantor assets remaining to satisfy the claims of the holders of the senior notes.
Bankruptcy laws may limit the ability of the senior noteholders to realize value from the collateral.
The right of the collateral agent to repossess and dispose of the collateral upon the occurrence of an event of default under the indenture governing the senior notes is likely to be significantly impaired by applicable bankruptcy law if a bankruptcy case were to be commenced by or against us before the collateral agent repossessed and disposed of the collateral. Upon the commencement of a case for relief under Title 11 of the United States Code, a secured creditor, such as the collateral agent, is prohibited from repossessing its security from a debtor in a bankruptcy case, or from disposing of security repossessed from such debtor, without bankruptcy court approval. Moreover, the bankruptcy code permits the debtor to continue to retain and use collateral even though the debtor is in default under the applicable debt instruments, provided that the secured creditor is given “adequate protection.” The meaning of the term “adequate protection” may vary according to circumstances, but it is intended in general to protect the value of the secured creditor’s interest in the collateral and may include cash payments or the granting of additional security if and at such times as the court in its discretion determines that the value of the secured creditor’s interest in the collateral is declining during the pendency of the bankruptcy case. A bankruptcy court may determine that a secured creditor may not require compensation for a diminution in the value of its collateral if the value of the collateral exceeds the debt it secures.
In view of the lack of a precise definition of the term “adequate protection” and the broad discretionary powers of a bankruptcy court, it is impossible to predict:
•
how long payments under the senior notes could be delayed following commencement of a bankruptcy case;
•
whether or when the collateral agent could repossess or dispose of the collateral;
•
the value of the collateral at the time of the bankruptcy petition; or
•
whether or to what extent holders of the senior notes would be compensated for any delay in payment or loss of value of the collateral through the requirement of “adequate protection.”
In addition, the indenture requires that, in the event of a bankruptcy, the trustee and the collateral agent not object to a number of important matters following the filing of a bankruptcy petition. After such filing, the value of the collateral could materially deteriorate and senior noteholders would be unable to raise an objection. The right of the holders of obligations secured by first priority liens on the collateral to foreclose upon and sell the collateral upon the occurrence of an event of default also would be subject to limitations under applicable bankruptcy laws if we or our existing subsidiary or any of our future subsidiaries become subject to a bankruptcy proceeding. Any disposition of the collateral during a bankruptcy case would also require permission from the bankruptcy court. Furthermore, in the event a bankruptcy court determines the value of the collateral is not sufficient to repay all amounts due on the senior notes, the holders of the senior notes would hold secured claims to the extent of the value of the collateral to which the holders of the senior notes are entitled and unsecured claims with respect to such shortfall. The majority of bankruptcy courts have found that the bankruptcy code only permits the payment and accrual of post-petition interest, costs and attorney’s fees to a secured creditor during a debtor’s bankruptcy case to the extent the value of its collateral is determined by the bankruptcy court to exceed the aggregate outstanding principal amount of the obligations secured by the collateral.
There is no established trading market for the senior notes, which could make it more difficult for senior noteholders to sell their senior notes and could affect adversely the price of their senior notes.
If the senior notes are traded after their initial issuance, the liquidity of the trading market in the senior notes, and the market price quoted for the senior notes, may be affected adversely by changes in the overall market for high yield securities and by changes in our financial performance or prospects or in the prospects for companies in the telecommunications industry generally. As a result, a senior noteholder cannot be sure that an active trading market will develop for the senior notes.
The initial purchasers of the outstanding senior notes have informed us that they intend to make a market in the senior notes. However, the initial purchasers have no obligation to do so, and may discontinue any market-making activities at any time without notice. We will not list the senior notes on any securities exchange. We cannot assure senior noteholders of the development of any market or of the liquidity of any market that may develop for the senior notes.
The indenture permits the formation of a holding company that would be permitted to take actions that may not be consistent with the best interests of the senior noteholders.
The indenture governing the senior notes permits the formation of a separate holding company that would be the parent company of Grande Communications Holdings, Inc. and its existing subsidiary and any future subsidiary. If such a holding company were formed, some of the restrictive covenants contained in the indenture would apply only to Grande Communications Holdings, Inc. and its existing subsidiary and any future subsidiary and not to the holding company. As a result, the holding company could take actions, such as using cash for purposes unrelated to debt service, which may not be consistent with the best interests of the senior noteholders.
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This annual report contains statements about future events, including without limitation, information relating to business development activities, as well as capital spending, financing sources and the effects of regulation and increased competition. All statements other than statements of historical fact are, or may be deemed to be, forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements can sometimes be identified by our use of forward-looking words such as “expect,” “should,” “may,” “will,” “anticipate,” “estimate,” or “intend” and other similar words or phrases. Similarly, statements that describe our objectives, plans or goals are or may be forward-looking statements. These statements involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be different from any future results, performance or achievements expressed or implied by these statements. You should review carefully all of the information, in this annual report, including the financial statements.
In addition to the risk factors described under the heading “Risk Factors,” the following important factors could affect future results, causing actual results to differ materially from those expressed in the forward-looking statements:
•
our dependence on existing management;
•
the local, regional, national or global economic climate;
•
an act of terrorism in the United States of America; and
•
changes in federal or state telecommunications laws or the administration of such laws.
These factors and the other risk factors discussed in this annual report are not necessarily all of the important factors that could cause our actual results to differ materially from those expressed in any of the forward-looking statements. Other unknown or unpredictable factors also could have material adverse effects on our future results. The forward-looking statements included in this annual report are made only as of the date of this annual report. We cannot ensure that any projected results or events will be achieved. We do not have and do not undertake any obligation to publicly update any forward-looking statements to reflect subsequent events or circumstances.
ITEM 1B.
ITEM 1B.
UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2.
PROPERTIES
We lease our corporate headquarters and network operations center in San Marcos, Texas, which consists of approximately 67,278 square feet of office space, as well as 11 other office sites in Texas, of approximately 184,094 square feet of office space collectively. We primarily lease the real property sites in each of our markets upon which our network equipment is located, including sites for our head-ends where programming is received via satellite, hubs, network equipment and points of presence. We have rights of way, licenses or other access rights to the real property over which our network fiber crosses, generally under our franchise agreements or contractual agreements with third parties. With respect to our long-haul network, we lease the real property sites where our switches, network equipment including collocation facilities and points of presence are situated.
ITEM 3.
ITEM 3.
LEGAL PROCEEDINGS
We are subject to litigation in the normal course of our business. However, there are no pending proceedings, which are currently anticipated to have a material adverse effect on our business, financial condition or results of operations.
ITEM 4.
ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
In July 2007, we submitted a consent solicitation statement to the holders of the Company’s senior notes. The consent solicitation requested consent to amend the indenture governing the senior notes to permit the issuance of $25,000,000 of additional senior notes. The holders of $86,000,000 in aggregate principal amount of the senior notes, which constituted a majority of the outstanding principal balance of the senior notes as of the record date, consented to amend the indenture to allow the Company to complete the issuance. The holders of $84,000,000 in aggregate principal amount did not respond to the consent solicitation before it terminated. The Company entered into a Supplemental Indenture to reflect this amendment on July 18, 2007.
The re-election of James M. Mansour, Duncan T. Butler, Jr. and William Laverack, Jr. as Class III directors to serve on the Company’s board of directors for a three-year term expiring in 2010 was submitted to a vote of and approved by the stockholders at the annual meeting of stockholders on December 12, 2007. The directors whose terms of office as directors continued after the meeting were: Roy H. Chestnutt, Lawrence M. Schmeltekopf, Richard W. Orchard, John C. Hockin and David C. Hull, Jr. There were no other matters voted upon at the 2007 annual meeting of shareholders. The following votes were cast at the 2007 annual meeting regarding the election of nominated directors:
PART II
ITEM 5.
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Price Range for Common Stock
Our stock is not traded on any stock exchange or quoted on any established trading market. No market makers currently make a market in our stock and we do not plan to engage a market maker. Therefore, there is no established public trading market and no high and low bid information or quotations available. As of December 31, 2007, we had 12,675,940 shares of common stock outstanding held by 193 holders of record.
Dividend Policy
We have never declared or paid any cash dividends on our capital stock and do not anticipate paying cash dividends on our capital stock in the foreseeable future. It is the current policy of our board of directors to retain earnings to finance the expansion of our operations. Future declaration and payment of dividends, if any, will be determined based on the then-current conditions, including our earnings, operations, capital requirements, financial condition, and other factors the board of directors deems relevant. In addition, our ability to pay dividends is limited by the terms of the Indenture.
Issuance of Unregistered Securities
During 2007, the Company issued 83,800 shares of common stock in connection with the exercise of options with a weighted average exercise price of $0.05 per share, and grants were awarded for options to purchase 2,948,000 shares of common stock and 2,000,000 shares of Series H preferred stock with an exercise price of $0.05 per share and $0.10 per share, respectively. We relied on the exemption set forth in Section 4(2) of the Securities Act of 1933 in issuing these securities.
In July 2007, we issued an additional $25.0 million of principal amount of our senior notes. We relied upon the exemption set forth in Rule 144A promulgated under the Securities Act of 1933 in issuing these securities. The additional senior notes were purchased by existing noteholders. For more information, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Availability of Capital”.
ITEM 6.
ITEM 6.
SELECTED FINANCIAL DATA
The data set forth below should be read in conjunction with our consolidated financial statements and related notes, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, and other financial information appearing elsewhere in this annual report.
(1)
The Company has reclassified the operating and financing portion of the cash flows attributable to negative book cash balances related to our zero-balance accounts for the annual periods ended December 31, 2003 and 2004. In prior periods, these cash flows were reported within the change in accounts payable in cash flows from operating activities, and have been reclassified to cash flows from financing activities. The effect on cash flows from operating activities was $(3.0) million and $0.8 million for the years ended December 31, 2003 and 2004, respectively. This revision did not have any affect on the Company’s cash balances, compliance with debt covenants, working capital, or operations.
(2)
Marketable homes passed are the number of residential and business units, such as single residence homes, apartments and condominium units, passed by our networks, other than those we believe are covered by exclusive arrangements with other providers of competing services.
(3)
Because we deliver multiple services to our customers, we report the total number of connections for video, voice and HSD service in addition to the total number of customers. We count each video, voice and HSD service purchase as a separate connection. For example, a single customer who purchases video, voice and HSD services would count as three connections. We do not record the purchase of long distance telephone service by a local telephone customer or the purchase of digital cable services by an analog cable customer as additional connections. However, we do record each purchase of an additional telephone line by a local telephone customer as an additional connection. More detailed information is discussed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the caption “Marketable Homes Passed, Customers and Connections.”
Non-GAAP Financial Measures
Income before interest income, interest expense, income taxes, depreciation and amortization is commonly referred to in our business as “EBITDA.” EBITDA is not a measure of financial performance under U.S. generally accepted accounting principles. We believe EBITDA is often a useful measure of a company’s operating performance and is a significant basis used by our management to measure the operating performance of our business. Because we have funded and completed the build-out of our networks by raising and expending large amounts of capital, our results of operations reflect significant charges for depreciation, amortization and interest expense. EBITDA, which excludes this information, provides helpful information about the operating performance of our business, apart from the expenses associated with our physical plant or capital structure. EBITDA is frequently used as one of the bases for comparing businesses in our industry, although our measure of Adjusted EBITDA may not be comparable to similarly titled measures of other companies. EBITDA does not purport to represent operating loss or cash flow from operating activities, as those terms are defined under generally accepted accounting principles, and should not be considered as an alternative to those measurements as an indicator of our performance, liquidity or ability to service debt obligations. The Company believes loss on extinguishment of debt, goodwill impairments, non-cash stock-based compensation and other non-cash expense are similar to amortization and interest expense in that it is more useful to report EBITDA net of these amounts to better measure operating performance in comparison to prior periods. However, because of the nature of these charges, the Company is referring to EBITDA, net of loss on early extinguishment of debt, goodwill impairments, non-cash stock-based compensation charges, and other non-cash expense as “Adjusted EBITDA”.
ITEM 7.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following is a discussion of our consolidated financial condition and results of operations for the years ended December 31, 2005, 2006, and 2007 and other factors that are expected to affect our prospective financial condition. The following discussion and analysis should be read together with our consolidated financial statements and related notes beginning on page of this annual report.
Overview
Grande’s primary business is providing a bundled package of cable television (“video”), telephone (“voice”), and broadband Internet (“HSD”) other services to residential and small and medium sized business customers in Texas. We provide these services in seven markets in the state of Texas using local broadband networks that we constructed. We refer to the homes and businesses that our network is capable of providing services to as “marketable homes passed”. As of December 31, 2007, we had the ability to market services to 340,058 distinct homes and businesses over our networks and had 145,675 residential and business customers. Our operating revenues were $189.9 million in 2006 compared to $197.1 million for 2007.
Grande was founded in October 1999 and was funded with $232 million of initial equity capital to pursue a retail strategy of constructing broadband networks in order to offer bundled video, voice and HSD services to customers. Operating revenues from bundled services were $146.1 million in 2006 compared to $155.0 million for 2007.
We believe that an important measure of our growth potential is the number of marketable homes passed by our networks and the marketable homes we are able to pass in the future in the markets in which we currently operate. Marketable homes passed are the number of residential and business units, such as single residential homes, apartments and condominium units, passed by our networks, other than those we believe are covered by exclusive arrangements with other providers of competing services. Since 2001, we have grown our marketable homes passed through the construction of our networks. The expansion of our networks has, in turn, allowed us to pursue a retail strategy of offering bundled video, voice and HSD services to residential and business customers. We have derived an increasing percentage of our revenues from our bundled services and we expect this trend to continue. Because of our local networks and existing fixed infrastructure in the markets in which we currently operate, we believe we can continue to grow our business without incurring the significant capital investment required to launch operations in new markets.
In addition, we have leveraged our retail metro network build-out with the 2003 acquisition of a long haul fiber optic network, primarily located in Texas, to allow us to provide broadband transport services to medium and large enterprises and communications carriers. Operating revenues for broadband transport services were $8.6 million in 2006 compared to $9.4 million for 2007.
In July 2000, when our network construction was still in a very early stage, we acquired Thrifty Call, which had an established telephone and data network that served as the platform for the provisioning of residential voice and HSD services and that still provides wholesale network services to medium and large enterprises and communications carriers in the wholesale market. Operating revenues for network services were $35.2 million in 2006 compared to $32.7 million for 2007.
Our network services are primarily provided using our existing infrastructure and personnel with minimal incremental operating costs and capital expenditures for maintenance. By leveraging our brand, communications infrastructure, voice and data volume, and personnel that predominately support our core retail business and its products, we have gained efficiencies of scale by offering telecommunications and HSD products into wholesale markets.
On January 18, 2008, we issued a press release announcing that our board of directors has authorized the Company to explore all of its strategic alternatives to enhance shareholder value. The board of directors will work with the Company’s management team and its legal and financial advisors to evaluate the Company’s available alternatives. We have engaged Waller Capital Partners LLC to assist us in exploring strategic alternatives. There can be no assurance that the exploration of strategic alternatives will result in the Company adopting or approving any strategic alternative. We undertake no obligation to make any further announcements regarding the exploration of strategic alternatives unless and until a final decision is made.
We have incurred net losses for the past five years and expect to continue to incur net losses in the future. However, we had positive Adjusted EBITDA during the past five years. See “Non-GAAP Financial Measures” below for a discussion of this non-GAAP measure of our operating performance as well as our use of Adjusted EBITDA.
Our financial results depend upon many factors that significantly affect our results of operations including, without limitation:
•
the availability of, and our ability to obtain additional funding, if necessary,
•
our ability to obtain enough customers for our services to offset the costs of operating our networks, and
•
increasing programming and other costs.
Availability of Capital
As described more fully under “Liquidity and Capital Resources” below, our principal sources of capital going forward will primarily be cash on hand and cash flow from operations. If we do not continue to increase the number of customers and the average prices received for our services, cash flow from operations will be adversely effected and cash on hand will decline.
Since inception, we have been funded primarily with private equity investments and the issuance of debt securities. Between February 2000 and October 2003, we completed a series of private placements of our preferred stock, raising aggregate gross proceeds of $338.2 million. The net proceeds from these private placements have been used to fund our network build-out, operations, and our acquisitions. As a result of these equity investments and our merger with ClearSource in 2002, where stock was used as consideration, we now have $509 million of total invested equity capital and a base of over 20 institutional private equity investors.
We have also raised net proceeds of approximately $180.1 million of senior secured debt, including premiums and net of discounts and financing costs. During March 2004, we raised net proceeds of approximately $123.8 million in a private placement of 136,000 units, with each unit consisting of a $1,000 principal amount of 14% senior secured note due 2011 (“senior notes”) and a warrant to purchase 100.336 shares of our common stock. The senior notes are governed by the indenture between Grande and U.S. Bank National Association, as Indenture Trustee, dated March 23, 2004 (“Indenture”). We used a portion of the net proceeds from the offering to repay all amounts outstanding under our then-existing senior credit facility, which was terminated upon repayment.
In March 2006, we raised net proceeds of approximately $30.5 million in a private placement of an additional $32.0 million in aggregate principal amount of senior notes. These additional senior notes were issued under the Indenture. We are using the proceeds for capital expenditures and working capital purposes.
On July 18, 2007, we completed a private placement offering of an additional $25 million in aggregate principal amount of senior notes for gross proceeds of approximately $26.0 million including a premium on issuance of $1.0 million. Debt issuance costs were approximately $0.2 million. We are using the net proceeds for capital expenditures and working capital purposes. These additional senior notes were issued under the Indenture and are part of the same series of senior notes as those issued in March 2004 and March 2006. The holders of a majority of the outstanding principal balance of the senior notes consented to the amendment of the Indenture to allow the Company to complete this issuance and we entered into a Supplemental Indenture to reflect this amendment on July 18, 2007.
During 2007, we completed equipment financing of $4.1 million with a term of 24 months, which was utilized for the purchase of network equipment. The financing is secured by the network equipment purchased with the proceeds of the borrowing and bears interest at an effective annual rate of approximately 15.3% with monthly payments equal to 4.2% multiplied by the total amount borrowed. This financing is permitted under the Indenture governing the senior notes.
Marketable Homes Passed, Customers and Connections
We report marketable homes passed as the number of residential and business units, such as single family residence homes, apartments and condominium units, passed by our networks other than those we believe are covered by exclusive arrangements with other providers of competing services. As of December 31, 2007, our networks passed 340,058 marketable homes and we had 145,675 residential and business customers.
Because we deliver multiple services to our customers, we report our total number of connections for video, voice, HSD and other services in addition to our total number of customers. We count each video, voice, HSD and other service purchase as a separate connection. For example, a single customer who purchases video, voice, and HSD service would count as three connections. Similarly, a single customer who purchases our HSD service and our voice service would count as two connections. We do not record the purchase of long distance telephone service by a local telephone customer or digital cable services by an analog cable customer as additional connections. However, we do record each purchase of an additional telephone line by a local telephone customer as an additional connection. As of December 31, 2007, we had 308,881 connections.
Competition
The broadband communications industry is highly competitive. We compete primarily on the basis of the price, availability, reliability, variety, quality of our offerings, our people, and on the quality of our customer service. Our ability to compete effectively depends on our ability to maintain high-quality services at prices generally equal to or below those charged by our competitors. Price competition in the retail services and broadband transport services markets generally has been intense and is expected to continue, although cable rates increase annually and AT&T recently raised DSL rates. The continuing trend toward business combinations and alliances in the telecommunications industry will create significant new competitors. As a result of these business combinations and the introduction of VoIP offerings, we anticipate that the competitive environment will become increasingly intense. In addition to terrestrial competition, we continue to see consumers choose to eliminate a second line, their long distance, and/or their primary landline and use wireless telephone service instead. This dynamic is more prevalent in younger, more transient households such as MDUs in which students or young adults tend to move every twelve to eighteen months. Advances in technology also are leading to changes in video distribution platforms, making downloadable, on-demand video content accessible in both traditional wireline and new wireless mobile viewing devices. These and other developments are requiring traditional communications providers such as us to regularly rethink the model for successfully marketing and providing video, voice and HSD content and services to consumers.
Operating Revenues
We derive our operating revenues primarily from monthly charges for the provision of video, voice, HSD and other services to residential and business customers. In addition, we derive operating revenues by providing broadband transport services to medium and large enterprises and communications carriers as well as providing network services by offering telecommunications and HSD products to medium and large enterprises and communications carriers within wholesale markets. These services are a single business provided over a unified network. However, since our different products and services generally involve different types of charges and in some cases different billing methods, we have presented information on our revenues from each major product line.
Bundled services revenues-video, voice, HSD and other. We typically provide video, voice, HSD and other services on a bundled basis for fixed monthly fees billed in advance, with the amount of the monthly fee varying significantly depending upon the particular bundle of services provided. We also charge usage-based fees for additional services, such as pay-per-view movies that involve a charge for each viewing and long-distance services that involve charges by the number of minutes of use. We generally bill for these usage-based services monthly in arrears. We also generate revenues from one-time charges for the installation of premises equipment. Most of our bundled offerings include fees for equipment rental, although in some instances we sell modems to customers. Revenue generated from equipment sales is an insignificant portion of our total revenues. We also charge monthly or one-time fees for additional services, including advertising. We collect from our cable customers and include in our gross revenues the fees payable to cable franchise authorities, which are usually approximately 5% of our revenues from cable subscriptions. We began offering security services as part of our bundle in June 2004. We discontinued actively marketing our security services in 2006. However, we continue to provide service to our existing customer base. The security revenue is included in HSD and other.
Broadband transport services revenues. Our revenues from broadband transport services, which consist of access to our metro area networks and point-to-point circuits on our long-haul fiber network, involve fixed monthly fees billed in advance, where the amount charged varies with the amount of capacity, type of service and whether any customized capacity or services are provided. Our revenues also include non-recurring charges for construction, installation and configuration services, which can range significantly depending upon the customer’s needs.
Network services revenues. Our revenues from network services consist primarily of revenues from switched carrier services and managed modem services. We bill for most of our network services monthly in arrears based on actual usage. However, some network services, particularly our managed modem services, involve fixed monthly charges billed in advance. Some network services include non-recurring fees for installation or other work needed to connect the customer to our networks. There are monthly charges or negotiated fees for other services such as VoIP terminations, directory assistance, web hosting, database, collocation, and technical support.
Costs and Expenses
Cost of Revenues
Cost of revenues includes those expenses that are directly related to the generation of operating revenues and has fixed and variable components, however it does not include depreciation or amortization. Our network supports the products and services that we provide to customers, and due to a common network infrastructure and many of the same resources and personnel being used to generate revenues from the various product and service categories it is difficult to determine cost of revenues by product.
Our cost of revenues include the following:
•
Video costs. Programming costs historically have been the largest portion of the cost of providing our video services and we expect this trend to continue. We have entered into contracts for cable programming through the National Cable Television Cooperative and directly with programming providers to provide programming to be aired on our networks. We pay a monthly fee for these programming services based on the average number of subscribers to the program, although some fees are adjusted based on the total number of subscribers to the system or the system penetration percentage. Since programming cost is based on numbers of subscribers, it will increase as we add more subscribers. It will also increase to the extent costs per channel increase over time, and may change depending upon the mix of channels we offer in each market from time to time. Our cable costs also include retransmission fees for local programming and fees payable to cable franchise authorities, which are usually approximately 5% of our revenues from cable subscriptions.
•
Voice costs. Our cost of revenues associated with delivering voice services to residential and business customers consist primarily of transport costs, which are comprised mostly of amounts needed for the operation, monitoring and maintenance of our networks, and also include access and other fees that we pay to other carriers to carry calls outside of our networks. Transport costs are largely fixed so long as we do not need to procure additional equipment or lease additional capacity. Transport costs are expected to increase when new network facilities need to be obtained. The access fees are generally usage-based and, therefore, variable.
•
HSD and other costs. Our cost of revenues associated with delivering HSD and other services to residential and business customers consists primarily of transport costs and fees associated with peering arrangements we have with other carriers. Transport costs and peering fees for this service are largely fixed as long as we do not need to procure additional equipment or lease additional capacity, but transport costs and peering fees may increase when new facilities for connecting to the Internet need to be obtained. Our security-related costs are primarily related to system monitoring with a third-party provider.
•
Broadband transport services costs. Our cost of revenues associated with delivering broadband traffic consists primarily of fixed transport costs, which are comprised mostly of amounts needed for the operation, monitoring and maintenance of our networks, and also include access and other fees that we pay to other carriers to carry traffic outside of our networks. These costs are mostly fixed in nature. There are some variable costs associated with external maintenance and with private line services, which can have a component that requires us to pay other carriers for a portion of the private line. Broadband transport services costs also include non-recurring costs for construction, installation and configuration services, which can vary significantly depending upon the customer’s needs.
•
Network services costs. Our cost of revenues associated with delivering traffic consists primarily of transport costs, mostly amounts needed for the operation, monitoring and maintenance of our networks, and access and other fees that we pay to other carriers to carry traffic outside of our networks. These costs are primarily fixed with respect to the monitoring of the traffic we carry on our networks, although there are variable components associated with external maintenance costs and other items. The access and other carrier fees are variable and usage-based.
Selling, general and administrative expenses
Our selling, general and administrative expenses include all of the expenses associated with operating and maintaining our networks that are not cost of revenues. These expenses primarily include employee compensation and departmental costs incurred for network design, monitoring and maintenance. They also include employee compensation and departmental costs incurred for customer disconnection and reconnection and service personnel, customer service representatives and management and sales and marketing personnel. Other included items are advertising expenses, promotional expenses, corporate and subsidiary management, administrative costs, bad debt expense, professional fees, taxes, insurance and facilities costs.
Depreciation and amortization
Depreciation and amortization expenses include depreciation of our broadband networks and equipment and other intangible assets.
Operating Data -Bundled Services
Results of Operations
The following table sets forth financial data as a percentage of operating revenues.
Year Ended December 31, 2007 Compared to Year Ended December 31, 2006
Operating Revenues. Our operating revenues for 2006 and 2007 were $189.9 million and $197.1 million, respectively, an increase of $7.2 million, or 4%. This increase was driven primarily by a $8.9 million and $0.9 million increase in bundled services revenues and broadband transport services revenues, respectively, partially offset by a $2.5 million decrease in revenues from network services.
Operating revenues for our bundled services for 2006 and 2007 were $146.1 million and $155.0 million, respectively, an increase of $8.9 million, or 6%. The increased revenues from bundled services were primarily due to a 5% growth in the number of connections, from 295,124 as of December 31, 2006 to 308,881 as of December 31, 2007, and, to a lesser extent, from the cable rate increases described below. The additional connections and revenues resulted primarily from the continued increase in penetration of existing marketable homes, the growth of our commercial business revenue, and to a lesser extent, sales to new marketable homes built during 2007.
Operating revenues for our video services for 2006 and 2007 were $57.4 million and $64.2 million, respectively, an increase of $6.8 million, or 12%. Approximately 59% of the $6.8 million increase was due to our annual cable rate increase that occurred in January 2007, with the remainder due to increased connections and an increased number of customers adding premium services and advanced services, such as HD and DVR.
Operating revenues for our voice services for 2006 and 2007 were $57.6 million and $56.1 million, respectively, a decrease of $1.5 million, or 3%, due to a 2% decrease in average monthly revenue per telephone connection during 2007 compared to 2006 coupled with a 2% decrease in the number of connections during 2007 compared to 2006. Telephone connections decreased due to competitive pressures and changing consumer preferences, as more customers choose to adopt VoIP products or use their wireless phones as their primary phone line.
Operating revenues for our HSD and other services for 2006 and 2007 were $31.1 million and $34.7 million, respectively, an increase of $3.6 million, or 12%, primarily due to a 12% increase in connections related to residential high speed service and business Ethernet service.
Operating revenues for our broadband transport services for 2006 and 2007 were $8.6 million and $9.4 million, respectively, an increase of $0.8 million, or 9% as a result of an increase in construction as well as moderate customer growth.
Operating revenues for our network services for 2006 and 2007 were $35.2 million and $32.7 million, respectively, a decrease of $2.5 million, or 7%. This decrease consisted of a $1.3 million decrease in revenues from data services as the result of a $0.9 million decrease in reciprocal compensation revenue partially due to a regulatory mandated reduction in such compensation as well as a decrease in volume from customers. In addition, there was a $0.8 million and $0.6 million decrease in revenues from national directory assistance service and carrier switched services, respectively, due to decreases in customer volume.
Cost of Revenues. Our cost of revenues for 2006 and 2007 were $63.9 million and $68.3 million, respectively, an increase of $4.4 million, or 7%. Cost of revenues as a percentage of revenues increased from 34% of revenues in 2006 to 35% of revenues in 2007. The increase in our cost of revenues was primarily due to an increase in bundled services video costs of approximately $5.8 million and an increase of $0.1 million in wholesale and bundled services voice and HSD costs that was partially offset by a $1.4 million decrease in other wholesale services costs.
Selling, General and Administrative Expense. Our selling, general and administrative expense for 2006 and 2007 was $97.8 million and $93.7 million, respectively, a decrease of $4.1 million, or 4%. Selling, general and administrative expense decreased as a percentage of revenues from 52% to 47%. Decreases in property tax, a 2006 nonrecurring early termination expense related to a property lease, reductions in contract labor charges as sales and customer service positions were brought in-house, as well as decreases in legal fees, provision for doubtful accounts, employee relocation, utilities and other administrative expenses totaled approximately $6.4 million, but such decreases were partially offset by increases related to compensation and employee benefits primarily related to the new sales and customer service positions described above, stock based compensation, and other miscellaneous expenses that totaled approximately $2.3 million. We expect our selling, general and administrative expense to continue to decrease in 2008 as we continue to focus on cost reductions and gain efficiencies.
Depreciation and Amortization Expense. Our depreciation and amortization expense for 2006 and 2007 was $56.0 million and $56.8 million, respectively, an increase of $0.7 million, or 1%. The increase in depreciation expense was primarily related to property, plant and equipment additions during the year ended December 31, 2007, primarily for customer premise equipment, network construction and capitalized labor expenses. During both 2006 and 2007, we received sales tax refunds as a result of a review of vendor invoices in the years 2004 and 2005. Because a portion of the sales taxes associated with those invoices were capitalized as property and equipment and were partially depreciated, $0.9 million and $0.7 million of the refund was applied as a reduction of depreciation expense during 2006 and 2007, respectively. The increases in depreciation expense were partially offset by a decrease in depreciation expense related to sales and dispositions as well as certain assets that became fully depreciated during the year ended December 31, 2007.
Interest Expense. For 2006 and 2007, our interest expense, which includes interest incurred net of capitalized interest, was $24.0 million and $29.0 million, respectively. Our interest expense increased primarily due to the private placement of an additional $25.0 million of senior notes in the third quarter of 2007. For 2006 and 2007, we had capitalized interest of $2.2 million and $0.6 million, respectively, a decrease of $1.6 million, or 73%.
Gain on Disposal of Assets. Our gain on disposal of assets for 2006 and 2007 was $2.4 million and $0.1 million, respectively, a decrease of $2.3 million. The 2006 net gain was primarily due to the sale of certain off-net MDU assets during the first half of 2006 for net proceeds of $2.5 million. These assets were non-strategic in nature and were originally acquired in our October 2003 acquisition of Advantex. The net gain recognized during 2007 related primarily to amortization of deferred gains related to the sale and leaseback of Company land and buildings and customer premise equipment of approximately $0.4 million partially offset by the net loss on sale or disposal of certain communications plant, vehicles, network and other equipment.
Goodwill impairment. We performed our annual process to test the carrying value of goodwill as of October 1, 2005 and 2006 on our wholesale and retail reporting units, as determined in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142-Goodwill and Other Intangible Assets (“SFAS 142”). In 2006, the goodwill impairment test resulted in an impairment of $93.6 million, the entire amount of goodwill associated with the retail reporting unit. The retail reporting unit primarily included the assets, including a portion of the goodwill from the Thrifty Call acquisition and all of the goodwill associated with the ClearSource merger, liabilities and cash flows from bundled services and our broadband transport services. During 2006, management set projections in line with the current competitive environment and our liquidity position resulting in a downward revision to the future cash flow projections and a lower fair value of the retail reporting unit.
Income tax Expense. For the year ended December 31, 2007, our income tax expense was $1.1 million. Effective January 1, 2007, the state of Texas changed its method of taxation from a franchise tax, which was based on taxable capital, to a tax based on gross margin. This change resulted in a different financial statement presentation of the tax to the state of Texas. Prior to January 1, 2007, the Texas franchise tax expense was included as a component of selling, general and administrative expense in the accompanying condensed consolidated statements of operations. The gross margin tax is presented as income tax expense during the year ended December 31, 2007.
Year Ended December 31, 2006 Compared to Year Ended December 31, 2005
Operating Revenues. Our operating revenues for 2005 and 2006 were $194.7 million and $189.9 million, respectively, a decrease of $4.8 million, or 2% primarily as a result of a $15.6 million decrease in operating revenues from network services, partially offset by growth in bundled services revenue of $10.8 million.
Operating revenues for our bundled services for 2005 and 2006 were $135.3 million and $146.1 million, respectively, an increase of $10.8 million, or 8%. The increased revenues from bundled services were primarily due to growth in the number of connections, from 276,142 as of December 31, 2005 to 295,124 as of December 31, 2006, and, to a lesser extent, from the cable rate increases described below. The additional connections and revenues resulted primarily from the continued increase in penetration of existing marketable homes and to a lesser extent, sales to new marketable homes built in 2006.
Operating revenues for our video services for 2005 and 2006 were $50.1 million and $57.4 million, respectively, an increase of $7.3 million, or 15%. Approximately 34% of the $7.3 million increase was due to our annual cable rate increase that occurred in January 2006, with the remainder due to increased connections and an increased number of customers adding premium services and advanced services, such as HD and DVR.
Operating revenues for our voice services for 2005 and 2006 were $58.7 million and $57.6 million, respectively, a decrease of $1.1 million, or 2%, due to a 6% decrease in average monthly revenue per unit, offset by a 1% growth in telephone connections. Approximately 41% of the decrease in average monthly revenue per unit was due to a regulatory mandated reduction in meet point billing access rates.
Operating revenues for our HSD and other services for 2005 and 2006 were $26.6 million and $31.1 million, respectively, an increase of $4.5 million, or 17%, primarily as a result of growth in broadband connections which increased approximately 18% in 2006 over 2005.
Operating revenues for our broadband transport services for 2005 and 2006 were flat at $8.6 million. These services have experienced circuit attrition and pricing compression, which has outpaced our customer growth in 2004, 2005, and the first half of 2006. Our revenue for broadband transport services increased during the second half of 2006 compared to the second half of 2005 due to moderate customer growth.
Operating revenues for our network services for 2005 and 2006 were $50.8 million and $35.2 million, respectively, a decrease of $15.6 million, or 31%. This decrease was driven by three factors. First, we experienced a decrease in domestic carrier switched services revenue, which fell by $9.6 million, as a result of a decrease in volume. Second, our decision to de-emphasize our international carrier switched services business, which historically was marginally profitable, resulted in a decrease of $3.9 million. Finally, reciprocal compensation revenue decreased by $2.0 million from 2005 to 2006 due to a regulatory mandated reduction.
Cost of Revenues. Our cost of revenues for 2005 and 2006 were $72.5 million and $63.9 million, respectively, a decrease of $8.6 million, or 12%. The decrease in our overall cost of revenues was primarily due to the decrease in network services revenue, which resulted in a decrease in the variable component of network services costs. Cost of revenues as a percentage of revenues decreased from 37% of revenues in 2005 to 34% of revenues in 2006.
Selling, General and Administrative Expense. Our selling, general and administrative expense for 2005 and 2006 was $96.0 million and $97.8 million, respectively, an increase of $1.8 million, or 2%. The increase was primarily due to the cost of growing the bundled services business, increased focus on customer service, and management changes that occurred during 2006. As the bundled service business grew, we increased our expenditures on sales and marketing, installing new customers, and billing. We also increased our investment in our call centers in order to improve the customer experience and drive sales from this sales channel. Finally, we integrated new individuals into our senior management team who replaced former members of the team. Selling, general and administrative expense increased as a percentage of revenues from 49% to 52% primarily due to the 31% decrease in network service revenue relative to the fixed cost components included in selling, general and administrative expense as well as the growth in selling, general and administrative costs described above.
Depreciation and Amortization Expense. Our depreciation and amortization expense for 2005 and 2006 was $59.5 million and $56.0 million, respectively, a decrease of $3.5 million, or 6%. The decrease was primarily due to certain intangible assets becoming fully amortized during 2005, a $1.8 million impairment recorded in the fourth quarter of 2005 on the franchise agreement intangible asset as a result of the SICFA approval, which eliminated the need for individual city franchise agreements, and a $0.9 million reduction in depreciation in the third quarter of 2006 relating to a sales tax refund. We received a refund in the amount of $2.0 million and incurred professional fees, interest and use tax of $1.1 million as a result of the conclusion of a sales tax audit and review of vendor invoices for the years 2000 through 2003. Because the sales taxes associated with those invoices were capitalized as property and equipment and were fully depreciated, the net refund of $0.9 million was applied as a reduction of depreciation expense.
Interest Expense. For 2005 and 2006, our interest expense, which includes interest incurred net of capitalized interest, was $18.8 million and $24.0 million, respectively. Our interest expense increased primarily due to the private placement of an additional $32.0 million of senior notes in the first quarter of 2006. For 2005 and 2006, we had capitalized interest of $3.3 million and $2.2 million, respectively, a decrease of $1.1 million, or 33%. The decrease in capitalized interest was primarily due to decreased network construction activity and decreased capital expenditures.
Goodwill impairment. We performed our annual process to test the carrying value of goodwill as of October 1, 2005 and 2006 on our wholesale and retail reporting units, as determined in accordance with SFAS 142. For the 2005 annual impairment test, we determined the fair values of our reporting units based on a combination of (i) estimated discounted future cash flow projections, as well as assumptions of terminal value and (ii) market multiples for comparable companies. During the 2006 annual impairment test, we engaged a third-party appraisal firm to assist us in the determination of the fair value of the reporting units, based in part by estimates developed by management based on a combination of (i) estimated discounted future cash flow projections, as well as assumptions of terminal value and (ii) market multiples for comparable companies.
In 2005, the goodwill impairment test resulted in an impairment of $39.6 million, the entire amount of goodwill associated with the wholesale reporting unit. The wholesale reporting unit includes the assets, including a portion of the goodwill associated with the Thrifty Call acquisition, liabilities, and cash flows from network services. During the last half of 2005, we revised projections downward for our network services line of service based on our revised business strategy, trends in the industry and management’s analysis of the competitive environment, which negatively impacted the wholesale reporting unit’s future cash flow projections.
In 2006, the goodwill impairment test resulted in an impairment of $93.6 million, the entire amount of goodwill associated with the retail reporting unit. We also used a third-party appraisal firm to assist us in the determination of the value of the significant tangible and intangible long-lived assets of the reporting unit as part of this impairment calculation. The retail reporting unit primarily included the assets, including a portion of the goodwill from the Thrifty Call acquisition and all of the goodwill associated with the ClearSource merger, liabilities and cash flows from bundled services and our broadband transport services. During 2006, management set projections in line with the current competitive environment and our liquidity position resulting in a downward revision to the future cash flow projections and a lower fair value of the retail reporting unit.
Non-GAAP Financial Measures
We measure our operating performance on earnings before interest income, interest expense, income taxes, depreciation and amortization, referred to as “EBITDA.” EBITDA is not a measure of financial performance under GAAP. We believe EBITDA is often a useful measure of a company’s operating performance and is a significant basis used by our management to measure the operating performance of our business.
Because we have funded the build-out of our networks by raising and expending large amounts of capital, our results of operations reflect significant charges for depreciation, amortization, and interest expense. EBITDA, which excludes this information, provides helpful information about the operating performance of our business, apart from the expenses associated with our physical plant or capital structure. We manage all areas of our business to generate positive EBITDA, and when we have choices about the market or area in which to best deploy our resources we generally direct our resources towards the network construction that is expected to generate the most EBITDA. EBITDA is frequently used as a basis for comparing businesses in our industry, although our measure of EBITDA may not be comparable to similarly titled measures of other companies. EBITDA does not purport to represent operating loss or cash flow from operating activities, as those terms are defined under GAAP, and should not be considered as an alternative to those measurements as an indicator of our performance.
In the fourth quarter of 2005 and 2006, we recognized a goodwill impairment of $39.6 million and $93.6 million, respectively, associated with the results of our annual impairment test. In the first quarter of 2006, Grande began recognizing compensation expense for stock-based compensation in accordance with SFAS No. 123(R), Share-Based Payment (“SFAS 123(R)”), which is a non-cash item. The Company believes goodwill impairments, non-cash stock-based compensation, and other non-cash expense are similar to amortization and interest expense, in that it is more useful to report EBITDA net of these amounts to better measure operating performance in comparison to prior periods. However, because of the nature of these charges, the Company is referring to EBITDA, net of goodwill impairments, non-cash stock-based compensation charges, and other non-cash expense as “Adjusted EBITDA”.
Adjusted EBITDA was $31.1 million and $35.5 million during the years ended December 31, 2006 and 2007, respectively, an increase of $4.4 million, or 14%. The increase was primarily due to a $7.3 million increase in revenues as well as a $3.8 million decrease in selling, general and administrative expenses, excluding stock-based compensation and franchise tax expense, partially offset by a $4.4 million increase in costs of revenues and a $2.3 million decrease in net gain on sale of assets.
Adjusted EBITDA was $27.5 million and $31.1 million during the years ended December 31, 2005 and 2006, respectively, an increase of $3.6 million, or 13%. The increase was primarily due to a $8.6 million decrease in costs of revenues as well as a $1.9 million increase in net gain on sale of assets, partially offset by a $5.6 million decrease in revenues and other income and a $1.3 million increase in selling, general and administrative expenses, excluding stock-based compensation and franchise tax expense.
Because a significant portion of our cost of revenues and overhead expenses are generally fixed in nature, increasing revenue should result in further increases in EBITDA/Adjusted EBITDA and in EBITDA/Adjusted EBITDA as a percentage of revenues. To the extent the increased revenues are the result of adding residential and business customers for our bundled services, which have higher gross margins than network services, EBITDA/Adjusted EBITDA should increase more quickly on a percentage basis.
The reconciliation of EBITDA/Adjusted EBITDA to net income is as follows:
____________________________
(1)
Adjusted EBITDA includes gain on sale of assets of $0.4 million in 2005, $2.4 million in 2006 and $0.1 million in 2007.
Liquidity and Capital Resources
Sources and Uses of Funds
Since inception, we have been funded primarily with private equity investments and issuance of debt securities. Between February 2000 and October 2003, we completed a series of private placements of our preferred stock, raising aggregate gross proceeds of $338.2 million from the sale of our capital stock. The net proceeds from these private placements were used to fund our network build-out, operations, and our acquisitions. As a result of equity investments and our stock-for-stock merger with ClearSource in 2002, where stock was used as consideration, we now have $509 million of total invested equity capital and a base of over 20 institutional private equity investors.
We have also raised net proceeds of approximately $180.1 million from the sale of our senior notes including premiums and net of discounts and financing costs. In March 2004, we issued $136.0 million principal amount at maturity of senior notes with net proceeds of approximately $123.8 million and in March 2006, we raised net proceeds of approximately $30.5 million in a private placement of an additional $32 million in aggregate principal amount of senior notes. Interest on the senior notes is payable semi-annually each April 1 and October 1. We used a portion of the net proceeds from the issuance of the senior notes in 2004 to repay all amounts outstanding under our then-existing senior credit facility. We used the net proceeds from the sale of the additional senior notes in March 2006 for capital expenditures and working capital purposes.
In March 2006, we raised net proceeds of approximately $30.5 million in a private placement of an additional $32.0 million in aggregate principal amount of senior notes. These additional senior notes were issued under the Indenture. We used the net proceeds for capital expenditures and working capital purposes.
On July 18, 2007, we completed a private placement offering of an additional $25 million in aggregate principal amount of senior notes for gross proceeds of approximately $26.0 million including a premium on issuance of $1.0 million. Debt issuance costs were approximately $0.2 million. We are using the net proceeds for capital expenditures and working capital purposes. These additional senior notes were issued under the Indenture and are part of the same series of senior notes as those issued in March 2004 and March 2006. The holders of a majority of the outstanding principal balance of the senior notes consented to the amendment of the Indenture to allow the Company to complete this issuance and we entered into a Supplemental Indenture to reflect this amendment on July 18, 2007.
During 2007, we completed equipment financing of $4.1 million with a term of 24 months, which was utilized for the purchase of network equipment. The financing is secured by the network equipment purchased with the proceeds of the borrowing and bears interest at an effective annual rate of approximately 15.3% with monthly payments equal to 4.2% multiplied by the total amount borrowed. This financing is permitted under the Indenture governing the senior notes.
As of December 31, 2007, we had total cash and cash equivalents of $48.1 million and $203.6 million of long-term debt and capital lease obligations outstanding, net of current portion, and net of discounts and premiums of $5.0 million.
As of December 31, 2007, we had net working capital of $19.8 million, compared to net working capital of $20.2 million as of December 31, 2006. The $0.4 million decrease in working capital resulted primarily from a $5.2 million increase in current liabilities as a result of a $3.5 million increase in accrued payables and accrued expenses as well as a $1.6 million increase in the current portion of long-term debt related to the network equipment purchases financed during 2007. The $5.2 million increase in current liabilities was partially offset by a $4.8 million increase in current assets primarily related to the $4.2 million increase in cash.
Our primary sources of liquidity are cash on hand and cash flows from operating activities. Provided that we meet our cash flow projections in our current business plan, we expect that we will not require additional financing and that we will manage our cash position above $20 million in accordance with the covenant set forth in the Indenture over the next twelve months. This covenant prohibits our making capital expenditures relating to the build-out of new or additional parts of our network if such expenditures would result in us having less than $20 million in cash and cash equivalents. Our business plan is based on estimates regarding expected future costs and expected revenues. Our costs may exceed or our revenues may fall short of our estimates, our estimates may change, and future developments may affect our estimates. Any of these factors may increase our need for funds to complete construction in our markets, which would require us to seek additional financing.
We may need additional financing to fund our operations or to undertake initiatives not contemplated by our business plan or obtain additional cushion against possible shortfalls. We also may pursue additional financing as opportunities arise. Future financings may include a range of different sizes or types of financing, including the sale of additional debt or equity securities. However, we may not be able to raise additional funds on favorable terms or at all. Our ability to obtain additional financing depends on several factors, including future market conditions; our success or lack of success in penetrating our markets and growing our overall income; our future creditworthiness; and restrictions contained in agreements with our investors or lenders, including the restrictions contained in the Indenture. These financings could increase our level of indebtedness or result in dilution to our equity holders. Additionally, we can call our existing senior notes beginning in April 2008, giving us the near term ability to refinance our bonds in the event better pricing and terms were available to us in the market.
Cash Flows from Operating Activities
Net cash provided by operations totaled $14.8 million, $9.7 million and $11.7 million for 2005, 2006 and 2007, respectively. The net cash flow activity related to operations consists primarily of our operating results adjusted by changes in operating assets and liabilities and non-cash transactions including:
•
depreciation, amortization and accretion expense;
•
non-cash compensation expense;
•
non-cash interest expense;
•
provision for bad debt;
•
goodwill impairments; and
•
gain on sale of assets.
Depreciation and amortization for 2005, 2006 and 2007 was $59.5 million, $56.0 million and $56.8 million, respectively. Goodwill impairment for 2005 and 2006 was $39.6 million and $93.6 million, respectively. There were no goodwill impairments in 2007. Other non-cash charges for 2005, 2006 and 2007 were $6.7 million, $3.6 million and $6.1 million, respectively.
As of December 31, 2007, we had a $6.8 million balance in accrued interest payable related to interest due on our senior notes, which will be paid on April 1, 2008.
Cash Flows from Investing Activities
Our net cash used in investing activities for 2005, 2006 and 2007 was $28.4 million, $26.4 million and $33.6 million, respectively. During 2005, these net cash outflows were primarily due to the build-out of our network. Cash flows used in investing activities in 2006 consisted primarily of $30.9 million in property, plant and equipment purchases, partially offset by $4.2 million proceeds on sales tax refunds and asset sales. During 2007, cash flows used in investing activities consisted primarily of $35.3 million in property, plant and equipment purchases, partially offset by $1.8 million proceeds on sales tax refunds and asset sales.
Cash Flows from Financing Activities
Our net cash provided by (used in) financing activities for 2005, 2006 and 2007 was $(0.9) million, $33.9 million and $26.0 million, respectively. Cash flows from financing activities in 2006 consisted primarily of the net proceeds from the private placement of an additional $32 million in aggregate principal amount of senior notes and net proceeds of $7.4 million primarily related to the sales leaseback arrangement for customer premise equipment partially offset by $3.2 million payments on long-term debt. During 2007, cash flows from financing activities consisted primarily of the net proceeds from borrowings of $30.1 million related to a private placement of $25 million in aggregate principal amount of senior notes and a loan obligation used to finance equipment purchases, offset by $4.3 million payments on long-term debt.
Capital Expenditures
We had capital expenditures of approximately $48.2 million, $30.9 million and $35.3 million, including capitalized interest, in 2005, 2006 and 2007, respectively. These capital expenditures relate to: network construction; initial installation costs; the purchase of customer premise equipment, such as cable set-top boxes and cable modems; corporate and network equipment, such as switching and transport equipment; and billing and information systems. The increase in capital expenditures during 2007 was primarily due to capital equipment purchases related to our long haul fiber optic network upgrade. The Indenture prohibits us from making capital expenditures when the aggregate amount of cash and cash equivalents held by us (after giving effect to such planned capital expenditure) would be less than $20 million.
During the year ending December 31, 2008, the Company intends to manage its capital expenditures in accordance with the covenant set forth in the Indenture to ensure that cash is not less than $20 million.
Contractual Obligations and Commercial Commitments
We are obligated to make payments under a variety of contracts and other commercial arrangements, including the following:
Long-term Debt and Equipment Financing. In March 2004, the Company completed a private placement offering for 136,000 units, with each unit consisting of (1) $1,000 of senior notes and (2) a warrant to purchase 100.336 shares of common stock. The senior notes mature on April 1, 2011 and accrue interest at the rate of 14% per annum with the interest payable semi-annually in cash in arrears on April 1 and October 1. In March 2006, we raised net proceeds of approximately $30.5 million in a private placement of an additional $32.0 million in aggregate principal amount of senior notes. These additional senior notes were issued under the Indenture and are part of the same series of senior notes as those issued in March 2004.
On July 18, 2007, we completed a private placement offering of an additional $25 million in aggregate principal amount of senior notes for gross proceeds of approximately $26.0 million including a premium on issuance of $1.0 million. Debt issuance costs were approximately $0.2 million. These additional senior notes were issued under the Indenture and are part of the same series of senior notes as those issued in March 2004 and March 2006. The holders of a majority of the outstanding principal balance of the senior notes consented to the amendment of the Indenture to allow the Company to complete this issuance and we entered into a Supplemental Indenture to reflect this amendment on July 18, 2007.
Our subsidiary, Grande Communications Networks, Inc., (the “Subsidiary Guarantor”), has unconditionally guaranteed, jointly and severally, the payment of the principal, premium and interest (including any additional interest on the senior notes) on a senior secured basis.
The senior notes and the Subsidiary Guarantor’s guarantees thereof are secured by a first priority perfected security interest, subject to certain permitted encumbrances, in substantially all of our subsidiary’s property and assets, including substantially all of its property, plant and equipment.
The senior notes may be redeemed, at our election, as a whole or from time to time in part, at any time after April 1, 2008, upon not less than 10 nor more than 60 days’ notice to each holder of senior notes to be redeemed, subject to the conditions and at the redemption prices (expressed as percentages of principal amount) set forth below, together with accrued and unpaid interest and Liquidating Damages (as defined in the Indenture), if any, to the applicable redemption date.
If we experience specific kinds of change of control events, each holder of senior notes may require us to repurchase all or any portion of such holder’s senior notes at a purchase price equal to 101% of the principal amount of the senior notes, plus accrued and unpaid interest to the date of repurchase.
The Indenture contains covenants that, among other things, limit our ability to:
•
incur additional indebtedness, issue disqualified capital stock (as defined in the Indenture) and, in the case of our restricted subsidiaries, issue preferred stock;
•
create liens on our assets;
•
pay dividends on, redeem or repurchase our capital stock or make other restricted payments;
•
make investments in other companies;
•
enter into transactions with affiliates;
•
enter into sale and leaseback transactions;
•
sell or make dispositions of assets;
•
place restrictions on the ability of our restricted subsidiaries to pay dividends or make other payments to us; and
•
engage in certain business activities.
In addition, the Indenture contains a covenant restricting our capital expenditures relating to the build-out of new or additional parts of our network if such expenditures would result in us having less than $20 million in cash and cash equivalents.
The Indenture also contains customary events of default, including nonpayment of principal or interest, violations of covenants, cross default and cross acceleration to certain other indebtedness and material judgments and liabilities.
During 2007, we completed equipment financing of $4.1 million with a term of 24 months, which was utilized for the purchase of network equipment. The financing is secured by the network equipment purchased with the proceeds of the borrowing and bears interest at an effective annual rate of approximately 15.3% with monthly payments equal to 4.2% multiplied by the total amount borrowed. This financing is permitted under the Indenture governing the senior notes.
Capital Leases. We lease office and facilities space under leasing arrangements. We also have certain capital leases for customer premise equipment, telecom switching equipment, software, computers and office equipment.
Operating Leases. We lease office space, vehicles and other assets for varying periods. Leases that expire are generally expected to be renewed or replaced by other leases.
Maintenance Agreements. We have numerous agreements for the maintenance of leased fiber optic capacity.
Purchase Commitments: During January 2005, we entered into a minimum purchase agreement with a vendor for the purchase of $5.6 million of fiber optic equipment and installation and maintenance services through January 2008. During March 2008, we entered into Amendment No. 1 to the minimum purchase agreement extending the term of the purchase commitment through December 31, 2008. If we do not make the minimum purchases through the expiration or termination of this agreement, we will be required to pay a fee of 30% of the remaining unfulfilled amount. Purchases under this agreement were $1.0 million and $0.5 million during the years ended December 31, 2006 and 2007, respectively.
The following table represents the contractual obligations described above as of December 31, 2007:
Our plans with respect to network construction and other capital expenditures are discussed above under the caption “Capital Expenditures.” We believe those planned expenditures do not constitute contractual obligations or binding commitments because, in general, we have the ability to accelerate or postpone construction of our networks depending upon cash availability, subject to the need to eventually complete the network in accordance with our single-family residential development agreements.
We have also entered into several employment agreements with key executives of the Company. For a discussion surrounding the terms of these agreements, please refer to “Executive Compensation” under the caption “Employment Agreements, Severance Benefits and Change in Control Provisions”.
Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance with accounting principles that are generally accepted in the United States. To prepare these financial statements, we must make estimates, judgments and assumptions that we believe are reasonable based upon the information available. These estimates and assumptions affect the reported amounts of assets, liabilities, revenues and expenses as well as the disclosure of contingent assets and liabilities. We periodically evaluate our estimates and assumptions and base our estimates and assumptions on our best knowledge of current events and actions we may undertake in the future. Actual results may ultimately differ from these estimates. We believe that, of our significant accounting policies, the following may involve a higher degree of judgment and complexity.
Revenue Recognition
Revenue from residential and small and medium sized business customers is principally derived from bundled packages of video, voice, HSD and other services. Bundled services revenue consists of fixed monthly fees and usage based fees for long distance service and is recorded as revenue in the period the service is provided. Our revenues are recognized when services are provided, regardless of the period in which they are billed. Amounts billed in advance are reflected in the balance sheet as deferred revenue and are deferred until the service is provided. Installation revenues obtained from bundled service connections are recognized in accordance with SFAS No. 51, Financial Reporting by Television Cable Companies, as the connections are completed since installation revenues recognized are less than the related direct selling costs. Installation costs are included in property, plant, and equipment and depreciated over the estimated life of communications plant. Local governmental authorities impose franchise fees on the majority of our franchises of up to a federally mandated maximum of 5% of annual gross revenues derived from the operation of the cable television system to provide cable television services, as provided in the franchise agreements. Such fees are collected on a monthly basis from our customers and periodically remitted to local franchise authorities. Franchise fees collected and paid of approximately $2.2 million, $2.5 million, and $2.9 million during the years ended December 31, 2005, 2006, and 2007, respectively, are reported as revenues and cost of revenues, respectively. The Federal Communications Commissions imposes a tax on long distance calls to fund telephone service for the poor, and to support telecommunications services for libraries, schools, and rural health care providers. Such taxes are collected on a monthly basis from our customers and periodically remitted to the Universal Service Fund (“USF”). Sales and other taxes imposed by governmental authorities are also collected on a monthly basis from our customers and periodically remitted to governmental authorities. Revenue is presented net of the applicable USF, sales and other taxes.
Revenue from broadband transport services is principally derived from providing medium and large enterprises and communication carriers with access to our metro area networks and point-to-point circuits on our long-haul fiber optic network. Revenue from network services is principally derived from switched carrier services and managed modem services. Broadband transport and network services revenue consists of fixed monthly fees and usage based fees and is recorded as revenue in the period the service is provided. Amounts billed in advance are reflected in the balance sheet as deferred revenue and are deferred until the service is provided. Revenue also includes upfront non-recurring fees for construction, installation and configuration services that are deferred and recognized over the related service contract period.
In instances where multiple deliverables are sold contemporaneously to the same counterparty, we follow the guidance in EITF Issue No. 00-21, Revenue Arrangements with Multiple Deliverables, and SEC Staff Accounting Bulletin No. 104, Revenue Recognition. Specifically, if the Company enters into sales contracts for the sale of multiple products or services, then the Company evaluates whether it has objective fair value evidence for each deliverable in the transaction. If the Company has objective fair value evidence for each deliverable of the transaction, then it accounts for each deliverable in the transaction separately, based on the revenue recognition policies outlined above. The residual method is used when no fair value is available for the deliverable. For example, this would occur when the Company enters into an agreement for service that includes the Company providing equipment in connection with the service and the subscriber paying an installation fee as well as monthly charges. Because the Company is providing both a product and a service, revenue is allocated to the product and monthly subscription service based on relative fair value and revenue is allocated to installation services using the residual method. To date, product revenues have not been significant.
Classification of Various Direct Labor and Other Overhead Costs
Our business is capital intensive, and large portions of our financial resources are spent on capital activities associated with building our networks. We capitalize costs associated with network construction, initial customer installations, installation refurbishments and the addition of network equipment necessary to enable provision of bundled or network services. Capitalized costs include materials, direct labor costs and certain indirect costs. We capitalize direct labor costs associated with our personnel based upon the specific time devoted to construction and customer installation activities. Capitalized indirect costs are those relating to the activities of construction and installation personnel and overhead costs associated with the relevant support functions. Costs for repairs and maintenance, and disconnection and reconnection, are charged to operating expense as incurred, while equipment replacement is capitalized.
Judgment is required to determine the extent to which indirect costs, or overhead, are incurred as a result of specific capital activities, and therefore should be capitalized. We allocate overhead based upon the portion of indirect costs that contribute to capitalizable activities using an overhead rate, based on an actual rate, applied to the amount of direct labor capitalized based upon our analysis of the nature of costs incurred in support of capitalizable activities. The primary costs that are included in the determination of overhead rates are (i) employee benefits and payroll taxes associated with capitalized direct labor, (ii) direct variable costs associated with capitalizable activities, consisting primarily of installation and construction vehicle operating costs, (iii) the cost of support personnel, such as personnel who directly assist with capitalizable installation activities, and (iv) indirect costs directly attributable to capitalizable activities. For 2005, 2006 and 2007, $10.6 million, $8.3 million and $8.5 million of labor and overhead costs were capitalized, respectively. Capitalized costs are depreciated along with the physical assets to which they relate, which have lives of three to ten years depending on the type of asset.
Valuation of Long-Lived Assets and Intangible Assets
We evaluate the recoverability of property, plant and equipment for impairment when events or changes in circumstances indicate that the net book value of an asset may not be recoverable. Such events or changes in circumstances could include such factors as loss of customers accounting for a high percentage of revenues from particular network assets, changes in technology, fluctuations in the fair value of assets, adverse changes in market conditions or poor operating results. When such factors and circumstances exist, we compare the projected undiscounted future cash flows associated with the related asset or group of assets over their estimated useful lives against their respective carrying amounts. Impairment, if any, is based on the excess of the carrying amount over the fair value of those assets and is recorded in the period in which the determination was made. While we believe that our estimates of future cash flows are reasonable, different assumptions regarding such cash flows could materially affect our evaluation of asset recoverability.
Allowance for Doubtful Accounts
Accounts receivable are recorded at their net realizable values. The Company uses estimates to determine the allowance for doubtful accounts and records an accounts receivable reserve for known collectibility issues, as such issues relate to specific transactions or customer balances. These estimates are based on historical collection experience, current trends, credit policy and a percentage of the Company’s customer accounts receivable. In determining these percentages, the Company looks at historical write-offs of the receivables. The Company writes off accounts receivable when it becomes apparent based upon age or customer circumstances that such amounts will not be collected.
Stock Based Compensation
Prior to the adoption of SFAS 123(R), on January 1, 2006 we measured compensation costs for options issued or modified under our stock-based compensation plans using the intrinsic-value method of accounting. Under the intrinsic-value method, we recorded deferred compensation expense for stock options awarded to employees and directors to the extent that the option exercise price was less than the fair market value of common stock on the date of grant.
On January 1, 2006 we adopted the fair value recognition provisions of SFAS 123(R). We apply the provisions of SFAS 123(R) to new stock option grants and to stock option grants that are modified, repurchased or cancelled subsequent to January 1, 2006 using the prospective method of transition. Compensation expense calculated under SFAS 123(R) is amortized to compensation expense on a straight-line basis over the vesting period of the underlying stock option grants. We will continue to apply the intrinsic-value method to determine compensation expense for stock options granted prior to the adoption of SFAS 123(R).
Determining the appropriate fair value model and calculating the fair value of share-based payment awards requires the input of highly subjective assumptions, including the expected life of the share-based payment awards and stock price volatility. We use the Black-Scholes-Merton model to value our stock option awards. The assumptions used in calculating the fair value of share-based payment awards represent management’s best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change and management uses different assumptions, share-based compensation expense could be materially different in the future. Because our shares are not traded on a public market, we use comparable companies as a basis for our expected volatility. This may materially impact the fair value of stock option grants. In addition, we are required to estimate the expected term and forfeiture rate and only recognize expense for those shares expected to vest. If the actual forfeiture rate is materially different from the estimate, share-based compensation expense could be significantly different from what has been recorded in the current period.
The foregoing list is not intended to be a comprehensive list of all of our accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by accounting principles generally accepted in the United States, with no need for us to judge the application. There are also areas in which our judgment in selecting any available alternative would not produce a materially different result.
Recent Accounting Pronouncements
Business Combinations
In December 2007, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 141 (Revised 2007), Business Combinations (“SFAS 141(R)”). SFAS 141(R) will significantly change the accounting for business combinations. Under SFAS 141(R), an acquiring entity will be required to recognize all the assets acquired and liabilities assumed in a transaction at the acquisition-date fair value with limited exceptions. SFAS 141(R) will change the accounting treatment for certain specific acquisition related items including: (1) expensing acquisition related costs as incurred; (2) valuing noncontrolling interests at fair value at the acquisition date; and (3) expensing restructuring costs associated with an acquired business. SFAS 141(R) also includes a substantial number of new disclosure requirements. SFAS 141(R) is to be applied prospectively to business combinations for which the acquisition date is on or after January 1, 2009. We expect SFAS 141(R) will have an impact on our accounting for future business combinations once adopted but the effect is dependent upon the acquisitions that are made in the future.
Fair Value Measurements
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value in applying generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 applies whenever an entity is measuring fair value under other accounting pronouncements that require or permit fair value measurement. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, however the FASB provided a one year deferral for implementation of the standard for non-financial assets and liabilities. We do not expect the adoption of SFAS 157 to have a material impact on our consolidated financial statements.
In February 2006, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115 (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. SFAS 159 does not affect any existing accounting literature that requires certain assets and liabilities to be carried at fair value. SFAS 159 was effective for us on January 1, 2008. We did not apply the fair value option therefore; SFAS 159 did not have an impact on our consolidated financial statements.
ITEM 7A.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to market risk relates primarily to changes in interest rates on our investment portfolio. Our marketable investments consist primarily of short-term fixed income securities. We invest only with high credit quality issuers and we do not use derivative financial instruments in our investment portfolio. We do not believe that a significant increase or decrease in interest rates would have a material impact on the fair value of our investment portfolio.
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Item 8 is incorporated by reference to pages through herein.
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer, who is our principal executive officer, and our Chief Financial Officer, who is our principal financial officer, have evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) or Rule 15d-15(e), as applicable, under the Securities Exchange Act of 1934) as of December 31, 2007. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to Grande, including its consolidated subsidiary, required to be included in this report and the other reports that we file or submit under the Securities Exchange Act of 1934.
During 2007, there was no change in our internal controls over financial reporting that has materially affected, or is likely to materially affect, our internal controls over financial reporting.
In designing and evaluating the disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable, not absolute, assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based upon the above evaluation, we believe that our controls provide such reasonable assurances.
Management’s Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f). Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2007 based on the framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on that evaluation, our management concluded that our internal control over financial reporting was effective as of December 31, 2007.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit us to provide only management’s report in this annual report.
ITEM 9B.
ITEM 9B.
OTHER INFORMATION
None
PART III
ITEM 10.
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Directors
The following table sets forth the name and age of each director, indicating all positions and offices with our Company currently held by the director as well as the term of office for each director (1):
____________________________
(1)
James M. Mansour served as Chairman of the board of directors from January 2005 until his resignation in January 2008.
(2)
Member of the audit committee.
(3)
Member of the compensation committee.
(4)
Member of the finance committee.
(5)
Member of the nominating committee.
(6)
Audit committee financial expert.
(7)
Chairman of the audit committee.
(8)
Term expires at 2008 shareholders’ meeting.
(9)
Term expires at 2009 shareholders’ meeting.
(10)
Term expires at 2010 shareholders’ meeting.
Set forth below are descriptions of the backgrounds of each of our directors.
Roy H. Chestnutt joined Grande as our Chief Executive Officer in February 2006 and has served as a member of our board of directors since February 2006. In June 2006, Mr. Chestnutt was appointed President of the Company in addition to his role as Chief Executive Officer. In January 2008, Mr. Chestnutt was appointed Chairman of the board of directors upon James Mansour’s resignation. Prior to joining Grande, Mr. Chestnutt was the Senior Vice President of National Field Sales and General Business for Sprint-Nextel. He was responsible for the General Business segment, which focuses on nationwide wireline and wireless operations of direct sales channels, value-added resellers (VARs), business solutions partners, sales operations and pre-sale support. Before Nextel merged with Sprint, Mr. Chestnutt held positions at Nextel Communications as Regional Vice President of the Southwest in Austin and of the West in the San Francisco Bay Area from 2002 to 2006. He also served as President of the Texas/Oklahoma area from its Austin offices. Mr. Chestnutt also has general management experience with PrimeCo Personal Communications and AirTouch Cellular. Mr. Chestnutt earned an MBA from the University of San Francisco with an emphasis in General Management and International Business and a BS in Business Administration from San Jose State University with a focus in marketing.
Lawrence M. Schmeltekopf was appointed as a member of our board of directors and as Chairman of the audit committee of the board of directors in June 2006. Mr. Schmeltekopf currently serves as Assistant Controller-Accounting and Internal Reporting at Valero Energy Corporation, a Fortune 500 energy company based in San Antonio, Texas, and has held this position for five years. Prior to working for Valero, from 2000 to 2002, Mr. Schmeltekopf was an audit partner in the Austin office of Arthur Andersen LLP and was the audit engagement partner on the Company’s audit by Arthur Andersen in 2000 and 2001. Mr. Schmeltekopf received his BBA from Texas State University and is a Certified Public Accountant.
Richard W. Orchard was appointed as a member of our board of directors in October 2006. From November 2004 to September 2006, Mr. Orchard served as Chief Transition Officer for Sprint-Nextel where he managed all aspects of the $36 billion dollar merger between Sprint and Nextel. Prior to the Sprint-Nextel merger, he was with Nextel for over ten years, serving as Eastern Regional President and during his last four years as a Senior Vice President and Chief Service Officer. Prior to joining Nextel in 1994, Mr. Orchard spent over 10 years with PacTel/Airtouch and 5 years with Motorola Communications. Mr. Orchard also currently serves on the board of directors of Peco II, a telecom power equipment manufacturer and National Safeplace, a nationwide outreach for at-risk kids. Mr. Orchard received a BA in Political Science from the University of California, Santa Barbara.
John C. Hockin has served as a member of our board of directors since November 2002. Mr. Hockin has been a Portfolio Manager (and co-founder) of Whitney Green River Fund, L.P. since November 2004. Prior to that, he was an investment professional at J.H. Whitney & Co. since 1999. Mr. Hockin received his BA from Yale and his MBA from the Stanford Business School.
David C. Hull, Jr. has served as a member of our board of directors since February 2000. Since 1993, Mr. Hull has been a managing director of Centennial Ventures. From 1986 to 1993, Mr. Hull served as general partner, during which time he was promoted to managing general partner, of Criterion Venture Partners, the venture arm of TransAmerica. Prior to joining Criterion, from 1976 to 1985 he was senior vice president of finance, treasurer and director of General Leisure Corporation, a restaurant and hotel operating company, and a vice president of Texas Capital Corporation, a small business investment company. Mr. Hull currently serves on the board of directors of Centennial Holdings I, LLC, Augmentix Corporation and ExteNet Systems, Inc. Mr. Hull received his BS in Chemical Engineering and his MBA from The University of Texas at Austin.
Duncan T. Butler, Jr. has served as a member of our board of directors since February 2000. Since April 2000, Mr. Butler has served as a managing director of Centennial Ventures and he has served as a managing director of Prime New Ventures since October 1994. Mr. Butler currently also serves on the board of directors of Masergy Communications, Inc., a global network service provider and Hoak Media, a television and radio broadcasting company. Mr. Butler received his BBA and his MBA from The University of Texas at Austin and his JD from The University of Texas School of Law.
William Laverack, Jr. has served as a member of our board of directors since May 2001. Mr. Laverack is a managing director of J. H. Whitney & Co., which he joined in 1993, and managing partner of Laverack Capital Partners, LLC, which he founded in 2005. Mr. Laverack received his BA and MBA from Harvard University.
Executive Officers
The following table sets forth the name and age of each named executive officer, indicating all positions and offices with our Company currently held by the executive officer (1):
____________________________
(1)
William C. “Chad” Jones, Jr. served as Chief Service Officer until January 2008.
Set forth below are descriptions of the backgrounds of each of our executive officers, other than Mr. Chestnutt, whose position and background is described above.
Michael L. Wilfley has served as our Chief Financial Officer since July 2000. Mr. Wilfley has over 20 years experience as a chief financial officer, including seven years as a chief financial officer in the telecommunications industry. Previously, from 1998 to 2000, Mr. Wilfley was the chief financial officer of Thrifty Call, Inc., a telecommunications company, where he was responsible for the capital markets and mergers and acquisitions efforts that led to our eventual acquisition of Thrifty Call. Prior to working for Thrifty Call, from 1993 to 1997, Mr. Wilfley served as the chief financial officer for Littlefield Real Estate Co., a private investment company. Mr. Wilfley serves on the board of directors of Littlefield Corporation. Mr. Wilfley is a certified public accountant and a graduate of The University of Texas at Austin.
W.K.L. “Scott” Ferguson, Jr. has served as our Chief Operating Officer since February 2006. Prior to that, from July 2005 to February 2006, he served as Interim Chief Executive Officer and President, and from June 2002 to January 2005, Executive Vice President, Retail Services and from February 2000 to June 2002 as Chief Operating Officer. Previously, from 1997 to 1999, Mr. Ferguson was a founding partner and senior vice president of PrimeOne, L.P., a broadband video services company. At PrimeOne, Mr. Ferguson was involved with operating, sales and customer service strategy for BellSouth, SBC Communications, Inc. and Southern New England Telephone Corporation broadband trials and businesses. Prior to working at PrimeOne, Mr. Ferguson served in various capacities at Prime Cable, a cable multiple systems operator based in Austin, Texas, including vice president of administrative services and vice president of operations. Prior to Prime Cable, Mr. Ferguson worked for Tenneco, Inc. in the corporate finance and investor relations groups as well as Arthur Young & Co. where he focused in tax practice. He is a certified public accountant and a graduate of The University of Texas at Austin, where he earned his BBA degree in Finance and an MBA in Accounting and Finance.
Jeffrey A. Brennan has served as our Senior Vice President of Business Services since April 2006. Mr. Brennan is responsible for leading Grande’s network services and enterprise sales departments, and engineering and network operations. Prior to joining Grande, Mr. Brennan served as Vice President of Sprint’s Public Sector for the West Region from 2005 to 2006 and was Area Vice President for Nextel’s Pacific Northwest, from 2002 to 2005. He has worked for several companies in the telecommunications industry including Primeco, US West and Verizon/GTE. He began his career at Verizon/GTE as a telephone traffic engineer and then held positions in network planning, sales operations, product management and national account sales. At Verizon/GTE, Mr. Brennan was responsible for marketing and planning for sales of private line and switched services for a national fiber optic and satellite network serving the North American and Caribbean markets. Mr. Brennan earned a MBA and a BBA in Management from Angelo State University. He also holds a Radio Communication Technology degree from the Community College of the Air Force.
Contractual Provisions Relating to Grande’s Board of Directors
In November 2005, certain stockholders and Grande entered into an investor rights agreement under which those stockholders agreed to vote all of their Grande capital stock in favor of certain designees to the board of directors. The board of directors currently consists of seven members and, under the investor rights agreement, may consist of no more than ten directors. Currently, six of our directors were elected in accordance with designations made under the terms of the investor rights agreement. Under the terms of the investor rights agreement, Robert Hughes, representing the Robert W. Hughes Charitable Remainder Trust No. 1, has the right to designate one member of the board as designated by the common stockholders. The holders of our Series A preferred stock have the right to designate five representatives to Grande’s board of directors, with two of the five to be designated by Centennial Fund VI, L.P., on behalf of itself and the other Centennial entities that are Grande stockholders, and two of the five to be designated by J. H. Whitney IV, L.P. and its affiliates that are Grande stockholders. The holders of our Series D preferred stock and Series E preferred stock together as a single class have the right to designate one representative to Grande’s board of directors. The nominating committee has the right to select a representative to Grande’s board of directors, who must be approved by the board of directors and the holders of a majority of Grande’s capital stock, other than the stock held by the founders of Grande identified in an exhibit to the investor rights agreement. The person serving as Grande’s president or chief executive officer will also serve on Grande’s board of directors.
Centennial has designated one of our current directors, Mr. Hull, and Whitney has designated two of our current directors, Messrs. Laverack and Hockin. Mr. Schmeltekopf is the director designated by the holders of the Series A preferred stock; Mr. Butler is the director designated by the holders of the outstanding Series D preferred stock and the Series E preferred stock; until his resignation in January 2008, Mr. Mansour served as the director selected by the nominating committee of the board of directors; Mr. Chestnutt is our president and chief executive officer; and Mr. Orchard holds a seat on the board of directors that is not required to be designated in accordance with the investor rights agreement. The right of Centennial and Whitney each to continue to designate one of their two designees to the board of directors is subject to these entities continuing to maintain certain minimum ownership percentages in our Company. If Centennial and Whitney fail to maintain such investment, then the holders of a majority of Series A preferred stock, voting together as a single class, will have the right to designate the two designees, resulting in their having the right to designate a total of three designees to the board of directors.
Pursuant to the investor rights agreement, to the extent that a holder of at least 15 million shares of preferred stock does not have a representative on our board of directors, such holder has the right to designate a non-voting observer to attend meetings of the board of directors. The right of observers to attend meetings of the board of directors is subject to exclusion required to protect confidential information or to preserve and protect the attorney-client privilege. We require all board observers to execute a confidentiality agreement on customary terms with respect to all non-public information that they receive or are given access to as a result of their attendance at board meetings.
Under the investor rights agreement, our board of directors must meet at least six times a year and must maintain nominating, audit and compensation committees. The audit committee may not include any representatives of our management. The nominating and compensation committees must include at least one of Centennial’s directors and at least one of Whitney’s directors, and the directors designated by the holders of Series A preferred stock must comprise a majority of the members of such committees.
Director Independence
Although we have no formal written director independence standards, in February 2008, our board of directors analyzed the independence of all members of the board at that time and determined that all six members who are not officers of the Company were deemed to be independent as that term is defined under the listing standards of the NASDAQ Global Select Market. The board of directors also determined that all members of the audit committee met the additional independence requirements of the applicable SEC rules regarding audit committee membership. In addition, the board of directors determined that all members of the compensation committee and the nominating committee met the independence requirements of the NASDAQ Global Select Market. We believe that the Company’s ratio of independent directors represents a commitment to the independence of the board and a focus on matters of importance to our stockholders.
Board Committees
Grande’s board of directors has established and maintains audit, compensation, nominating and finance committees.
The audit committee, currently consisting of Messrs. Schmeltekopf, Hull and Orchard, all of whom are independent directors, is responsible for appointing the firm to serve as independent accountants to audit Grande’s financial statements. The audit committee then discusses the scope and results of the audit with the independent accountants and reviews with the independent accountants and management Grande’s interim and year-end operating results. In addition to these activities, the audit committee considers the adequacy of internal accounting controls and audit procedures and approves all audit and non-audit services to be performed by the independent accountants. Mr. Schmeltekopf serves as the Chairman of the audit committee and is the “audit committee financial expert” as defined by SEC rules. The committee charter is available on our website at www.grandecom.com/about_Grande/investor_relations/corporate_governance.php.
The compensation committee oversees the establishment of the compensation policies applicable to management and administers Grande’s stock option plan. The compensation committee currently consists of Messrs. Butler, Hull and Laverack. The committee charter is available on our website at www.grandecom.com/about_Grande/investor_relations/corporate_governance.php.
Although no formal written policies and procedures are in place other than the compensation committee charter, the compensation committee is responsible, among other things, for:
•
establishing the salary scale of officers and employees of the Company;
•
examining periodically the compensation structure of the Company;
•
monitoring the health and welfare benefit and compensation plans of the Company;
•
determining the Annual Cash Incentive Plan; and
•
approval of equity incentive awards.
The compensation committee has the sole authority to discharge its responsibilities, including, requesting appropriate funding from the Company to compensate any advisor retained by the compensation committee. The compensation committee may delegate all or a portion of its duties and responsibilities to a board of director subcommittee. Additionally, the compensation committee may direct management to assist the committee in any of its duties. The compensation committee has not engaged any compensation consultants in setting executive compensation.
The nominating committee recommends individuals to serve on the board of directors. The nominating committee currently consists of Messrs. Hull, Laverack and Orchard. The nominating committee does not have a policy with regard to the consideration of any director candidates recommended by security holders because that process is governed by the terms of the investor rights agreement described above under “Contractual Provisions Relating to Grande’s Board of Directors.”
The finance committee makes recommendations to the board of directors regarding plans for expenditures by the Company. The finance committee also recommends an annual budget to the board of directors, advises the board of directors regarding the need for financing and makes recommendations regarding the terms of such financing and asset management in connection with the raising of funds. The finance committee currently consists of Messrs. Butler, Laverack and Schmeltekopf.
Compensation Committee Interlocks and Insider Participation
No member of the compensation committee was at any time during 2007 an officer or employee of Grande and no member had any relationship with Grande requiring disclosure as a related-party transaction in the section entitled “Certain Relationships and Related Transactions, and Director Independence.” No executive officer of Grande has served on the board of directors or compensation committee of any other entity that has or has had one or more executive officers who served as a member of the board of directors or the compensation committee during 2007.
Code of Ethics
We have adopted a code of ethics that applies to all of our employees including our executives, chief executive officer and chief financial officer. For a copy of our code of ethics contained in our corporate compliance policy, please visit our website at www.grandecom.com/about_Grande/investor_relations/corporate_governance.php. We will disclose changes to or waivers of the code of ethics on this website.
ITEM 11.
ITEM 11.
EXECUTIVE COMPENSATION
Compensation Discussion and Analysis
We provide a total compensation program that we believe will be perceived by both our employees and our stockholders as fair and equitable. In addition to conducting analyses of market pay levels and considering individual circumstances related to each executive officer, we also consider the pay of each executive officer relative to our other executive officers and with respect to the role and responsibilities of the position held. We have designed the total compensation program to be consistent for our executive management team and, primarily, without regard to level of employment.
The purpose of our compensation program is to reward and sustain exceptional organizational and individual performance. This Compensation Discussion and Analysis explains our compensation philosophy and objectives, compensation policies and practices, and elements of our compensation program with respect to our chief executive officer, chief financial officer, and the other three most highly compensated executive officers, collectively referred to as the named executive officers (“NEOs”).
Compensation Philosophy and Objectives
Grande’s compensation philosophy is to provide an attractive, flexible, and market competitive total compensation program tied to performance and aligned with stockholder interests. We believe that total compensation includes everything the employee perceives to be of value resulting from the employment relationship and that will motivate the employee to perform.
We consider the following objectives in setting the compensation components for our executive officers:
•
design competitive total compensation and rewards programs to enhance our ability to attract and retain experienced executives, whose knowledge, skills and performance are critical to our success;
•
set compensation and incentive levels that are competitive with our peer group, as described below;
•
drive and reward performance that supports the Company’s financial and strategic goals;
•
provide a significant percentage of total compensation that is “at-risk”, or variable, based on predetermined performance criteria;
•
align the interests of our executive officers and stockholders by motivating executive officers to increase stockholder value through equity incentives in the form of stock options;
•
ensure fairness among the executive management team by recognizing the contributions each executive makes to our success; and
•
foster a shared commitment among executives by coordinating the Company, their team and individual goals.
In establishing compensation that we believe is competitive, we review the compensation practices and market data of companies with revenue and company size similar to ours both within our industry and as applicable to general industry groups, which we refer to as our “peer group”. We have chosen to benchmark our compensation against our peer group to ensure internal equity and consistency with external market practices. To identify our peer group, we participate in salary surveys from time to time to gain access to various survey data. We utilize two different compensation analysis tools to assist us in this process for our executive positions: The Thobe Group survey and Salary.com’s Executive Compensation Database.
The Thobe Group survey is a national telecom industry specific survey tool. Companies participating in this survey include:
Broadwing Communications
Citizens Communications
Integra Telecom CLEC
Cablevision
HickoryTech
Mpower Communications
Charter Communications
Integra Telecom ILEC
Pac-West Telecomm, Inc.
Covad
QWEST
RCN Corporation
Cox Communications, Inc.
AT&T Inc.
TDS Metrocom
Global Crossing, Inc.
TDS Telecommunications, Inc.
TelCove
ALLTEL Corporate
Verizon Communications
Time Warner Telecom
ALLTEL Wireline
Birch Telecom
PAETEC
CenturyTel, Inc.
Enventis Telecom
XO Communications
Cincinnati Bell
IBasis
Williams Communications Group
Salary.com is a national compensation benchmark subscription service with over 7,000 subscribers consisting of over 10 million employees that offer real time survey information on general industry positions that can be searched by revenue and company size. Salary.com combines one of the largest databases of U.S. public company executives with on-demand software to create a leading source of executive and director compensation information. Because survey participation is confidential, specific companies in our peer group are not identifiable.
The comparative peer group data is used to help determine fair and equitable base salary adjustments each year when budgeting for merit increases and salary adjustments, as necessary. The peer group comparison is taken into consideration along with individual and company performance to determine the final merit and/or salary adjustment, if any. Although the peer group data is used to determine base pay changes as defined above, ultimately discretion is used by the compensation committee and Grande’s chief executive officer for the final determination of a salary change, based on the benchmark data, company and individual performance. The peer group benchmarks chosen for consideration are those relative to our industry and size, and are primarily used for base pay considerations, but also serve to assess the continued competitiveness of the NEOs’ total cash compensation package.
Executive Compensation Policies and Practices
Our compensation committee, which is composed of three non-management independent directors, oversees the establishment and the administration of the compensation policies applicable to our NEOs and administers our stock incentive plan. Annually, the compensation committee reviews recommendations and approves base pay changes and bonus distributions for Grande’s chief executive officer. Benchmark data, as well as individual and company performance is taken into consideration at this time. Additionally, the compensation committee will review base pay changes and bonus distribution recommendations made by Grande’s chief executive officer for the other NEO’s, when it is outside the scope of the NEO’s employment agreement, where applicable (not all NEO’s have an employment agreement). For NEO’s who have written contracts, any changes or amendments to the agreement will be ratified by the compensation committee. For more information on our compensation committee, including information on the scope of its authority, please see “Board Committees” above. The compensation committee has adopted the material policies described below related to executive compensation, as documented in the Company’s total compensation program for all employees, to provide consistency in the application of compensation across all grades levels and to help maintain internal and external equity. These policies and practices are evaluated by management and reviewed by the compensation committee on an annual basis for effectiveness through benchmark survey participation and data analysis, employee retention results and internal survey findings.
Allocation between currently paid out and long term compensation. The compensation we currently pay consists of base pay and annual cash incentive compensation pursuant to our Annual Cash Incentive Plan. Long-term compensation consists entirely of awards of stock options pursuant to our stock incentive plan. We grant stock options as a long-term incentive and retention tool. The allocation between long-term and currently paid out compensation is based on consideration of how our peer group uses long-term and currently paid compensation to pay their executive officers as well as internal equity between established pay grades.
Allocation between cash and non-cash compensation. It is our policy to allocate all currently paid compensation in the form of cash and all long-term compensation in the form of awards of options to purchase our common stock and Series H preferred stock to provide a long-term retention incentive. We consider competitive market practices and internal equity considerations when determining the allocation between cash and non-cash compensation.
Health and Welfare Programs. It is our policy that there shall be no material difference in the health and welfare benefit offerings made to our executive management and those that are offered to all employees of the Company.
Elements of Executive Compensation
We provide what we believe is a competitive total compensation package to our NEOs through a combination of base salary, an annual cash incentive plan, an equity incentive plan and broad-based benefits programs.
Overall, our compensation programs are designed to be consistent with the philosophy and objectives set forth above. The basic elements of our compensation programs are summarized in the table below, followed by a more detailed discussion of each total compensation component.
All pay elements are cash-based except for the equity incentive program, which is an equity-based (stock options) award. We consider market pay practices and practices of our peer group in determining the amounts to be paid, what components should be paid in cash versus equity, and how much of a NEO’s compensation should be short-term versus long-term. Our goal is to be at or around the 50th percentile of our peer group for cash compensation. All benchmark goals are discretionary.
Our executive officers, including the NEOs, are assigned to pay grades, determined by comparing position-specific roles and responsibilities with the market pay data and our internal structure. Each pay grade has a base salary range with corresponding cash and equity incentive award opportunities. We believe this is the most transparent and flexible approach to achieve the objectives of our executive compensation program.
In general, compensation or amounts received by executives from prior compensation from us are not taken into account in setting other elements of compensation, such as base pay, cash incentive plan payments, or awards of stock options under our equity incentive program. With respect to new executive officers, we take into account their prior base salary and annual cash incentive, as well as the contribution expected to be made by the new executive officer, our business needs and the role of the executive officer with the Company. As with all of our employees, we believe that our executive officers should be fairly compensated, which we believe includes the 50th percentile of our peer group, each year relative to market pay levels of the external peer group and internal equity among executive officers.
There are no differences in how targets are set or the compensation philosophy and objectives among the NEOs. The elements of the compensation package are different among the NEOs, including Grande’s chief executive officer, based on the existence of an individual employment agreement for certain NEOs. The primary difference between NEOs with an employment agreement and those without an employment agreement is the severance benefit guarantee and the level of benefit within the specific compensation element (i.e. cash incentive percentage). Additionally, the level of approval required for compensation changes is different for Grande’s chief executive officer and other NEOs.
The decision to award changes in one element, for instance, base salary, did not affect any changes that may have been made in another, for instance stock option incentives. Awarding a base salary increase and equity incentives are the most likely scenario where one decision may impact the other, however, that has not yet been the case at Grande. Health and welfare plans and 401(k) matching are administered evenly to all employees, without regard to level, across the Company.
Base Salary
We review salary ranges and individual salaries for all employees, including our NEOs, on an annual basis. We review the base salary for each executive officer based on consideration of median pay levels of our peer group and internal factors such as the individual’s performance and experience, the position’s scope and responsibilities, and the pay of other officers.
We consider market median pay levels (the 50th percentile) among individuals in comparable positions with transferable skills within our peer group as described above.
We also consider the following when establishing or adjusting the base salary of any executive officer:
•
Our business need for the executive officer’s skills;
•
The contributions that the executive officer has made or we believe will make to our success;
•
The transferability of the executive officer’s managerial skills to other potential employers;
•
The relevance of the executive officer’s experience to other potential employers, particularly in the telecommunications industry; and
•
The readiness of the executive officer to assume a more significant role with another potential employer.
We believe a competitive base salary is necessary to attract and retain an executive management team with the appropriate abilities and experience required to lead us. Specifically, we target the market median (50th percentile) of our peer group base salary, while total compensation is targeted at or around the 75th percentile of our peer group, considering individual performance and experience, in order to ensure that each executive is appropriately compensated. The 50th and 75th percentiles are determined by assessing market competitive compensation data as described above.
The base salaries earned by our NEOs are set forth below in the Summary Compensation Table. During the year ended December 31, 2007, total compensation earned by our NEOs was approximately $1.9 million, with our chief executive officer earning approximately $0.7 million of that amount. We believe that the base salary earned by our executive officers during 2007 achieved our executive compensation objectives, compares favorably to published survey data of peers within our industry and general industry, and are within our target of providing a base salary at or around the market median for our company size.
In 2007, adjustments to our NEOs’ compensation were made based on a review of current market pay levels benchmarked in the published surveys described above. In addition to the benchmark survey data, factors taken into account in making any changes for 2007 included the performance of the NEO, as identified by our company results, the role and responsibilities of the executive officer, and the relationship of the NEO’s base salary to the base salary of our other executives.
Annual Cash Incentive Plan
We have established a written Annual Cash Incentive Plan pursuant to which our executive officers, including our NEOs, are eligible to receive an annual cash incentive payment based upon our performance against annual established performance targets, including financial measures and other factors such as individual performance. We believe that the Annual Cash Incentive Plan helps focus our executive officers’ efforts and reward NEOs for annual operating results that help create value for our stockholders. The Annual Cash Incentive Plan is presented to the compensation committee for review, and ultimately to the board of directors for their approval with such modifications deemed appropriate by the board of directors. For 2007, the Annual Cash Incentive Plan was based on a percentage of base salary subject to the Company’s performance exceeding the Adjusted EBITDA goal. The incentive plan targets for the Annual Cash Incentive Plan are determined during our annual planning process, which generally begins in October preceding the following fiscal year for which targets for the Annual Cash Incentive Plan are set. We have chosen Adjusted EBITDA as the goal because we believe that achieving our Adjusted EBITDA goal each year requires the concerted effort and teamwork of many different functions within Grande under the oversight of the NEOs. It is also heavily impacted by the dynamic, highly competitive and regulated nature of our industry and the markets within which we operate. To achieve our annual company goal is, therefore, a stretch goal for our executive team. See “Management’s Discussion and Analysis of Financial Conditions and Results of Operations” under the heading “EBITDA/Adjusted EBITDA” for a discussion of this non-GAAP measure of our operating performance as well as our use of Adjusted EBITDA. When our performance exceeds the Adjusted EBITDA threshold, funds are set-aside into a bonus pool for distribution to our NEOs and other eligible employees. Funds continue to accumulate in the bonus pool until the maximum potential performance payout for all NEOs and other eligible employees is met. The compensation committee may exercise discretion by adjusting awards based on its consideration of each NEO’s individual performance, and for each NEO other than the chief executive officer, based on a review of such NEO’s performance as communicated to the compensation committee by the chief executive officer. Executive performance is reviewed against the budgeted financial goals as well as internal goals set in support of the financial goals such as operational efficiency goals or employee retention goals. The goals are mutually agreed upon by and between the chief executive officer, the individual executive and the executive team. The chief executive officer’s performance is evaluated by the compensation committee based on overall company performance against the budgeted financial goals as approved by the board of directors. The Annual Cash Incentive Plan awards for all executive officers, including the NEOs, must be reviewed and recommended by the compensation committee for approval and ultimately must be approved by the board of directors before being paid. The compensation committee and the board of directors may modify the Annual Cash Incentive Plan awards prior to their payment.
Incentive award opportunities are targeted to result in Cash Incentive Plan payments comparable to the market median (50th percentile) of the external peer group assuming our target business objectives are achieved. If the target level for the performance goals is exceeded, executives and other eligible employees have an opportunity to earn cash incentive awards above the median of the market of our peer group. We have chosen the 50th percentile because we believe that it allows us to attract and retain executives, and we have chosen the 75th percentile as a target for exceptional performance because we believe it will provide an appropriate incentive for striving to earn better than average cash compensation. If the target level for the performance goal is not achieved, executives and other eligible employees earn no cash incentive plan payments. In 2007, our NEOs did not meet the target performance goal, which resulted in no cash incentive payment under the Cash Incentive Plan. However, a reward in the form of a discretionary cash incentive payment, outside the Cash Incentive Plan, and as authorized by the compensation committee and approved by the board of directors, was made to all eligible employees including the NEOs.
Equity Incentive Plans (Stock Options)
We believe that equity incentive awards are the best way to create incentives and reward the performance of our employees, including our NEOs, which improves the Company’s performance and increases shareholder value thereby strengthening the mutual interests between NEOs and shareholders. By providing equity awards to our NEOs, they are not only rewarded for past performance but also have long-term incentive to continue to promote the Company’s success.
We have utilized stock options as the form of our equity incentives. We chose stock options because we believe that stock options align employee incentives with the interests of our stockholders because options have value only if the value of our stock increases over time. The compensation committee makes discretionary stock option grants to NEOs of the Company based on a number of factors including each NEO’s personal performance ; the importance of the individual to the future success of the Company; and overall contribution to the Company’s success, all as determined by the chief executive officer. The compensation committee also grants equity awards to newly hired executive officers as a way of promoting long-term incentive in the Company as the stock awards are earned over a long-term period. Typically, the size of grants are set at a level that is deemed appropriate to create a meaningful opportunity for stock ownership based upon the NEO’s performance, position, potential for future responsibility and promotion, and overall expected contribution to the Company’s success. The compensation committee also considers other factors in determining the size of the grant such as the amount of unvested options held by the individual from prior grants, the length of time that the employee has been with the Company and the amount of other compensation earned by the NEO. The relative weight given to each of these factors varies from individual to individual. Peer group practices play a minimal role in the determination of individual awards. We believe that the fact that we offer equity awards makes our compensation practices competitive with our peer group. However, the amounts of the awards are determined by internal factors only, such as performance and equity as compared to other executives.
Stock option grants are triggered by new hire and at the time of internal promotion to a higher grade level associated with an increased grant award or at the discretion of the compensation committee for reward or retention purposes. All new hires are assigned a stock option grant amount based on their grade level at the time of hire. New hire stock option awards as well as stock option awards associated with an internal promotion are subject to board approval and the grant dates associated with all option grants is the date the option awards are approved by the board.
On May 2, 2007, the compensation committee granted options to the NEOs to purchase a total of 1.1 million shares of Series H preferred stock. No restricted stock awards were made to any NEO during 2007.
Stock Incentive Plan Summary
On October 25, 2006, the board of directors of the Company approved and adopted the Grande Communications Holdings, Inc. Second Amended and Restated 2000 Stock Incentive Plan (the “2000 Stock Incentive Plan”). The stockholders approved the 2000 Stock Incentive Plan at the annual stockholders meeting on December 6, 2006.
•
Administration. Our board of directors or a committee designated by the board of directors, such as the compensation committee (in either case, we refer to such body as the board of directors).
•
Stock Subject to the Plan. The number of shares of common stock available for issuance under the Plan is the lesser of (i) 10% of all of the shares of capital stock on a fully diluted basis, as if all such shares of capital stock were converted to common stock or (ii) 82,000,000 shares of common stock. Of the shares available for issuance under the Plan, 30,000,000 shares of Series H preferred stock and 12,000,000 shares of common stock are designated as “Executive Compensation Shares”. The maximum number of shares that may be reserved for issue pursuant to incentive stock options under the 2000 Stock Incentive Plan may not exceed 82,000,000 shares of stock.
As of December 31, 2007, the number of shares that are reserved for issuance upon exercise of outstanding option agreements are 41.5 million shares of common stock that are not Executive Compensation Shares, 9.7 million shares of common stock that are Executive Compensation Shares and 27.8 million shares of Series H preferred stock (all shares of Series H preferred stock are Executive Compensation Shares). As of December 31, 2007, the number of shares that remain available for future issuance under the 2000 Incentive Stock Plan are 26.8 million shares of common stock that are not Executive Compensation Shares, 2.3 million shares of common stock that are Executive Compensation Shares, and 2.2 million shares of Series H preferred stock.
•
Eligibility. Officers, employees, directors, consultants or advisers to the Company are eligible to participate in the plan. The 2000 Stock Incentive Plan provides that the Executive Compensation Shares may only be issued to directors, officers or key employees, as approved by the board of directors from time to time.
•
Awards Under the 2000 Stock Incentive Plan. We may award “incentive stock options” and “non-statutory stock options” under the 2000 Stock Incentive Plan (in either case we refer to such awards as the options(s)).
Incentive Stock Options. Incentive stock options awarded under the 2000 Stock Incentive Plan must have an exercise price of at least 100% of the fair market of our stock on the date of grant. In the case of an employee who owns more than 10% of our voting power, the exercise price will be the greater of the aggregate par value of the stock and at least 110% of the fair market value of the stock on the date of grant.
Non-Statutory Stock Options. We can award non-statutory stock options to any person eligible under the 2000 Stock Incentive Plan. The minimum exercise price for non-statutory stock options under the 2000 Stock Incentive Plan is 85% of the fair market value of our stock on the date of grant, provided, however, that (i) if the grantee owns more than 10% of our voting power, the exercise price will be the greater of the aggregate par value of the stock and at least 110% of the fair market value of the stock on the date of grant, (ii) to the extent that the option is intended to comply with Section 409A of the Internal Revenue Code of 1986, as amended, the exercise price will be the greater of the aggregate par value of the stock and at least 100% of the fair market value of the stock on the date of grant.
•
Restricted Stock. Restricted stock may be granted under the 2000 Stock Incentive Plan and may be subject to vesting conditions that may be prescribed by the board of directors, including the satisfaction of corporate or individual performance objectives or continued service to the Company. In making an award of restricted stock, the board of directors will determine the restrictions that will apply, the period during which the award will be subject to such restrictions, and the price, if any, payable by a recipient. The restricted stock may not be sold, transferred, assigned, pledged or otherwise encumbered or disposed of during the restriction period or prior to the satisfaction of any other conditions prescribed by the board of directors. A recipient of a restricted stock award must purchase the restricted stock from the Company at a purchase price equal to the greater of the aggregate par value of the stock and at least 85% of the fair market value of the stock on the date of grant, or if the recipient owns more than 10% of our voting power, then the purchase price will be the greater of the aggregate par value of the stock and at least 100% of the fair market of the stock on the date of grant. The purchase price for the restricted stock shall be payable in cash or cash equivalents or, if the board of directors determines, payable in consideration for past services rendered to the Company. Unless the board of directors otherwise provides in an award agreement, holders of restricted stock shall have the right to vote such stock and to receive any dividends and distributions declared or paid with respect to such stock. Restricted stock is also subject to a right of first refusal of the Company that the Company may assign to any of its stockholders or affiliates. The right of first refusal will not apply to transfers of restricted stock that occurs as a result of the death of the participant, but will apply to the executor, administrator, personal representative, estate and legatees, beneficiaries and assigns.
•
Vesting. Options and restricted stock awards vest as determined by the board of directors and as stated in the individual’s Award Agreement. Vesting is subject to a participant’s continued employment or service with the Company. Vesting of such options and restricted stock awards are subject to acceleration upon a Change of Control unless the board of directors exercises the right to cancel vested options or the option agreement provides otherwise. Generally, unless a specific award agreement provides otherwise, the options with respect to shares of stock that are not Executive Compensation Shares provide for a vesting of the total number of option shares over a four year period, commencing with vesting of 25% of the option shares on the first anniversary of the vesting start date, and an additional 25% for each of the three following anniversaries of that date. Generally, unless a specific award agreement provides otherwise, the options for Executive Compensation Shares and Series H preferred stock vest as follows: (i) 25% of the total option shares on the first anniversary of the vesting start date, (ii) 2.1% of the option shares on the last day of each of the first 35 months after such first anniversary, and (iii) 1.5% of the option shares on the last day of the 36th month after such first anniversary.
For newly hired employees, including NEOs, and newly elected directors, the vesting start date is based on the first day of employment or of service. In no case is the option grant date or exercise price backdated. The Company entered into an employment agreement with Mr. Chestnutt in December 31, 2005 (the "Original Employment Agreement") whereby, among other things, the Company agreed to grant to Mr. Chestnutt certain options to acquire shares of Series H preferred stock and common stock designated as Executive Compensation Stock. The options were not immediately granted to Mr. Chestnutt in order for the Company to amend the original 2000 Incentive Stock Plan (the "Original Plan") to comply with Section 409A of the Internal Revenue Code of 1986, as amended and to add the Series H preferred stock and Executive Compensation Stock to the shares available for issuance under the Original Plan, among other things. On June 28, 2006, the Board approved the amendment and restatement of the Original Plan. Also on that date, the Board approved the grant of certain stock options to Mr. Chestnutt and also an amendment to Mr. Chestnutt’s employment agreement that provided such options would be in lieu of the stock options that the Company previously agreed to grant to Mr. Chestnutt under the Original Employment Agreement. For more information on the vesting schedule of certain options for the NEOs and certain directors, see the tables of Outstanding Equity Awards at Fiscal Year End and Directors Outstanding Equity Awards at Year End.
•
Other Terms Applicable to Options. Option agreements may contain other provisions that the board of directors determines are appropriate relating to when the options will become exercisable, the times at which and circumstances under which the options may be exercised and the methods by which the exercise price may be paid. Options that become exercisable will expire no later than ten years from the date the options were granted; however, in certain cases the Options will expire five years from the date they were granted (i.e., in the case of options granted to an employee who owns stock representing more than 10% of our voting power). Also, non-qualified options granted with respect to the right to purchase shares of Series H preferred stock include certain restrictions on the timing of when the options may be exercised. The exercise price is payable in cash or in cash equivalents and, for so long as the Company’s stock is not publicly traded, through a cashless exercise paid in Company stock held by the participant, provided that the option agreement does not prohibit cashless exercises. If the Company stock becomes publicly traded, then, to the extent permitted by the Company or as provided in an option agreement, a participant may pay the exercise price of an option as a cashless exercise in Company stock.
•
Adjustments Upon Changes in Capitalization, Recapitalization or Reorganization
Changes in Capitalization. The number of shares of stock subject to the 2000 Stock Incentive Plan (whether awarded or reserved but not awarded) as well as the price per share of stock subject to the 2000 Stock Incentive Plan (whether awarded or reserved but not awarded) shall be proportionately adjusted for a different number of kind of shares or other securities of the Company due to any recapitalization, reclassification, stock split, reverse split, combination of shares, exchange of shares, stock dividend or other distribution payable in capital stock or other increase or decrease in such shares effected without receipt of consideration by the Company.
Reorganization in which the Company is the Surviving Entity and in which No change of Control Occurs. If the Company is the surviving entity in any reorganization, merger or consolidation of the Company with one or more other entities and in which no change of control occurs, any option granted under the 2000 Incentive Stock Option Plan , the number of shares of stock subject to an option granted prior to such reorganization, merger or consolidation will be adjusted to the number of shares that a holder of the number of shares of stock subject to the option would have been entitled immediately following such reorganization, merger or consolidation. The exercise price subject to an option granted prior to such reorganization, merger or consolidation will be proportionately adjusted so that the aggregate exercise price after such reorganization, merger or consolidation will be the same as the aggregate exercise price was prior to such reorganization, merger or consolidation.
•
Change of Control.
Acceleration of Vesting. In the event of a change of control, vesting will be accelerated under the restricted stock award agreements awarded under the 2000 Stock Incentive Plan, unless a particular award agreement provides otherwise. In the event of a change of control, vesting will be accelerated under the option agreements awarded under the 2000 Stock Incentive Plan, unless (i) a particular option agreement provides otherwise or (ii) an express provision is made in writing in connection with the change of control that vesting will not be accelerated.
Cancellation of Vested Options. In the event of a change of control, the board of directors may elect to cancel the vested options (including the options which become vested by reason of acceleration), if the cancellation date is no earlier than the last to occur of (a) the 15th day following delivery of the cancellation notice and (b) the 60th day prior to the proposed date for the consummation of the change of control. Unless the participant elects in writing to waive the right to a conditional exercise, any option exercise due to a cancellation related to a change of control will be conditional, meaning that if the transaction does not occur within 180 days of the proposed date for the consummation of the change of control, the exercising participant will be refunded all amounts paid to exercise his option, the exercise of the option will be void, and the option will be reissued.
Change of Control under the Option Agreements for the Purchase of Shares that are Not Executive Compensation Shares. Generally, under the option agreements regarding rights to purchase Company shares that are not Executive Compensation Shares, a change of control means:
(i) a change in ownership of the Company such that an individual or corporation or a group of persons acting in concert, excluding stockholders or affiliates of the Company (we refer to such a person, corporation or group as a Person) acquires more than 50% of the combined voting power of our stock, but it will not be a change of control if the Person already owns more than 50% of the total fair market value or combined voting power of our stock; or
(ii) a change in the effective control of the Company such that a Person acquires or has within the preceding 12 month period acquired, directly or indirectly, ownership of a number of shares of our stock which constitutes 50% of the combined voting power of our stock, provided, however, that if a Person already owns 50% or more of the combined voting power of our stock, the acquisition of additional shares of our stock by such Person is not a change of control; or
(iii) a change in the ownership of the assets of the Company such that a Person acquires or has within the preceding 12 month period acquired assets of the Company that has a total gross fair market value of all of the assets of the Company as determined by the board of directors (which will not be less than a minimum percentage required to comply with Section 409A of the Internal Revenue Code of 1986, as amended); provided that it will not be a change of control if (a) assets are transferred to an entity that is controlled by the stockholders of the Company immediately after the transfer, (b) the Company transfers assets to a Person that is a stockholder of the Company immediately before the asset transfer in exchange for the stockholder’s stock in the Company, (c) the Company transfers assets to an entity of which 50% or more of the total value or voting control is owned, directly, or indirectly, by the Company, (d) the Company transfers assets to a Person that owns, directly or indirectly, 50% or more of the total value or voting power of all of our stock, or (e) the Company transfers assets to an entity, at least 50% of the total value or voting power of which is owned, directly or indirectly, by a Person that owns, directly or indirectly, 50% or more of the total value or voting power of all of our stock.
Some of the NEOs and directors have option agreements for the purchase of shares of common stock that are not Executive Compensation Shares. For more information, see the tables of Outstanding Equity Awards at Fiscal Year End and Directors Outstanding Equity Awards at Year End.
Change of Control under the Option Agreements for the Purchase of Executive Compensation Shares. Under the existing option agreements regarding rights to purchase Company shares that are Executive Compensation Shares, the definition of a change of control includes all of the events described in the immediately preceding subparagraphs (i) - (iii) and also includes:
(A) a change in the ownership of the assets of the Company such that a Person acquires or has within the preceding 12 month period acquired assets of the Company that has a total gross fair market value of 50% or more of the assets of the Company as determined by the board of directors, rather than of all of the assets of the Company (as required in the immediately preceding subparagraph (iii) with respect to options to acquire shares that are not Executive Compensation Shares), subject to the same exceptions to a change of control outlined in (a)-(e) of such subparagraph (iii); or
(B) a change in the effective control of the Company such that as a result of any tender offer, merger or other business combination, sale of assets or contested election, or any combination of the foregoing transactions, a majority of the persons who were members of the board of directors is, within a 12 month period, replaced by individuals whose appointment or election to the board of directors is not endorsed by a majority of the board of directors prior to such appointment or election.
All of the NEOs and some of the directors have option agreements for the purchase of Series H preferred stock (all shares of Series H preferred stock available for issuance under the 2000 Stock Incentive Plan are Executive Compensation Shares) and some of the NEOs and directors have options for the purchase of shares of common stock that are Executive Compensation Shares. For more information on the option agreements to acquire shares of Executive Compensation Shares for the NEOs and directors, see the tables of Outstanding Equity Awards at Fiscal Year End and Directors Outstanding Equity Awards at Year End.
•
Rights of First Refusal of the Company and Repurchase Rights. Under the terms of the 2000 Stock Incentive Plan, Company stock acquired through the exercise of an option agreement is subject to transfer restrictions and to a right of first refusal of the Company. The right of first refusal will not apply to transfers of restricted stock that occurs as a result of the death of the participant, but will apply to the executor, administrator, personal representative, estate and legatees, beneficiaries and assigns. The Company may assign any of its rights of first refusal to any of its stockholders or affiliates. Unless otherwise provided in an option agreement, upon termination of a participant’s service or employment with the Company, the Company will have the right to purchase all of the stock acquired under or that will be acquired under the option agreement at the fair market value of the stock.
•
Termination, Amendment or Suspension. The board of directors may terminate, amend or suspend the 2000 Stock Incentive Plan as to any shares of stock as to which grants have not been made at any time, subject to the stockholder approval required under applicable law. No termination, amendment or suspension of the 2000 Stock Incentive Plan may, without the consent of the participant, alter or impair the rights or obligations under any grant awarded prior to such termination, amendment or suspension.
However, the plan and each restricted stock award and option granted under the 2000 Stock Incentive Plan may be amended, modified or supplement either with the participant’s consent for any reason or without the participant’s consent, as necessary or desirable, by the board of directors to cause the 2000 Stock Incentive Plan and all grants to satisfy Section 409A of the Internal Revenue Code of 1986, as amended, or other applicable law.
•
Regulatory Considerations:
Section 162(m). The 2000 Stock Incentive Plan is designed to meet the requirements of Section 162(m) of the Internal Revenue Code. Our intention is to structure compensation arrangements to maximize the Company’s available deductions consistent with Section 162(m) unless the compensation committee reasonably believes that the best interests of the Company and its shareholders will be served by structuring compensation for a given executive officer, or executive officers, differently. The maximum number of shares of capital stock that may be granted under an option under the 2000 Stock Incentive Plan in any fiscal year to an employee cannot exceed 82,000,000 shares of Common Stock and 30,000,000 shares of Series H preferred stock.
Nonqualified Deferred Compensation. On October 22, 2004, the American Jobs Creation Act of 2004 was signed into law and established Internal Revenue Code Section 409A, which changed the tax rules applicable to nonqualified deferred compensation arrangements. While the amendment and modification of nonqualified deferred compensation plans and agreement to comply with the final regulations issued under Section 409A is not required until December 31, 2008, we believe that we are and have been operating in good faith compliance with the statutory provisions of Section 409A that were effective January 1, 2005, and the relevant regulations and other guidance relating to Section 409A that has been issued by the Department of Treasury and the Internal Revenue Service.
Accounting for Stock-Based Compensation. Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS 123(R).
Health and Welfare Benefits Plan
We provide a competitive benefits package to all full-time employees, which includes health and welfare benefits, such as medical, dental, vision care, disability insurance, life insurance benefits, and a 401(k) savings plan (see below). We have no structured executive perquisite benefits (e.g., club memberships or company vehicles) for any executive officer, including the NEOs, and we currently do not provide any deferred compensation programs or supplemental pensions to any executive officer, including the NEOs.
Retirement Savings Opportunity (401(k) Plan )
We maintain a 401(k) retirement and savings plan for all of our employees. The 401(k) plan is intended to qualify under section 401(k) of the Internal Revenue Code, so that contributions and the income earned on those contributions are not taxable to our employees until they make withdrawals from the plan. Subject to statutory limits, participants in the 401(k) plan may elect to contribute up to 100% of their current compensation. All of the contributions to the 401(k) plan made by our employees are fully vested at all times. Additionally, we offer a matching contribution of $0.50 per dollar contributed by the employee, up to a maximum of 6% of the employee’s salary. Employees earn vesting credits for these matching contribution based upon years of service at a rate of 33% per year, for the first three years of service. Benefits under the 401(k) plan are paid upon a participant’s retirement, death, disability or termination of employment, and are based on the amount of a participant’s contributions plus vested employer contributions, as adjusted for gains, losses and earnings. The 401(k) plan is comparable in all area of plan design to companies within our peer group.
Pension Benefits
We do not have any plan that provides for payments or other benefits at, following, or in connection with, retirement.
Non-Qualified Deferred Compensation
We do not have any plan that provides for the deferral of compensation on a basis that is not tax-qualified.
Policy on Recovery of Compensation
Our chief executive officer and chief financial officer are required to repay certain bonuses and equity-based compensation they receive if we are required to restate our financial statements as a result of misconduct, as required by Section 304 of the Sarbanes-Oxley Act of 2002.
Compensation Committee Report
The compensation committee has reviewed and discussed the Compensation Discussion and Analysis with management. Based upon such review, the related discussions and such other matters deemed relevant and appropriate by the compensation committee, the compensation committee has recommended to the board of directors that the Compensation Discussion and Analysis be included in the Company’s Annual Report on Form 10-K.
Duncan T. Butler, Jr. (Chairman)
David C. Hull, Jr.
William Laverack, Jr.
Summary Compensation Table
The following table summarizes the compensation paid to or earned by our Chief Executive Officer, our Chief Financial Officer and to each of our three most highly compensated executive officers other than the Chief Executive Officer and Chief Financial Officer who were serving as executive officers at the end of our last fiscal year.
____________________________
(1)
Bonus column includes an accrued discretionary bonus for Mr. Chestnutt, which was paid by the Company in January 2008. Bonuses to all other NEOs were discretionary bonuses awarded by the board of directors and paid in 2007. No bonuses were paid under our Annual Cash Incentive Plan.
(2)
Compensation cost for all option awards was based on the grant-date fair value estimated in accordance with the provisions of SFAS 123(R). Compensation cost calculated under SFAS 123(R) is amortized to compensation expense on a straight-line basis over the vesting period of the underlying stock option grants. See footnote No. 9, “Stockholder’s Equity” in the Notes to our Consolidated Financial Statements included in this annual report for the valuation assumptions used in determining the fair value of option grants.
(3)
All Other Compensation includes car allowance and 401(k) employer match. The following table presents the incremental cost of the components of All Other Compensation for the NEOs.
(4)
Mr. Chestnutt, Mr. Jones, and Mr. Brennan joined Grande in February 2006, May 2006, and April 2006, respectively; therefore, 2006 compensation included in this table represents a partial year.
(5)
Mr. Jones voluntarily resigned as Chief Service Officer in January 2008. There were no severance payments associated with his voluntary resignation.
Grants of Plan-Based Awards
The following table sets forth information with respect to grants of plan-based awards for the year ended December 31, 2007 to the NEOs.
____________________________
(1)
The Annual Cash Incentive Plan provides for a single payment that is awarded based upon a pro-rata share of the Company’s performance in excess of a pre-determined threshold as determined by the board of directors (see “Annual Cash Incentive Plan”). The amounts reflected in the table represent amounts that were possible if the target had been met during 2007. As noted in the Summary Compensation Table above, there were no payments made to NEOs under the Annual Cash Incentive Plan during 2007, however, the board of directors approved a discretionary bonus.
(2)
Our stock is not traded on any stock exchange or quoted on any established trading market. The exercise price of options granted is determined by the compensation committee of our board of directors and is based on the business judgment of management of the Company and the compensation committee as well as the provisions under our 2000 Stock Incentive Plan as discussed above in “Awards Under the 2000 Stock Incentive Plan.” The exercise price shall meet or exceed the estimated fair value of the underlying stock on the date of grant.
(3)
Reflects option awards granted during 2007 under the 2000 Stock Incentive Plan. Grant-date fair value was estimated in accordance with the provisions of SFAS 123(R). See footnote No. 9, “Stockholder’s Equity “ in the Notes to our Consolidated Financial Statements included in this annual report for the valuation assumptions used in determining the fair value of option grants. Estimates of forfeitures related to service-related vesting conditions are disregarded in computing the value shown in this column.
(4)
Series H Preferred Stock Options (Executive Compensation Shares) vest 25% on February 2, 2008, 2.1% on the last day of each of the first 35 months after February 2, 2008, and 1.5% on the last day of the 36th month after February 2, 2008.
(5)
Mr. Jones voluntarily resigned as Chief Service Officer in January 2008 and these options were forfeited.
Material Terms of Option Repricing
On May 3, 2006, the compensation committee of the board of directors approved the repricing of all common stock options outstanding to current employees to an exercise price of $0.05 per share. Repricing of non-employee common stock options are made at the discretion of the compensation committee. Stock options that are outstanding under the 2000 Stock Incentive Plan, subject to the repricing, were originally issued with exercise prices ranging from $0.10 per share to $0.80 per share. The Company recognized no additional compensation expense as a result of this modification due to the options having no fair value.
Outstanding Equity Awards at Fiscal Year End
The following table sets forth certain information relating to outstanding equity awards to the NEOs as of December 31, 2007.
____________________________
(1)
Unless otherwise noted, all stock option grants vest ratably over a four-year term from the Option Grant Date.
(2)
All options shown in the above table granted before May 3, 2006 were repriced to $0.05 per share on May 3, 2006. See “Material Terms of Option Repricing”.
(3)
Series H Preferred Stock Options (Executive Compensation Shares) vest 25% on December 31, 2006, 2.083% on the last day of each of the first 36 months after December 31, 2006, and the remainder on January 1, 2010.
(4)
Series H Preferred Stock Options (Executive Compensation Shares) vest 100% on February 13, 2007. Vested Series H Preferred Stock Options are only exercisable within the applicable exercise period, which shall commence on the first to occur of (i) March 16, 2009, (ii) the date of a Change of Control, and (iii) the date of termination of Mr. Chestnutt’s service with the Company or any of its affiliates. If March 16, 2009 occurs first, then the vested Series H Preferred Stock Options will only be exercisable in the period beginning on March 16, 2009 and ending on March 15, 2010. If a Change of Control is the first to occur, then the vested Series H Preferred Stock Options will only be exercisable in the period beginning 90 days prior to the Change of Control and ending on the 75th day after the Change of Control. If Mr. Chestnutt’s service is terminated first (for any reason other than for Cause), then the vested Series H Preferred Stock Options are only exercisable: (i) within the period commencing on the date of the termination of service and ending on the later of (x) December 31 of the calendar year in which the service termination occurred and (y) March 15 following the service termination date, if such termination of service is other than by reason of Voluntary Termination or for Cause, or (ii) within the period beginning on the service termination date and ending on the 90th day after the service termination date, if such termination is by reason of a Voluntary Termination. If Mr. Chestnutt’s service is terminated first and such termination is for Cause, then there will not be any applicable exercise period and the Series H Preferred Stock Options will terminate and become null and void on the service termination date.
(5)
Series H Preferred Stock Options (Executive Compensation Shares) vest 100% on February 13, 2008. Vested Series H Preferred Stock Options are only exercisable within the applicable exercise period, which shall commence on the first to occur of (i) March 16, 2010, (ii) the date of a Change of Control, and (iii) the date of termination of Mr. Chestnutt’s service with the Company or any of its affiliates. If March 16, 2010 occurs first, then the vested Series H Preferred Stock Options will only be exercisable in the period beginning on March 16, 2010 and ending on March 15, 2011. If a Change of Control is the first to occur, then the vested Series H Preferred Stock Options will only be exercisable in the period beginning 90 days prior to the Change of Control and ending on the 75th day after the Change of Control. If Mr. Chestnutt’s service is terminated first (for any reason other than for Cause), then the vested Series H Preferred Stock Options are only exercisable: (i) within the period commencing on the date of the termination of service and ending on the later of (x) December 31 of the calendar year in which the service termination occurred and (y) March 15 following the service termination date, if such termination of service is other than by reason of Voluntary Termination or for Cause, or (ii) within the period beginning on the service termination date and ending on the 90th day after the service termination date, if such termination is by reason of a Voluntary Termination. If Mr. Chestnutt’s service is terminated first and such termination is for Cause, then there will not be any applicable exercise period and the Series H Preferred Stock Options will terminate and become null and void on the service termination date.
(6)
Series H Preferred Stock Options (Executive Compensation Shares) vest 100% on February 13, 2009. Vested Series H Preferred Stock Options are only exercisable within the applicable exercise period, which shall commence on the first to occur of (i) March 16, 2011, (ii) the date of a Change of Control, and (iii) the date of termination of Mr. Chestnutt’s service with the Company or any of its affiliates. If March 16, 2011 occurs first, then the vested Series H Preferred Stock Options will only be exercisable in the period beginning on March 16, 2011 and ending on March 15, 2012. If a Change of Control is the first to occur, then the vested Series H Preferred Stock Options (Executive Compensation Shares) will only be exercisable in the period beginning 90 days prior to the Change of Control and ending on the 75th day after the Change of Control. If Mr. Chestnutt’s service is terminated first (for any reason other than for Cause), then the vested Series H Preferred Stock Options (Executive Compensation Shares) are only exercisable: (i) within the period commencing on the date of the termination of service and ending on the later of (x) December 31 of the calendar year in which the service termination occurred and (y) March 15 following the service termination date, if such termination of service is other than by reason of Voluntary Termination or for Cause, or (ii) within the period beginning on the service termination date and ending on the 90th day after the service termination date, if such termination is by reason of a Voluntary Termination. If Mr. Chestnutt’s service is terminated first and such termination is for Cause, then there will not be any applicable exercise period and the Series H Preferred Stock Options (Executive Compensation Shares) will terminate and become null and void on the service termination date.
(7)
Series H Preferred Stock Options (Executive Compensation Shares) vest 100% on February 13, 2010. Vested Series H Preferred Stock Options are only exercisable within the applicable exercise period, which shall commence on the first to occur of (i) March 16, 2012, (ii) the date of a Change of Control, and (iii) the date of termination of Mr. Chestnutt’s service with the Company or any of its affiliates. If March 16, 2009 occurs first, then the vested Series H Preferred Stock Options will only be exercisable in the period beginning on March 16, 2012 and ending on March 15, 2013. If a Change of Control is the first to occur, then the vested Series H Preferred Stock Options will only be exercisable in the period beginning 90 days prior to the Change of Control and ending on the 75th day after the Change of Control. If Mr. Chestnutt’s service is terminated first (for any reason other than for Cause), then the vested Series H Preferred Stock Options are only exercisable: (i) within the period commencing on the date of the termination of service and ending on the later of (x) December 31 of the calendar year in which the service termination occurred and (y) March 15 following the service termination date, if such termination of service is other than by reason of Voluntary Termination or for Cause, or (ii) within the period beginning on the service termination date and ending on the 90th day after the service termination date, if such termination is by reason of a Voluntary Termination. If Mr. Chestnutt’s service is terminated first and such termination is for Cause, then there will not be any applicable exercise period and the Series H Preferred Stock Options will terminate and become null and void on the service termination date.
(8)
Common Stock Options (Executive Compensation Shares) vest 25% on February 13, 2007, 2.1% on the last day of each of the first 35 months after February 13, 2007, and 1.5% on the last day of the 36th month after February 13, 2007.
(9)
Series H Preferred Stock Options (Executive Compensation Shares) vest 25% on February 13, 2007, 2.1% on the last day of each of the first 35 months after February 13, 2007, and 1.5% on the last day of the 36th month after February 13, 2007.
(10)
Series H Preferred Stock Options (Executive Compensation Shares) vest 25% on February 2, 2008, 2.1% on the last day of each of the first 35 months after February 2, 2008, and 1.5% on the last day of the 36th month after February 2, 2008.
(11)
Series H Preferred Stock Options (Executive Compensation Shares) vest 25% on April 24, 2007, 2.1% on the last day of each of the first 35 months after April 24, 2007, and 1.5% on the last day of the 36th month after April 24, 2007.
(12)
Common Stock Options (Executive Compensation Shares) vest 25% on April 24, 2007, 2.1% on the last day of each of the first 35 months after April 24, 2007, and 1.5% on the last day of the 36th month after April 24, 2007.
(13)
Mr. Jones voluntarily resigned as Chief Service Officer in January 2008 and all unvested options were forfeited upon his resignation date.
(14)
Series H Preferred Stock Options (Executive Compensation Shares) vest 25% on May 1, 2007, 2.1% on the last day of each of the first 35 months after May 1, 2007, and 1.5% on the last day of the 36th month after May 1, 2007.
(15)
Common Stock Options (Executive Compensation Shares) vest 25% on May 1, 2007, 2.1% on the last day of each of the first 35 months after May 1, 2007, and 1.5% on the last day of the 36th month after May 1, 2007.
(16)
Common Stock Options (not Executive Compensation Shares) were repriced from $0.25 to $0.05. See “Material Terms of Option Repricing”.
(17)
Common Stock Options (not Executive Compensation Shares) were repriced from $0.60 to $0.05. See “Material Terms of Option Repricing”.
(18)
Common Stock Options (not Executive Compensation Shares) were repriced from $0.80 to $0.05. See “Material Terms of Option Repricing”.
(19)
Common Stock Options (not Executive Compensation Shares) were repriced from $0.20 to $0.05. See “Material Terms of Option Repricing”.
(20)
Common Stock Options (not Executive Compensation Shares) were repriced from $0.50 to $0.05. See “Material Terms of Option Repricing”.
Option Exercises
There were no options exercised by any of the NEOs or directors during the year ended December 31, 2007.
Compensation of Directors
Compensation of directors is the responsibility of the compensation committee of the board of directors. There are no formal standard compensation arrangements for directors that have been adopted by the Company or the board of directors. Certain directors are compensated with a combination of cash and stock options to compensate for their contributions to the oversight of the Company. Stock option pricing and practices are governed by the terms and conditions of the 2000 Stock Incentive Plan and the option agreements.
The following table sets forth the compensation paid to our directors in 2007. The directors named are the only directors who received compensation during 2007.
____________________________
(1)
Mr. Mansour resigned in January 2008. For 2007, he received monthly compensation of $6,250 for his service as the Chairman of the board of directors. Mr. Schmeltekopf receives monthly compensation of $1,666 for his service as Chairman of the audit committee. Mr. Orchard receives monthly compensation of $1,666 for his service as a director. Directors are reimbursed for their reasonable out-of-pocket expenses incurred in attending meetings. Other than the above, directors do not receive cash compensation for serving on the board of directors or any of its committees.
(2)
Compensation cost for all option awards was based on the grant-date fair value estimated in accordance with the provisions of SFAS 123(R). Compensation cost calculated under SFAS 123(R) is amortized to compensation expense on a straight-line basis over the vesting period of the underlying stock option grants. See footnote No. 9, “Stockholder’s Equity” in the Notes to our Consolidated Financial Statements included in this annual report for the valuation assumptions used in determining the fair value of option grants.
Grant of Plan Based Awards to Directors
No options were granted to board members during the year ended December 31, 2007.
Directors Outstanding Equity Awards at Year End
The following table sets forth certain information relating to outstanding equity awards to directors as of December 31, 2007.
____________________________
(1)
Mr. Mansour resigned in January 2008.
(2)
Common stock options (not Executive Compensation Shares) were repriced from $0.20 to $0.05. Options vest ratably over four years from the Option Grant Date.
(3)
Common stock options (not Executive Compensation Shares) were repriced from $0.80 to $0.05. Options vest ratably over four years from the Option Grant Date.
(4)
Common stock options (not Executive Compensation Shares) were repriced from $0.25 to $0.05. Options vest ratably over four years from the Option Grant Date.
(5)
Series H Preferred Stock Options (Executive Compensation Shares) vest 25% on June 20, 2007, 2.1% on the last day of each of the first 35 months after June 20, 2007, and 1.5% on the last day of the 36th month after June 20, 2007. Vested Series H Preferred Stock Options are only exercisable within the applicable exercise period, which shall commence on the first to occur of (i) June 27, 2016, (ii) the date of a Change of Control, and (iii) the date of termination of Mr. Schmeltekopf’s service with the Company or any of its affiliates. If June 27, 2016 occurs first, then the vested Series H Preferred Stock Options will only be exercisable in the period beginning on June 27, 2016 and ending on June 28, 2016. If a Change of Control is the first to occur, then the vested Series H Preferred Stock Options will only be exercisable in the period beginning 90 days prior to the Change of Control and ending on the 75th day after the Change of Control. If Mr. Schmeltekopf’s service is terminated first (for any reason other than for Cause), then the vested Series H Preferred Stock Options are only exercisable: (i) within the period commencing on the date of the termination of service and ending on the later of (x) December 31 of the calendar year in which the service termination occurred and (y) March 15 following the service termination date, if such termination of service is other than by reason of Voluntary Termination or for Cause, or (ii) within the period beginning on the service termination date and ending on the 90th day after the service termination date, if such termination is by reason of a Voluntary Termination. If Mr. Schmeltekopf’s service is terminated first and such termination is for Cause, then there will not be any applicable exercise period and the Series H Preferred Stock Options will terminate and become null and void on the service termination date.
(6)
Common stock options (not Executive Compensation Shares) vest 25% on June 20, 2007, 25% on June 20, 2008, 25% on June 20, 2009 and 25% on June 20, 2010.
(7)
Series H Preferred Stock Options (Executive Compensation Shares) vest 25% on October 25, 2007, 2.1% on the last day of each of the first 35 months after October 25, 2007, and 1.5% on the last day of the 36th month after October 25, 2007. Vested Series H Preferred Stock Options are only exercisable within the applicable exercise period, which shall commence on the first to occur of (i) October 24, 2016, (ii) the date of a Change of Control, and (iii) the date of termination of Mr. Orchard’s service with the Company or any of its affiliates. If October 24, 2016 occurs first, then the vested Series H Preferred Stock Options will only be exercisable in the period beginning on October 24, 2016 and ending on October 25, 2016. If a Change of Control is the first to occur, then the vested Series H Preferred Stock Options will only be exercisable in the period beginning 90 days prior to the Change of Control and ending on the 75th day after the Change of Control. If Mr. Orchard’s service is terminated first (for any reason other than for Cause), then the vested Series H Preferred Stock Options are only exercisable: (i) within the period commencing on the date of the termination of service and ending on the later of (x) December 31 of the calendar year in which the service termination occurred and (y) March 15 following the service termination date, if such termination of service is other than by reason of Voluntary Termination or for Cause, or (ii) within the period beginning on the service termination date and ending on the 90th day after the service termination date, if such termination is by reason of a Voluntary Termination. If Mr. Orchard’s service is terminated first and such termination is for Cause, then there will not be any applicable exercise period and the Series H Preferred Stock Options will terminate and become null and void on the service termination date.
(8)
Common stock options (not Executive Compensation Shares) vest 25% on October 25, 2007, 25% on October 25, 2008, 25% on October 25, 2009 and 25% on October 25, 2010.
Employment Agreements, Severance Benefits and Change in Control Provisions
The inclusion of a severance arrangement serves to bridge the gap between the executive officer’s employment with Grande to his or her next employment engagement. The adoption of the change in control arrangements serves to motivate and reward the executive for returning the investment to the stockholder. Neither arrangement has materially influenced other compensation awards.
Employment Agreements
Roy H. Chestnutt entered an employment agreement (the “Chestnutt Agreement”) with Grande Communications Networks, Inc. (“Networks”) on December 31, 2005 with an effective date of January 26, 2006. Under the terms of the Employment Agreement, Mr. Chestnutt’s employment with Networks is at will. Mr. Chestnutt will be paid his current base salary of $400,000 per annum with such increases as may be determined by the board of directors, and Mr. Chestnutt is eligible to earn an annual bonus during each fiscal year during which he remains an executive employee of Networks of 100% of his then current base salary if the written annual performance goals adopted by both the board of directors and Mr. Chestnutt are achieved for that fiscal year. If only certain of the annual goals are achieved or if the annual goals are achieved only in part, then any bonus will be at the sole discretion of the board of directors. The Chestnutt Agreement provided that Mr. Chestnutt would receive an annual bonus for 2006 of at least 50% of the salary he earned in 2006, regardless of whether the annual goals were achieved for that year. The Chestnutt Agreement also provided for the reimbursement of relocation expenses incurred by Mr. Chestnutt. On June 28, 2006, Mr. Chestnutt and Networks entered into an Amendment (the “Amendment”) to the Chestnutt Agreement, whereby, among other things, Networks agreed to grant new stock options to Mr. Chestnutt that were in lieu of the stock options that Networks previously agreed to grant to Mr. Chestnutt under the Chestnutt Agreement. The options that were described in the Chestnutt Agreement could not be granted to Mr. Chestnutt under the 2000 Stock Incentive Plan because at that time, shares of common stock designated as Executive Compensation Shares and shares of Series H preferred stock could not be granted under such Plan. The Board amended the 2000 Stock Incentive Plan to comply with Section 409A of the Internal Revenue Code of 1986, as amended, and to add the Series H preferred stock and Executive Compensation Shares to the shares available for issuance under such Plan. The options that were granted to Mr. Chestnutt pursuant to the Amendment were issued at the same exercise price and were with regard to the right to purchase the same number and class of shares as had been described in the Chestnutt Agreement.
The Chestnutt Agreement, as amended to date, also provides certain benefits payable upon the occurrence of the following triggering events:
•
If Networks terminates the Agreement without cause or Mr. Chestnutt terminates the Agreement for good reason upon 60 days prior written notice, then Networks must pay Mr. Chestnutt severance in the amount of twelve months salary at his then current base salary and Networks will continue Mr. Chestnutt’s then current insurance and health care coverage until the first anniversary of the date of such termination, provided that Networks may cease providing such insurance and health care coverage at an earlier date if Mr. Chestnutt receives equivalent benefits from his next full time employer. Payment of the severance amount will be made by Networks in equal monthly installments over 12 months. To the extent this severance pay exceeds certain amounts, as set forth in applicable Treasury Regulations, the excess amount of severance pay will not begin sooner than 6 months following the employment termination date. The payment of the severance is conditioned upon Mr. Chestnutt’s delivery to Networks of a release of claims in a form satisfactory to the Board of Directors. The Chestnutt Agreement defines “cause” as (i) the commission by Mr. Chestnutt of a felony or a crime involving moral turpitude or the commission of any other act involving dishonesty, disloyalty or fraud, (ii) conduct by Mr. Chestnutt tending to bring Networks into substantial public disgrace or disrepute, (iii) the failure by Mr. Chestnutt to cure within 30 days of notice of his failure perform in any material respect his obligations under the Chestnutt Agreement or the reasonable directives of the Board of Directors, (iv) gross negligence or willful misconduct of Mr. Chestnutt in providing the services required by the Chestnutt Agreement or (v) the habitual use of alcohol or drugs. The Chestnutt Agreement defines “good reason termination” as any of the following actions by the Board of Directors: (i) material diminishment of Mr. Chestnutt’s duties and responsibilities; (ii) material relocation of the office where Mr. Chestnutt is to work to an area outside of the Austin/San Antonio corridor, Texas; (iii) removal of Mr. Chestnutt from the Board of Directors without cause; (iv) stripping Mr. Chestnutt of the title of Chief Executive Officer without cause, provided such action either causes Mr. Chestnutt to report to someone other than the Board or materially reduces the budget over which he has control; or (v) material reduction of Mr. Chestnutt’s base salary without cause. A termination will only be considered a “good reason termination” if Mr. Chestnutt provides the Board with written notice of an event giving rise to such termination within 90 days of its occurrence, the Board fails to remedy the event within 30 days of such notice, and Mr. Chestnutt provides 60 days notice of his intent to terminate the contract (such notice provided no later than 1 year following the occurrence of the event).
•
In the event of a voluntary termination by Mr. Chestnutt upon 60 days written notice, Mr. Chestnutt will be entitled to the amount of base pay accrued and unpaid through the effective date of termination.
W.K.L. “Scott” Ferguson, Jr. entered into an Employment Agreement (the “Ferguson Agreement”) with Networks on June 28, 2006. Under the terms of the Ferguson Agreement, as amended to date, Mr. Ferguson’s employment is at will. Networks will pay Mr. Ferguson his current bi-weekly salary of $8,070.77 (annualized equates to $209,840) with such increases from time to time as may be determined by the Chief Executive Officer and an annual incentive bonus each fiscal year equal to 50% of his annual salary if annual performance goals adopted by both Mr. Ferguson and the Chief Executive Officer are met for that fiscal year. If only certain or a portion of the annual goals are met during a fiscal year, Mr. Ferguson may earn a bonus in an amount determined by and at the discretion of the Chief Executive Officer and approved by the board of directors. Additional bonuses may be awarded to Mr. Ferguson based on achievement of the Company’s objectives with such bonuses being at the sole discretion of the board of directors. In addition, the Ferguson Agreement also provided for the grant of options to acquire shares of Series H preferred stock. The Ferguson Agreement also provides certain benefits payable upon the occurrence of the following triggering events:
•
If Networks terminates the Agreement without cause or Mr. Ferguson terminates the Agreement for good reason upon 60 days prior written notice, Networks must (i) pay Mr. Ferguson severance in the amount equal to his then current bi-weekly base salary multiplied by 26, provided that if Mr. Ferguson receives any W-2 wages (during the severance period of 52 weeks) as an employee of an employer other than Networks, then the amount of any severance pay payable to Mr. Ferguson by Networks shall be reduced by an amount equal to such wages, and (ii) continue Mr. Ferguson’s then current insurance and health care coverage until the first anniversary of the date of such termination, provided that Networks may cease providing such insurance and health care coverage at an earlier date if Mr. Ferguson receives equivalent benefits from his next full time employer. Payment of the severance amount will be made by Networks in equal bi-weekly installments over 52 weeks. To the extent this severance pay exceeds certain amounts, as set forth in applicable Treasury Regulations, the excess amount of severance pay will not begin sooner than 6 months following the employment termination date. The payment of the severance is conditioned upon Mr. Ferguson’s delivery to Networks of a release of claims in a form satisfactory to the Board of Directors. The Ferguson Agreement defines “cause” as (i) the commission by Mr. Ferguson of a felony or a crime involving moral turpitude or the commission of any other act involving dishonesty, disloyalty or fraud, (ii) conduct by Mr. Ferguson tending to bring Networks into substantial public disgrace or disrepute, (iii) the failure by Mr. Ferguson to cure within 30 days of notice of his failure perform in any material respect his obligations under the Ferguson Agreement, his obligations under the Employee Confidentiality Information and Invention Assignment Agreement between Mr. Ferguson and Networks dated as of May 23, 2000, or the reasonable directives of the Chief Executive Officer or the Board of Directors, (iv) gross negligence or willful misconduct of Mr. Ferguson in providing the services required by the Ferguson Agreement or (v) any substance abuse of Mr. Ferguson in any manner interferes with the performance of his duties under the Ferguson Agreement. The Ferguson Agreement defines “good reason termination” as any of the following actions by Networks: (i) material diminishment of Mr. Ferguson’s duties and responsibilities; (ii) material relocation of the office where Mr. Ferguson is to work to an area outside of the Austin/San Antonio corridor, Texas; (iii) stripping Mr. Ferguson of the title of Chief Operating Officer without cause, provided such action either materially changes the authority, duties and responsibilities of the supervisor to which he reports or materially decreases the budget over which he has control; or (v) material reduction of Mr. Ferguson’s base salary without cause. A termination will only be considered a “good reason termination” if Mr. Ferguson provides Networks with written notice of an event giving rise to such termination within 90 days of its occurrence, Networks fails to remedy the event within 30 days of such notice, and Mr. Ferguson provides 60 days notice of his intent to terminate the contract (such notice provided no later than 1 year following the occurrence of the event).
•
In the event of a “voluntary termination” by Mr. Ferguson upon 60 days written notice, Mr. Ferguson will be entitled to the amount of base pay accrued and unpaid through the effective date of termination.
Michael Wilfley entered into an Employment Agreement (the “Wilfley Agreement”) with Networks on June 28, 2006. Under the terms of the Wilfley Agreement, as amended to date, Mr. Wilfley’s employment is at will. Networks will pay Mr. Wilfley his current bi-weekly salary of $9,615.38 (annualized equates to $250,000) and an annual bonus each fiscal year equal to 50% of his annual salary if annual performance goals adopted by both Mr. Wilfley and the Chief Executive Officer are met for that fiscal year. If only certain or a portion of the annual goals are met during a fiscal year, Mr. Wilfley may earn a bonus in an amount determined by and at the discretion of the Chief Executive Officer and approved by the Board of Directors. Additional bonuses may be awarded to Mr. Wilfley based on achievement of Networks’ objectives with such bonuses being at the sole discretion of the Board of Directors. In addition, the Wilfley Agreement provided for the grant of options to acquire shares of Series H preferred stock. The Wilfley Agreement also provides certain benefits payable upon the occurrence of the following triggering events:
•
If Networks terminates the Agreement without cause or Mr. Wilfley terminates the Agreement for good reason upon 60 days prior written notice, then Networks must (i) pay Mr. Wilfley severance in the amount equal to his then current bi-weekly base salary multiplied by 26, provided that if Mr. Wilfley receives any W-2 wages (during the severance period of 52 weeks) as an employee of an employer other than Networks, then the amount of any severance pay payable to Mr. Wilfley by Networks shall be reduced by an amount equal to such wages, and (ii) continue Mr. Wilfley’s then current insurance and health care coverage until the first anniversary of the date of such termination, provided that Networks may cease providing such insurance and health care coverage at an earlier date if Mr. Wilfley receives equivalent benefits from his next full time employer. Payment of the severance amount will be made by Networks in equal bi-weekly installments over 52 weeks. To the extent this severance pay exceeds certain amounts, as set forth in applicable Treasury Regulations, the excess amount of severance pay will not begin sooner than 6 months following the employment termination date. The payment of the severance is conditioned upon Mr. Wilfley’s delivery to Networks of a release of claims in a form satisfactory to the Board of Directors. The Wilfley Agreement defines “cause” as (i) the commission by Mr. Wilfley of a felony or a crime involving moral turpitude or the commission of any other act involving dishonesty, disloyalty or fraud, (ii) conduct by Mr. Wilfley tending to bring Networks into substantial public disgrace or disrepute, (iii) the failure by Mr. Wilfley to cure within 30 days of notice of his failure perform in any material respect his obligations under the Wilfley Agreement, his obligations under the Employee Confidentiality Information and Invention Assignment Agreement between Mr. Wilfley and Networks dated as of July 12, 2000, or the reasonable directives of the Chief Executive Officer or the Board of Directors, (iv) gross negligence or willful misconduct of Mr. Wilfley in providing the services required by the Wilfley Agreement or (v) any substance abuse of Mr. Wilfley in any manner interferes with the performance of his duties under the Wilfley Agreement. The Wilfley Agreement defines “good reason termination” as any of the following actions by Networks: (i) material diminishment of Mr. Wilfley’s duties and responsibilities; (ii) material relocation of the office where Mr. Wilfley is to work to an area outside of the Austin/San Antonio corridor, Texas; (iii) stripping Mr. Wilfley of the title of Chief Financial Officer without cause, provided such action either materially changes the authority, duties and responsibilities of the supervisor to which he reports or materially decreases the budget over which he has control; or (v) material reduction of Mr. Wilfley’s base salary without cause. A termination will only be considered a “good reason termination” if Mr. Wilfley provides Networks with written notice of an event giving rise to such termination within 90 days of its occurrence, Networks fails to remedy the event within 30 days of such notice, and Mr. Wilfley provides 60 days notice of his intent to terminate the contract (such notice provided no later than 1 year following the occurrence of the event).
•
In the event of a “voluntary termination” by Mr. Wilfley upon 60 days written notice, Mr. Wilfley will be entitled to the amount of base pay accrued and unpaid through the effective date of termination.
William C. “Chad” Jones, Jr. entered into an Employment Agreement (the “Jones Agreement”) with Networks on May 2, 2007. Under the terms of the Jones Agreement, Mr. Jones’ employment was at will. As of December 31, 2007, Networks paid Mr. Jones a bi-weekly salary of $8,374.42 (annualized equates to $217,735) and an annual bonus each fiscal year equal to 50% of his annual salary if annual performance goals adopted by both Mr. Jones and the Chief Executive Officer were met for that fiscal year. If only certain or a portion of the annual goals were met during a fiscal year, Mr. Jones may earn a bonus in an amount determined by and at the discretion of the Chief Executive Officer and approved by the Board of Directors. Additional bonuses may be awarded to Mr. Jones based on achievement of Networks’ objectives with such bonuses being at the sole discretion of the Board of Directors. The Jones Agreement also provided certain benefits payable upon the occurrence of the following triggering events:
•
If Networks terminates the Agreement without cause or Mr. Jones terminates the Agreement for good reason upon 60 days prior written notice, then Networks must (i) pay Mr. Jones severance in the amount equal to his then current bi-weekly base salary multiplied by 26, provided that if Mr. Jones receives any W-2 wages (during the severance period of 52 weeks) as an employee of an employer other than Networks, then the amount of any severance pay payable to Mr. Jones by Networks shall be reduced by an amount equal to such wages, and (ii) continue Mr. Jones’ then current insurance and health care coverage until the first anniversary of the date of such termination, provided that Networks may cease providing such insurance and health care coverage at an earlier date if Mr. Jones receives equivalent benefits from his next full time employer. Payment of the severance amount will be made by Networks in equal bi-weekly installments over 52 weeks. The payment of the severance is conditioned upon Mr. Jones’ delivery to Networks of a release of claims in a form satisfactory to the Board of Directors. The Jones Agreement defines “cause” as (i) the commission by Mr. Jones of a felony or a crime involving moral turpitude or the commission of any other act involving dishonesty, disloyalty or fraud, (ii) conduct by Mr. Jones tending to bring Networks into substantial public disgrace or disrepute, (iii) the failure by Mr. Jones to cure within 30 days of notice of his failure perform in any material respect his obligations under the Jones Agreement, his obligations under the Employee Confidentiality Information and Invention Assignment Agreement between Mr. Jones and Networks dated as of May 3, 2006, or the reasonable directives of the Chief Executive Officer or the Board of Directors, (iv) gross negligence or willful misconduct of Mr. Jones in providing the services required by the Jones Agreement or (v) any substance abuse of Mr. Jones in any manner interferes with the performance of his duties under the Jones Agreement. The Jones Agreement defines “good reason” as any of the following actions by Networks: (i) diminishment of Mr. Jones’ duties and responsibilities; (ii) relocation of the office where Mr. Jones is to work to an area outside of the Austin/San Antonio corridor, Texas; (iii) removal of Mr. Jones from the office of Chief Service Officer without cause; or (v) reduction of Mr. Jones’ base salary without cause.
•
In the event of a “voluntary termination” by Mr. Jones upon 60 days written notice, Mr. Jones will be entitled to the amount of base pay accrued and unpaid through the effective date of termination. In January 2008, this provision of the Jones Agreement was amended to provide that the notice period for a “voluntary termination” was shortened from 60 days to 13 days.
Severance Benefits
Severance Practices: While we have no formal severance plan for our executives, other than as set forth in the employment agreements described above, and have no obligation to pay severance unless it is covered in a written agreement, our practice has been to offer severance benefits to terminated executives (including NEOs that do not have an employment agreement) based on the position held and the length of service with the Company. We generally offer our executives severance benefits, subject to certain restrictive covenants described below, up to nine months of the then current base salary and health insurance benefits based upon length of service with the Company. Severance payments are generally payable on a bi-weekly basis in equal installments over the severance period.
Restrictive Covenants: In order to be eligible for severance benefits, all executives (including the NEOs) are required to enter into a Separation Agreement and Full and Final Release of Claims in a form satisfactory to the Company that includes certain restrictive covenants regarding, among other things, the following:
•
Confidentiality of information;
•
Continued adherence to company policies;
•
Noncompete covenants;
•
Nonsolicitation of customers; and
•
Other reasonable restrictions.
Death or Total Disability: Employment with the Company shall terminate upon death or total disability of the NEO. After such termination, the Company shall have no obligation or liability other than payment of earned compensation to the NEO, or the NEO’s estate, the amount of base salary accrued but unpaid at the date of death or total disability, as the case may be.
Change in Control Provisions
Reorganization, Sale of Assets or Sale of Stock which Involves a Change of Control. Except as provided by the board of directors pursuant to the authority described below or expressly provided in the stock option agreement, upon the occurrence of a change of control, as described below, all common and Series H Preferred stock options outstanding shall become immediately vested. For additional information regarding the definitions of change of control that apply to option agreements awarded to the NEOs, see “2000 Stock Incentive Plan Summary - Change of Control.”
Unless otherwise expressly provided in the individual’s stock option agreement, the board of directors may in its sole discretion, deliver a written notice canceling the unexercised vested portion (including the portion which becomes vested by reason of acceleration). If the common and Series H Preferred stock options outstanding are not canceled, express provision may be made in writing in connection with such change of control for the assumption or continuation of the common and Series H Preferred stock options outstanding, or for the substitution for such options of new options covering the stock of a successor entity, or a parent or subsidiary thereof, with appropriate adjustments as to the number and kinds of shares and exercise prices, in which event the 2000 Stock Incentive Plan and options theretofore granted shall continue in the manner and under the terms so provided and no acceleration shall occur.
Potential Payments upon Termination or Change in Control
The following table sets forth the estimated benefits that would have been payable to our NEOs as of December 31, 2007 if an event triggering a termination without cause by the Company or for good reason by the NEO or a change in control had occurred on that date. In determining the benefits payable upon certain terminations of employment, we have assumed in all cases that the NEO does not become employed by a new employer or return to work for us.
____________________________
(1)
In general, in the event of (i) death or total disability, (ii) a voluntary termination of employment without good reason and (iii) termination with cause by the Company, the NEOs would receive compensation and benefits accrued but unpaid. This would include accrued but unpaid salary and any balance under the 401(k) plan as well as any amounts due under any insurance plan in the case of death or total disability.
(2)
As of December 31, 2007, the exercise price for all stock options held by the NEOs exceeded the estimated fair market value attributed to the common and Series H preferred stock options at such date; therefore, no value has been placed on the options in the table above. Vesting of stock options upon a change of control (as defined in the option agreements) would be governed under the terms of the 2000 Stock Incentive Plan. Under the terms of the 2000 Stock Incentive Plan, the Company may repurchase any shares acquired by exercise of such stock options if the NEO’s employment is terminated, at a purchase price equal to the fair market value for such shares, as determined by the board of directors of the Company. See “Change in Control Provisions” above.
(3)
Continued medical benefits represent Cobra payments for medical and dental coverage that would be paid by the Company during the severance period for each NEO.
(4)
Represents payments to which the NEO would be entitled pursuant to his employment agreement with the Company. Actual amounts that would be paid out and the assumptions used in arriving at such amounts can only be determined at the time of such NEO’s termination and may differ materially from the amounts set forth in the table. Upon a change in control, other than accelerated vesting of stock options, the NEO is not entitled to any other benefits unless termination without cause by the Company or for good reason by the NEO also occurs at the time of the change in control.
(5)
Mr. Brennan does not have an employment agreement with the Company, therefore, severance and continued medical benefits is estimated based upon the Company’s historical practices for executive severance. See “Severance Practices” above. Upon a change in control, other than accelerated vesting of stock options, Mr. Brennan is not entitled to any other benefits.
(6)
Mr. Jones voluntarily resigned as Chief Service Officer in January 2008. There was no severance payments or continued medical benefits associated with his voluntary resignation.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Our outstanding voting securities consist of our common stock and seven series of preferred stock, Series A through Series G. Stockholders are entitled to one vote for each share of common stock held or issuable upon conversion of preferred stock. Except as otherwise provided in Grande Communications Holdings, Inc.’s restated certificate of incorporation or as required under Delaware law, the holders of the preferred stock are entitled to vote on an as-converted basis with the holders of our common stock as a single class on all matters presented for a vote to the holders of our common stock.
As of March 15, 2008, our outstanding capital stock consisted of 12,752,572 shares of common stock, 232,617,838 shares of Series A preferred stock, 20,833,333 shares of Series B preferred stock, 17,005,191 shares of Series C preferred stock, 114,698,442 shares of Series D preferred stock, 7,999,099 shares of Series E preferred stock, 11,758,278 shares of Series F preferred stock and 34,615,330 shares of Series G preferred stock. The total number of votes that could have been cast as of such date equaled 452,280,083. The Company has authorized 30,000,000 shares of Series H Preferred Stock, of which no shares are issued or outstanding. As of March 15, 2008, there were 152,107,016 outstanding warrants to purchase common stock, all exerciseable as of such date.
Principal Stockholders
The following table presents, as of March 15, 2008, information based upon our records and, to the extent described in the footnotes following the table, disclosures provided by representatives of the applicable holders, regarding each person known to us to be the beneficial owner of more than 5% of any class of our voting stock:
____________________________
*
Less than 1%.
(1)
The address of all principal stockholders is c/o Grande Communications Holdings, Inc., 401 Carlson Circle, San Marcos, Texas 78666.
(2)
Beneficial ownership is calculated in accordance with SEC rules and regulations. For the purpose of computing the percentage ownership of each beneficial owner, any securities which were not outstanding but which were subject to options, warrants, rights or conversion privileges held by such beneficial owner exercisable within 60 days were deemed to be outstanding in determining the percentage owned by such person, but were not deemed outstanding in determining the percentage owned by any other person.
(3)
Reflects the beneficial ownership percentage of such person or entity when both common stock and preferred stock vote together as a single class. Total voting power as of a particular date is calculated by dividing the number of common shares beneficially owned by such person by the sum of (i) the total number of shares of common stock outstanding, (ii) the total number of shares of preferred stock outstanding, and (iii) the number of securities which were not outstanding but which were subject to options, warrants, rights or conversion privileges held by such beneficial owner exercisable within 60 days of such date.
(4)
Includes the following shares:
(5)
Based upon our records and information provided by representatives of the various Centennial Ventures funds:
The following shares are beneficially owned by Centennial Holdings VI, LLC:
The following shares are beneficially owned by Centennial Holdings V, L.P.:
The following shares are beneficially owned by Centennial Holdings I, LLC:
Centennial Holdings VI, LLC (“Holdings VI”) is the general partner of each of Centennial Fund VI, L.P. and Centennial Entrepreneurs Fund VI, L.P., and is the managing member of CSP VI Management, LLC (“Strategic Management”), which is the general partner of Centennial Strategic Partners VI, L.P. (“Strategic Partners”). Accordingly, Holdings VI may be deemed to share beneficial ownership of all of the shares and warrants to purchase shares of capital stock of the issuer beneficially owned directly by them, and Strategic Management may be deemed to share beneficial ownership of the shares and warrants to purchase shares of capital stock of the issuer beneficially owned directly by Strategic Partners. Centennial Holdings V, L.P. (“Holdings V”) is the general partner of each of Centennial Entrepreneurs Fund V, L.P. (“Entrepreneurs V”) and Centennial Fund V, L.P. (“Fund V”). Accordingly, Holdings V may be deemed to share beneficial ownership of such shares and warrants to purchase shares of capital stock of the issuer. See footnote (11) to the Directors and Executive Officers beneficial ownership table below for a discussion of the relationships of Messrs. Butler and Hull to the Centennial Venture funds.
(6)
Includes the following shares:
(7)
Includes the following shares:
(8)
Includes the following shares:
(9)
Includes the following shares:
(10)
Includes the following shares:
(11)
Includes the following shares:
(12)
Includes the following shares:
(13)
Includes the following shares:
(14)
Includes the following shares:
(15)
Includes the following shares:
(16)
Includes the following shares:
(17)
Includes the following shares:
(18)
Includes the following shares:
(19)
Includes the following shares:
(20)
Includes the following shares:
(21)
Includes the following shares:
(22)
Includes the following shares:
(23)
Includes the following shares:
(24)
Includes the following shares:
(25)
Includes the following shares:
(26)
Includes the following shares:
(27)
Includes the following shares:
(28)
Includes the following shares:
(29)
Includes the following shares:
(30)
Includes the following shares:
(31)
Includes the following shares:
(32)
Includes the following shares:
(33)
Includes the following shares:
(34)
Includes the following shares:
(35)
Includes the following shares:
(36)
Includes the following shares:
(37)
Includes the following shares:
(38)
Includes the following shares:
(39)
Includes the following shares:
(40)
Includes the following shares:
(41)
Includes the following shares:
(42)
Includes the following shares:
(43)
Includes the following shares:
(44)
Includes the following shares:
(45)
Includes the following shares:
(46)
Includes the following shares:
(47)
Includes the following shares:
(48)
Includes the following shares:
Directors and Executive Officers
The following table presents, as of March 15, 2008, information regarding the beneficial ownership of our common stock and preferred stock by each of our directors and NEOs and all of our directors and NEOs as a group:
____________________________
*
Less than 1%.
(1)
The address of all directors and officers is c/o Grande Communications Holdings, Inc., 401 Carlson Circle, San Marcos, Texas 78666.
(2)
Beneficial ownership is calculated in accordance with SEC rules and regulations. For the purpose of computing the percentage ownership of each beneficial owner, any securities which were not outstanding but which were subject to options, warrants, rights or conversion privileges held by such beneficial owner exercisable within 60 days were deemed to be outstanding in determining the percentage owned by such person, but were not deemed outstanding in determining the percentage owned by any other person.
(3)
Reflects the beneficial ownership percentage of such person or group when both common stock and preferred stock vote together as a single class. Total voting power as of a particular date is calculated by dividing the number of common shares beneficially owned by such person by the sum of (i) the total number of shares of common stock outstanding, (ii) the total number of shares of preferred stock outstanding, and (iii) the number of securities which were not outstanding but which were subject to options, warrants, rights or conversion privileges held by such beneficial owner exercisable within 60 days of such date.
(4)
Includes 3,791,666 shares of common stock issuable upon exercise of common stock options and 2,333,333 shares of common stock issuable upon conversion of Series H preferred stock issuable upon exercise of Series H preferred stock options. All stock options are exercisable within 60 days of March 15, 2008.
(5)
Includes 3,432,863 shares of common stock issuable upon exercise of common stock options, 35,264 shares of common stock issuable upon exercise of common stock warrants, 110,947 shares of common stock issuable upon conversion of preferred stock and 1,268,750 shares of common stock issuable upon conversion of Series H preferred stock issuable upon exercise of Series H preferred stock options. All stock options and warrants are exercisable within 60 days of March 15, 2008.
(6)
Includes 700,000 shares of common stock, 2,405,113 shares of common stock issuable upon exercise of common stock options, 3,668 shares of common stock issuable upon exercise of common stock warrants, 11,654 shares of common stock issuable upon conversion of preferred stock and 1,268,750 shares of common stock issuable upon conversion of Series H preferred stock issuable upon exercise of Series H preferred stock options. All stock options and warrants are exercisable within 60 days of March 15, 2008.
(7)
Includes 500,000 shares of common stock issuable upon exercise of common stock options and 800,000 shares of common stock issuable upon conversion of Series H preferred stock issuable upon exercise of Series H preferred stock options. All stock options are exercisable within 60 days of March 15, 2008.
(8)
Includes 75,000 shares of common stock issuable upon exercise of common stock options and 108,333 shares of common stock issuable upon conversion of Series H preferred stock issuable upon exercise of Series H preferred stock options. All stock options are exercisable within 60 days of March 15, 2008.
(9)
Includes 75,000 shares of common stock issuable upon exercise of common stock options and 75,000 shares of common stock issuable upon conversion of Series H preferred stock issuable upon exercise of Series H preferred stock options. All stock options are exercisable within 60 days of March 15, 2008.
(10)
Each of Messrs. Butler and Hull is a managing director and on the investment committee of Holdings VI, Mr. Hull is a managing director and one of three general partners of Holdings V and is the Chief Executive Officer of Centennial Holdings I, L.L.C. (“Holdings I”), and Mr. Butler is a Senior Vice President of Holdings I. Because all decisions of the various Centennial Ventures funds with respect to voting and disposing of the issuer’s shares are made by more than three persons acting by majority vote, neither Messrs. Butler and Hull should be deemed to have direct or indirect beneficial ownership over any of the shares or warrants to purchase shares of capital stock of the issuer beneficially owned by the various Centennial Ventures funds and each of them expressly disclaims any such beneficial ownership.
(11)
Shares are owned by the Whitney Funds. Mr. Hockin is a former partner of Whitney & Co., an affiliate of the Whitney Funds. Mr. Hockin disclaims beneficial ownership of shares of our capital stock owned by the Whitney Funds.
(12)
Shares are owned by the Whitney Funds. Mr. Laverack is a managing member of the general partner of each of the Whitney Funds. Mr. Laverack may be deemed to share voting and dispositive power with respect to such shares. Mr. Laverack disclaims beneficial ownership of such shares except to the extent of his proportionate interest.
Investor Rights Agreement
We have entered into an amended and restated investor rights agreement with our preferred stockholders and certain of our common stockholders. This investor rights agreement sets forth certain preemptive rights, registration rights, transfer restrictions and covenants. See footnote No. 9, “Stockholder’s Equity” in the Notes to our Consolidated Financial Statements included in this annual report for a description of our investor rights agreement.
Securities Authorized for Issuance Under Equity Compensation Plan
The Company maintains the 2000 Stock Incentive Plan. The table below sets forth the following information as of December 31, 2007 for (i) all compensation plans previously approved by the Company’s shareholders and (ii) all compensation plans not previously approved by the Company’s shareholders:
(1)
the number of securities to be issued upon the exercise of outstanding options;
(2)
the weighted-average exercise price of such outstanding options; and
(3)
the number of securities remaining available for future issuance under the plans, other than securities to be issued upon the exercise of such outstanding options.
____________________________
(1)
Outstanding common stock options and common stock options available for future issuance that are designated as Executive Compensation Shares under the 2000 Stock Incentive Plan were 9,750,000 common stock options and 2,250,000 common stock options, respectively.
(2)
All Series H preferred stock options are designated as Executive Compensation Shares under the 2000 Stock Incentive Plan.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Related Person Transaction Approval
Although no formal written policy is in place, our board of directors reviews and approves all related person transactions where the amount exceeds $120,000. For these purposes, a “related person” is a director, nominee for director, executive officer, or holder of more than 5% of any series of our voting stock, or any immediate family member of any of the foregoing. This policy applies to any financial transaction, arrangement or relationship or any series of similar financial transactions, arrangements or relationships in which the Company is a participant and in which a related person has a direct or indirect interest.
Our board of directors will analyze the following factors, in addition to any other factors the members of the board deem appropriate, in determining whether to approve a related person transaction:
•
whether the terms are fair to Grande;
•
whether the transaction is material to Grande;
•
the role the related person has played in arranging the related person transaction;
•
the structure of the related person transaction; and
•
the interests of all related persons in the related person transaction.
Our board of directors may, in its sole discretion, approve or deny any related person transaction. Approval of a related person transaction may be conditioned upon Grande and the related person following certain procedures designated by the board.
Transaction with Robert Hughes
Hughes Family Partnership, L.P. has invested in a real estate purchase and leaseback transaction between Hill Partners, Inc. and Grande Communications, Inc. pursuant to which Grande Communications, Inc. pays approximately $67,000 per month to Hill Partners. Robert Hughes, a stockholder and a former member of our board of directors, is the managing general partner of Hughes Family Partnership, L.P.
Director Independence
For information on the independence of our directors, please see “Directors, Executive Officers and Corporate Governance-Director Independence.”
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTING FEES AND SERVICES
Audit fees include amounts billed for our annual audit, quarterly reviews and consultations related to the audit. Audit related fees include amounts billed for services rendered during the year ended December 31, 2006 and 2007 related to the debt filing and benefit plan audits. Tax services fees include amounts billed for services rendered during the year ended December 31, 2006 and 2007 for tax consulting and compliance. Other fees include amounts paid for research software.
Policy on Audit Committee Pre-Approval of Audit and Permissible Non-Audit Services of Independent Auditors
Under the terms of our audit committee charter, all audit and permitted non-audit services to be performed by our independent auditors must be pre-approved in advance by our audit committee. Our audit committee approved all of the permitted non-audit services performed by our independent auditors in 2006 and 2007. For a copy of our audit committee charter, please visit our website at www.grandecom.com/about_Grande/investor_relations/corporate_governance.php.
PART IV
ITEM 15.
ITEM 15.
EXHIBITS, FINANCIAL STATEMENT SCHEDULES
The following documents are filed as part of this Form 10-K:
(1)
Financial Statements
(2)
Financial Statement Schedule
(3)
Exhibits
Unless designated by an asterisk indicating that such document has been filed herewith, the Exhibits listed below have been heretofore filed by the Company pursuant to Section 13 or 15(d) of the Exchange Act and are hereby incorporated herein by reference to the pertinent prior filing.
____________________________
*
Filed herewith.
+
Management compensatory plan or agreement.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized.
POWER OF ATTORNEY
Know All Men By These Presents, that each person whose signature appears below constitutes and appoints Roy H. Chestnutt and Michael L. Wilfley and each and any of them, our true lawful attorneys-in-fact and agents, to do any and all acts and things in our names and our behalf in our capacities as trustees and officers and to execute any and all instruments for us and in our name in the capacities indicated below, which said attorneys and agents, or either of them, may deem necessary or advisable to enable said Corporation to sign any amendments to this Report on Form 10-K and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his or her substitute or substitutes, may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report on Form 10-K has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signature
Title
Date
/s/ ROY H. CHESTNUTT
President, Chief Executive Officer (Principal Executive Officer)
March 31, 2008
Roy H. Chestnutt
and Chairman of the Board of Directors
/s/ MICHAEL L. WILFLEY
Chief Financial Officer (Principal Financial Officer
March 31, 2008
Michael L. Wilfley
and Principal Accounting Officer)
/s/ DUNCAN T. BUTLER
Director
March 31, 2008
Duncan T. Butler
/s/ JOHN C. HOCKIN
Director
March 31, 2008
John C. Hockin
/s/ DAVID C. HULL, JR.
Director
March 31, 2008
David C. Hull, Jr.
/s/ WILLIAM LAVERACK, JR.
Director
March 31, 2008
William Laverack, Jr.
/s/ RICHARD W. ORCHARD
Director
March 31, 2008
Richard W. Orchard
/s/ LAWRENCE M. SCHMELTEKOPF
Director
March 31, 2008
Lawrence M. Schmeltekopf
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
GRANDE COMMUNICATIONS HOLDINGS, INC. AND SUBSIDIARY
AS OF DECEMBER 31, 2006 AND 2007 AND FOR EACH OF THE THREE YEARS
IN THE PERIOD ENDED DECEMBER 31, 2007
Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors of
Grande Communications Holdings, Inc. and Subsidiary
We have audited the accompanying consolidated balance sheets of Grande Communications Holdings, Inc. and Subsidiary as of December 31, 2006 and 2007, and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2007. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Grande Communications Holdings, Inc. and its Subsidiary as of December 31, 2006 and 2007, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2007, in conformity with U.S. generally accepted accounting principles.
As discussed in Note 2 to the consolidated financial statements, effective January 1, 2006, the Company adopted Financial Accounting Standards Board Statement of Financial Accounting Standards No. 123(R), “Shared Based Payment.”
/s/ Ernst & Young LLP
March 26,
Austin, Texas
GRANDE COMMUNICATIONS HOLDINGS, INC. & SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
The accompanying notes are an integral part of these consolidated financial statements.
GRANDE COMMUNICATIONS HOLDINGS, INC. & SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
The accompanying notes are an integral part of these consolidated financial statements.
GRANDE COMMUNICATIONS HOLDINGS, INC. & SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(In thousands)
The accompanying notes are an integral part of these consolidated financial statements.
GRANDE COMMUNICATIONS HOLDINGS, INC. & SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
The accompanying notes are an integral part of these consolidated financial statements.
GRANDE COMMUNICATIONS HOLDINGS, INC. & SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Background and Basis of Presentation
The primary business of Grande Communications Holdings, Inc. and its consolidated subsidiary, Grande Communications Networks, Inc. (collectively, the “Company”) is providing a bundled package of cable television (“video”), telephone (“voice”), and broadband Internet (“HSD”) and other services to residential and small and medium sized business customers in Texas. The Company provides these services in seven markets in the state of Texas using local broadband networks that the Company constructed. In addition, the Company provides broadband transport services to medium and large enterprises and communication carriers. The Company also provides network services by offering telecommunications and HSD products to medium and large enterprises and communication carriers within wholesale markets.
The accompanying consolidated financial statements of the Company have been prepared in conformity with U.S. generally accepted accounting principles. The consolidated financial statements include the accounts of Grande Communications Holdings, Inc.’s wholly owned subsidiary. All inter-company transactions and balances have been eliminated.
Certain reclassifications have been made to prior year amounts to conform to current year classifications. Accrued interest payable is presented separately in the accompanying consolidated balance sheets instead of being included in accrued liabilities. This change in presentation resulted in an increase in accrued interest payable and a decrease in accrued liabilities of $5.9 million as of December 31, 2006.
2. Summary of Significant Accounting Policies
Accounting Estimates
Preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying disclosures. These estimates are based on management’s best knowledge of current events and actions the Company may undertake in the future. Actual results may ultimately differ from these estimates.
Cash and Cash Equivalents
The Company considers all highly liquid investments with original maturities of three months or less to be cash and cash equivalents.
As a result of the Company’s cash management system, checks issued but not presented to the banks for payment may create negative book cash balances (zero-balance accounts). Such negative balances are included in accounts payable and total $3.5 million and $4.0 million as of December 31, 2006 and 2007, respectively.
The Company has entered into letter of credit agreements that restrict the use of cash. This restricted cash consists of cash maintained in a money market bank account. Restricted cash was approximately $2.9 million and $3.1 million as of December 31, 2006 and 2007, respectively, and is included as a component of other assets in the accompanying consolidated balance sheets.
Accounts Receivable
Accounts receivable are recorded at their net realizable values. The Company uses estimates to determine the allowance for doubtful accounts and records an accounts receivable reserve for known collectibility issues, as such issues relate to specific transactions or customer balances. These estimates are based on historical collection experience, current trends, credit policy and a percentage of the Company’s customer accounts receivable. In determining these percentages, the Company looks at historical write-offs of the receivables. The Company writes off accounts receivable when it becomes apparent based upon age or customer circumstances that such amounts will not be collected.
Property, Plant and Equipment
The Company’s industry is capital intensive and a large portion of the Company’s resources is spent on capital activities associated with building our network. Property, plant and equipment reflects the original cost of acquisition or construction, including costs associated with network construction and initial customer installations. Direct labor costs directly associated with capital projects are capitalized. The Company capitalizes direct labor costs associated with personnel based upon allocations of time devoted to network construction and customer installation activities. Costs capitalized as part of initial customer installations include materials, direct labor, and certain indirect costs. These indirect costs are associated with the activities of personnel who assist in connecting and activating the new service and consist of compensation and overhead costs associated with these support functions. Capitalized internal direct labor and overhead costs were approximately $10.6 million, $8.3 million and $8.5 million, during the years ended December 31, 2005, 2006 and 2007, respectively. Capitalized labor and overhead costs are depreciated along with the physical assets to which they relate, which have lives of three to ten years depending on the type of asset.
The costs of disconnecting service at a customer’s dwelling or reconnecting service to a previously installed dwelling are charged to operating expense in the period incurred.
Construction and other materials are valued at the lower of cost or market (determined on a weighted-average basis) and include customer premise equipment and certain plant construction materials. These items are transferred to the telecommunications plant when installed and activated.
Expenditures for repairs and maintenance are charged to expense when incurred. Expenditures for major renewals and betterments, which extend the useful lives of existing equipment, are capitalized and depreciated. Upon retirement or disposition of property, plant and equipment, the cost and related accumulated depreciation are removed from the accounts and any resulting gain or loss is recognized in the statements of operations.
Depreciation is calculated on the straight-line method based on the useful lives of the various classes of depreciable property. Assets recorded under capital leases are amortized over the lesser of the life of the underlying asset or the lease term and such amortization is included with depreciation and amortization expense. The average estimated lives of depreciable property, plant and equipment are:
Goodwill
The Company follows the Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Other Intangible Assets (SFAS 142), which recognizes that since goodwill and certain intangible assets may have indefinite useful lives, these assets are not amortized but are to be evaluated at least annually for impairment.
The Company used a two-step process to test for impairment of the carrying value of goodwill in accordance with SFAS 142. The first step of the process compared the fair value of each reporting unit with the carrying value of the reporting unit, including any goodwill. The Company utilized discounted cash flow and other valuation methodologies to determine the fair value of each reporting unit. If the fair value of each reporting unit exceeded the carrying amount of the reporting unit, goodwill is deemed not to be impaired in which case the second step in the process is unnecessary. If the carrying amount exceeded fair value, the Company performed the second step to measure the amount of impairment. Any impairment is measured by comparing the implied fair value of goodwill, calculated per SFAS 142, with the carrying amount of goodwill at the reporting unit, with the excess of the carrying amount over the fair value recognized as an impairment. During 2005 and 2006, the annual goodwill impairment tests resulted in an impairment of $39.6 million and $93.6 million, respectively, and as a result, all goodwill was written off as of December 31, 2006.
Intangible Assets
Intangible assets are accounted for in accordance with SFAS 142. The Company classifies intangible assets as definite-lived or indefinite-lived intangible assets. As of December 31, 2007, definite-lived intangibles include multiple family dwelling unit (“MDU”) exclusive access rights, which are amortized over the respective lives of the agreements, typically seven to eighteen years. The Company periodically reviews the appropriateness of the amortization periods related to its definite-lived assets. The Company does not currently have any intangible assets classified as indefinite-lived.
The Company tests for possible impairment of definite-lived intangible assets whenever events or changes in circumstances, such as a reduction in operating cash flow or a dramatic change in the manner that the asset is intended to be used indicates that the carrying amount of the asset is not recoverable. If indicators exist, the Company compares the undiscounted cash flows related to the asset to the carrying value of the asset. If the carrying value is greater than the undiscounted cash flow amount, an impairment charge is recorded in the statements of operations for amounts necessary to reduce the carrying value of the asset to fair value.
During the year ended December 31, 2005, the Company recognized a $1.8 million impairment related to a franchise fee intangible asset. Refer to Footnote No. 5 “Intangible Assets” for further discussion of the impairment. There were no impairments recognized on other definite-lived intangible assets during 2006 or 2007.
Long-Lived Assets
The Company evaluates its long-lived assets in accordance with SFAS No. 144, Accounting for the Impairment of Long-Lived Assets. Long-lived assets held and used by the Company are reviewed for impairment whenever events or changes in circumstances indicate that their net book value may not be recoverable. When such factors and circumstances exist, the Company compares the projected undiscounted future cash flows associated with the related asset or group of assets over their estimated useful lives against their respective carrying amounts. Impairment, if any, is based on the excess of the carrying amount over the fair value of those assets and is recorded in the period in which the determination was made.
Revenue Recognition
Revenue from residential and small and medium sized business customers is principally derived from bundled packages of video, voice, HSD and other services. Bundled services revenue consists of fixed monthly fees and usage based fees for long distance service and is recorded as revenue in the period the service is provided. Revenues are recognized when services are provided, regardless of the period in which they are billed. Amounts billed in advance are reflected in the balance sheet as deferred revenue and are deferred until the service is provided. Installation revenues obtained from bundled service connections are recognized in accordance with SFAS No. 51, Financial Reporting by Television Cable Companies, as the connections are completed since installation revenues recognized are less than the related direct selling costs. Installation costs are included in property, plant, and equipment and depreciated over the estimated life of communications plant. Local governmental authorities impose franchise fees on the majority of the Company’s franchises of up to a federally mandated maximum of 5% of annual gross revenues derived from the operation of the cable television system to provide cable television services, as provided in the franchise agreements. Such fees are collected on a monthly basis from the Company’s customers and periodically remitted to local franchise authorities. Franchise fees collected and paid of approximately $2.2 million, $2.5 million, and $2.9 million during the years ended December 31, 2005, 2006, and 2007, respectively, are reported as revenues and cost of revenues, respectively. The Federal Communications Commissions imposes a tax on long distance calls to fund telephone service for the poor, and to support telecommunications services for libraries, schools, and rural health care providers. Such taxes are collected on a monthly basis from the Company’s customers and periodically remitted to the Universal Service Fund (“USF”). Sales and other taxes imposed by governmental authorities are also collected on a monthly basis from the Company’s customers and periodically remitted to governmental authorities. Revenue is presented net of the applicable USF, sales and other taxes.
Revenue from broadband transport services is principally derived from providing medium and large enterprises and communication carriers with access to the Company’s metro area networks and point-to-point circuits on the Company’s long-haul fiber optic network. Revenue from network services is principally derived from switched carrier services and managed modem services. Broadband transport and network services revenue consists of fixed monthly fees and usage based fees and is recorded as revenue in the period the service is provided. Amounts billed in advance are reflected in the balance sheet as deferred revenue and are deferred until the service is provided. Revenue also includes upfront non-recurring fees for construction, installation and configuration services that are deferred and recognized over the related service contract period.
In instances where multiple deliverables are sold contemporaneously to the same counterparty, the Company follows the guidance in EITF Issue No. 00-21, Revenue Arrangements with Multiple Deliverables, and SEC Staff Accounting Bulletin No. 104, Revenue Recognition. Specifically, if the Company enters into sales contracts for the sale of multiple products or services, then the Company evaluates whether it has objective fair value evidence for each deliverable in the transaction. If the Company has objective fair value evidence for each deliverable of the transaction, then it accounts for each deliverable in the transaction separately, based on the revenue recognition policies outlined above. The residual method is used when no fair value is available for the deliverable. For example, this would occur when the Company enters into an agreement for service that includes the Company providing equipment in connection with the service and the subscriber paying an installation fee as well as monthly charges. Because the Company is providing both a product and a service, revenue is allocated to the product and monthly subscription service based on relative fair value and revenue is allocated to installation services using the residual method. To date, product revenues have not been significant.
Advertising Costs
The Company expenses all advertising costs as incurred. Total advertising expense for 2005, 2006 and 2007 was approximately $3.3 million, $2.6 million and $2.5 million, respectively, and is reflected as a component of selling, general and administrative expense in the accompanying consolidated statements of operations.
Debt Issuance Costs
Debt issuance costs are amortized over the life of the related indebtedness using a method that approximates the effective interest method. Amortization expense related to debt issuance costs charged to interest expense was approximately $1.0 million in each year ended December 31, 2005, 2006 and 2007.
Income Taxes
The Company utilizes the liability method of accounting for income taxes, as set forth in SFAS No. 109, Accounting for Income Taxes. Under the liability method, deferred taxes are determined based on the difference between the financial and tax bases of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse (see Note 7).
Effective January 1, 2007, the state of Texas changed its method of taxation from a franchise tax, which was based on taxable capital, to a tax based on gross margin. This change resulted in a different financial statement presentation of the tax to the state of Texas. Prior to January 1, 2007, the Texas franchise tax expense was included as a component of selling, general and administrative expense in the accompanying condensed consolidated statements of operations. The gross margin tax is presented as income tax expense during the year ended December 31, 2007.
Net Loss Per Share
The Company follows the provisions of SFAS No. 128, Earnings Per Share. Basic earnings per share is computed by dividing net income (loss) available to common shareholders by the weighted-average number of common shares outstanding during the period. Diluted earnings per share includes the weighted average number of common shares outstanding and the number of equivalent shares which would be issued related to the stock options and warrants using the treasury method, and convertible preferred stock using the if-converted method, unless such additional equivalent shares are anti-dilutive.
For the years ended December 31, 2005, 2006 and 2007, the Company reported a net loss, therefore, the following equivalent shares of common stock were not included in the computation of diluted EPS, as their effect was anti-dilutive:
Stock Based Compensation
As of December 31, 2007, the Company has a stock-based employee compensation plan, which is described more fully in Note 9. Prior to January 1, 2006, the Company accounted for the plan under the recognition and measurement provisions of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations, as permitted by SFAS No. 123, Accounting for Stock-Based Compensation. No stock-based employee compensation cost was recognized in the Consolidated Statement of Operations for the year ended December 31, 2005, as all options granted under those plans had an exercise price equal to the fair value of the underlying common stock on the date of grant. Prior to the adoption of SFAS No. 123(R), Share-Based Payment (“SFAS 123(R)”), the Company used the minimum value method of measuring stock options for the pro forma disclosure under SFAS 123. Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS 123(R), using the prospective transition method. Under that transition method, compensation cost recognized in 2006 and 2007 includes compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123(R). Results for prior periods have not been restated. Compensation expense calculated under SFAS 123(R) is amortized to compensation expense on a straight-line basis over the vesting period of the underlying stock option grants.
Fair Value of Financial Instruments
The carrying amounts reflected in the balance sheets for cash, cash equivalents, accounts receivable, accounts payable and accrued liabilities approximate fair value due to the short-term nature of the instruments. Fair value of the following debt instruments was estimated based on trading activity for the senior notes and borrowing rates currently available to the Company for equipment financing with similar terms and maturities:
Recent Accounting Pronouncements
Business Combinations
In December 2007, the FASB issued SFAS No. 141 (Revised 2007), Business Combinations (“SFAS 141(R)”). SFAS 141(R) will significantly change the accounting for business combinations. Under SFAS 141(R), an acquiring entity will be required to recognize all the assets acquired and liabilities assumed in a transaction at the acquisition-date fair value with limited exceptions. SFAS 141(R) will change the accounting treatment for certain specific acquisition related items including: (1) expensing acquisition related costs as incurred; (2) valuing noncontrolling interests at fair value at the acquisition date; and (3) expensing restructuring costs associated with an acquired business. SFAS 141(R) also includes a substantial number of new disclosure requirements. SFAS 141(R) is to be applied prospectively to business combinations for which the acquisition date is on or after January 1, 2009. The Company expects SFAS 141(R) will have an impact on the Company’s accounting for future business combinations once adopted but the effect is dependent upon the acquisitions that are made in the future.
Fair Value Measurements
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value in applying generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 applies whenever an entity is measuring fair value under other accounting pronouncements that require or permit fair value measurement. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, however the FASB provided a one year deferral for implementation of the standard for non-financial assets and liabilities. The Company does not expect the adoption of SFAS 157 to have a material impact on the consolidated financial statements.
In February 2006, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115 (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. SFAS 159 does not affect any existing accounting literature that requires certain assets and liabilities to be carried at fair value. SFAS 159 was effective for us on January 1, 2008. The Company did not apply the fair value option therefore; SFAS 159 did not have an impact on the consolidated financial statements.
3. Allowance for Doubtful Accounts
The activity in the Company’s allowance for doubtful accounts for the years ending December 31, 2005, 2006 and 2007 was as follows:
4. Property, Plant and Equipment
Property, plant and equipment consist of the following as of December 31, 2006 and 2007:
5. Intangible Assets
Definite-lived intangible assets consist of the following as of December 31, 2006 and 2007 (in thousands):
During the year ended December 31, 2005 the Company recognized a $1.8 million impairment related to a franchise fee intangible asset. No impairments were recognized during 2006 or 2007.
Amortization expense was $4.2 million, $0.3 million and $0.4 million for the years ending December 31, 2005, 2006 and 2007, respectively. The 2005 amortization expense was primarily related to the acquisition related subscriber base intangible that was fully amortized during 2005 and the $1.8 million impairment related to the franchise fee intangible. The weighted average remaining life for the MDU exclusive access rights intangible asset is approximately 6 years. Amortization expense associated with the net carrying value of definite-lived intangible assets is estimated to be $0.2 million in 2008 through 2012.
6. Accrued Liabilities
Accrued liabilities consist of the following as of December 31, 2006 and 2007:
7. Income Taxes
As of December 31, 2007, the Company had federal net operating loss carry-forwards of approximately $418 million. The net operating loss carry-forwards will expire beginning in 2020 if not utilized.
Utilization of the net operating losses may be subject to a substantial annual limitation due to the “change in ownership” provisions of the Internal Revenue Code of 1986. The annual limitation may result in the expiration of net operating losses before utilization.
Deferred income taxes reflect the net tax effect of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. The significant components of deferred tax assets and liabilities as of December 31, 2006 and 2007 are as follows:
The Company has established a valuation allowance equal to the net deferred tax asset due to uncertainties regarding the realization of the deferred tax asset based on the Company’s lack of earnings history. The valuation allowance increased approximately $23 million during the year ended December 31, 2007.
In July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109 (FIN 48), which clarifies the accounting and disclosure for uncertainty in tax positions, as defined. FIN 48 seeks to reduce the diversity in practice associated with certain aspects of the recognition and measurement related to accounting for income taxes. The Company adopted the provisions of FIN 48 as of January 1, 2007, and has reviewed filing positions in all of the federal and state jurisdictions where it is required to file income tax returns, as well as all open tax years in these jurisdictions. The Company has identified its federal tax return and its state tax returns in Texas as “major” tax jurisdictions, as defined. The only periods subject to examination for the Company’s federal tax returns are the 2004 through the 2007 tax years. The periods subject to examination for the Company’s state tax returns in Texas are years 2003 through 2007. The Company believes that its income tax filing positions and deductions will be sustained on audit and does not anticipate any adjustments that will result in a material adverse effect on the Company’s financial condition, results of operations, or cash flow. Therefore, no reserves for uncertain income tax positions have been recorded pursuant to FIN 48.
As discussed in Note 2, effective January 1, 2007, the State of Texas changed its method of taxation from a franchise tax, which was based on taxable capital, to a tax based on gross margin. This change significantly reduced the Company’s ability to utilize its net operating loss carryforwards in future periods under the Texas gross margin tax.
The Company’s provision for income taxes differs from the expected tax expense (benefit) amount computed by applying the statutory federal income tax rate of 35% to loss before income taxes primarily as a result of the following for the years ended December 31:
8. Long Term Debt
Long-term debt consists of the following as of December 31, 2006 and 2007:
14% Senior Secured Notes
Long-term Debt. In March 2004, the Company completed a private placement offering for 136,000 units each consisting of (1) $1,000 of senior notes due April 1, 2011 and (2) a warrant to purchase 100.336 shares of common stock. See the discussion of the warrants in footnote No. 9 below. The senior notes accrue interest at the rate of 14% per annum with the interest payable semi-annually in cash in arrears on April 1 and October 1. The senior notes are governed by the indenture between the Company and U.S. Bank National Association, as Indenture Trustee, dated March 23, 2004 (“Indenture”).
In March 2006, the Company raised net proceeds of approximately $30.5 million in a private placement of an additional $32.0 million in aggregate principal amount of senior notes. These additional notes were issued under the Indenture and are part of the same series of senior notes as those issued in March 2004.
On July 18, 2007, the Company completed a private placement offering of an additional $25 million in aggregate principal amount of senior notes for gross proceeds of approximately $26.0 million including a premium on issuance of $1.0 million. These additional senior notes were issued under the Indenture and are part of the same series of senior notes as those issued in March 2004 and 2006. The holders of a majority of the outstanding principal balance of the senior notes consented to the amendment of the Indenture to allow the Company to complete this issuance and the Company entered into a Supplemental Indenture to reflect this amendment on July 18, 2007.
Grande Communications Holdings, Inc.’s subsidiary, Grande Communications Networks, Inc., (the “Subsidiary Guarantor”), has unconditionally guaranteed, jointly and severally, the payment of the principal, premium and interest (including any additional interest on the senior notes) on a senior secured basis.
The senior notes and the Subsidiary Guarantor’s guarantees thereof are secured by a first priority perfected security interest, subject to certain permitted encumbrances, in substantially all of the subsidiary’s property and assets, including substantially all of its property, plant and equipment.
The senior notes may be redeemed, at the Company’s election, as a whole or from time to time in part, at any time after April 1, 2008, upon not less than 10 nor more that 60 days’ notice to each holder of notes to be redeemed, subject to the conditions and at the redemption prices (expressed as percentages of principal amount) set forth below, together with accrued and unpaid interest and Liquidating Damages (as defined in the Indenture), if any, to the applicable redemption date.
If the Company experiences specific kinds of change of control events, each holder of senior notes may require us to repurchase all or any portion of such holder’s senior notes at a purchase price equal to 101% of the principal amount of the senior notes, plus accrued and unpaid interest to the date of repurchase.
The Indenture contains covenants that, among other things, limit the Company’s ability to:
•
incur additional indebtedness, issue disqualified capital stock (as defined in the Indenture) and, in the case of restricted subsidiaries, issue preferred stock;
•
create liens on assets;
•
pay dividends on, redeem or repurchase capital stock or make other restricted payments;
•
make investments in other companies;
•
enter into transactions with affiliates;
•
enter into sale and leaseback transactions;
•
sell or make dispositions of assets;
•
place restrictions on the ability of restricted subsidiaries to pay dividends or make other payments to us; and
•
engage in certain business activities.
In addition, the Indenture contains a covenant restricting capital expenditures relating to the build-out of new or additional parts of the network if such expenditures would result in us having less than $20 million in cash and cash equivalents.
The Indenture also contains customary events of default, including nonpayment of principal or interest, violations of covenants, cross default and cross acceleration to certain other indebtedness and material judgments and liabilities.
The senior notes were issued with original offering discounts of $5.8 million in 2004 and $1.4 million in 2006 and at a premium of $1.0 million in 2007. These discounts and premiums are being amortized to interest expense using the effective interest method over the term of the underlying notes. Net amortization of discounts and premiums was $0.8 million, $1.1 million, and $1.2 million in 2005, 2006, and 2007, respectively.
The Company incurred debt issuance costs related to these units of $6.4 million in 2004, $0.1 million in 2006 and $0.2 million in 2007. Amortization of debt issuance costs was $1.0 million in 2005, 2006, and 2007.
Equipment Financing
During 2007, the Company completed equipment financing of $4.1 million with a term of 24 months, which was utilized for the purchase of network equipment. The financing is secured by the network equipment purchased with the proceeds of the borrowing and bears interest at an effective annual rate of approximately 15.3% with monthly payments equal to 4.2% multiplied by the total amount borrowed. This financing is permitted under the indenture between Grande and U.S. Bank National Association, as Indenture Trustee, dated March 23, 2004 (the “Indenture”) governing the 14% senior secured notes due 2011 (the “senior notes”).
Capitalized Interest
The Company capitalizes interest expense incurred from debt utilized to fund the construction of the network. The total amounts capitalized were approximately $3.3 million, $2.2 million and $0.6 million, during the years ended December 31, 2005, 2006 and 2007, respectively.
9. Stockholders’ Equity
Investor Rights Agreement
The Company has entered into an amended and restated investor rights agreement with preferred stockholders and certain common stockholders. This investor rights agreement sets forth certain preemptive rights, registration rights, transfer restrictions and covenants.
Preemptive Rights. Each preferred stockholder party to the investor rights agreement has the right to purchase its pro rata share of up to 85% of the equity securities that the Company may propose to issue and sell in any future offering. This right does not apply to and terminates upon the effective date of the registration statement pertaining to the first firm commitment underwritten public offering with an offering price of at least $1.30 per share and gross proceeds to us of at least $150 million.
Registration Rights. Preferred stockholders party to the investor rights agreement have the right to have their shares of stock registered under the Securities Act upon meeting certain minimum share and value thresholds for the shares to be registered. Once the thresholds for registration set forth in the investor rights agreement are met, such parties have the right to effect up to four long-form registrations (registrations using the Form S-1 or Form S-2 registration statement) and unlimited short-form registrations (registrations using the Form S-3 registration statement) as long as two such short-form registrations have not already been effected in the previous twelve months, though the number of shares registered may be limited if an underwriter to an offering advises us that marketing factors require a limitation on the number of shares to be underwritten. Each holder of preferred stock party to the investor rights agreement will also have the right to include its shares in a registration statement the Company files, though again the number of shares registered on behalf of such holder may be limited if an underwriter to an offering advises us that marketing factors require a limitation on the number of shares to be underwritten. The Company has also agreed to file a registration statement to register the securities held by the Series G preferred stockholders following the expiration or waiver of all lock-up arrangements entered into by the Series G preferred stockholders in connection with an initial public offering. The Company obtained a waiver from the preferred stockholders of any registration rights that may be triggered in connection with the filing of any registration statements required to be filed pursuant to the terms of the registration rights agreement and the equity registration rights agreement.
Transfer Restrictions. Before a stockholder party to the investor rights agreement may sell, transfer or exchange its stock, it must offer the shares first to the Company and second to the preferred stockholders. A preferred stockholder also has the right to participate in a sale of stock by another preferred stockholder. These transfer restrictions do not apply to transfers of capital stock to (a) an affiliate or family member of the stockholder, (b) a partner, member or stockholder of the stockholder entity, (c) a distribution in connection with the dissolution, winding-up or liquidation of a stockholder or (d) a transferee of a stockholder by will or the laws of intestate succession.
Covenants. In addition to customary covenants, the Company agreed to reserve and keep available enough shares of common stock to allow for the conversion of all preferred stock into common stock and placed a ceiling on the number of shares of common stock available for issuance under the stock option plan. The Company also agreed to provide certain information to the stockholders party to the investor rights agreement and agreed to have each employee, officer and consultant sign a proprietary information and inventions agreement.
Common Stock
In February 2000, the Company sold 11,410,000 shares of its $0.001 par value common stock. These shares are otherwise restricted as to their sale to a third party for a period ending the earlier of either an initial public equity offering or February 2010.
Preferred Stock
The Company’s $0.001 par value preferred stock may be issued from time to time in one or more series as determined by the Company’s board of directors.
The Company has authorized eight series of preferred stock, in alphabetical sequence from A to H (the “Preferred Stock”). As of December 31, 2007, no shares of Series H preferred stock has been issued, however, options to acquire Series H preferred stock have been granted. See below under the caption “Equity Incentive Plan” for discussion of the options related to Series H preferred stock.
The Preferred Stock is convertible into common stock at any time at the option of the holders, and automatically convertible to common stock upon the Company’s sale of its common stock in a firm commitment underwritten public offering meeting certain pricing specifications. The number of shares of common stock into which the Preferred Stock are convertible is based on a conversion price which initially provides for the conversion of one share of Preferred Stock to one share of common stock. The conversion price is adjusted for certain dilutive issuances, such as stock splits, stock dividends, recapitalizations or similar events, so that the number of shares of common stock issuable upon conversion is increased or decreased in proportion to any increase or decrease in the aggregate shares of common stock outstanding. The Preferred Stock is entitled to participate equally in the payment of dividends, when and as declared by the board of directors, on an as-converted basis. Such stock also has voting rights on an as-converted basis.
The Company entered into the Series G Preferred Stock Purchase Agreement, dated October 27, 2003, with a number of investors under which the Company sold 34,615,330 shares of Series G Preferred Stock (“Series G”) to such investors for a purchase price of $1.30 per share, for gross proceeds of $44,999,999. Each share of Series G preferred stock was initially convertible into one share of common stock at the election of the holder, based on a conversion ratio as defined in the agreement, initially set at one to one and adjusted from time to time based on certain anti-dilution provisions. The Company has also issued warrants to purchase 138,461,320 shares of common stock in connection with this sale of Series G preferred stock. For every share of Series G preferred stock purchased by an investor, such investor received four Warrants to purchase one share of common stock at an initial exercise price of $0.01 per share of common stock. The warrants have a ten year life and are immediately exercisable. Each share of Series G preferred stock has voting rights equal to the number of shares of common stock into which the preferred stock could then be converted.
The Company has an investor rights agreement, as amended, with all purchasers of its various preferred stock that includes certain registration rights, preemptive rights, transfer restrictions, company covenants and corporate governance provisions.
In the event of any liquidation, dissolution or winding up of the Company, the holders of the Series G preferred stock are entitled to receive, prior and in preference to any distribution to the holders of any other series of preferred stock or common stock, $3.90 per share plus declared but unpaid dividends on such shares. Any amounts remaining, after the payment to the holders of Series G preferred stock, will be distributed to the holders of the other series of preferred stock, prior and in preference to any distribution to the holders of common stock, an amount per share, which ranges from $1.00 to $2.50, plus declared but unpaid dividends on such shares. Additionally, upon the closing of an underwritten public offering, the holders of Series G preferred stock are entitled to receive $3.90 per share of value under an automatic conversion, with the right but not the obligation to receive $1.30 of the value in cash and the remainder in common stock. Upon such conversion, all declared but unpaid dividends shall be paid.
Stock Purchase Warrants
The Company valued the common stock warrants issued in connection with the Series G Preferred Stock at $0.20 per warrant or $27,692,307 and recorded this amount in additional paid in capital. The assumptions used to value these warrants were as follows: Expected Life-2 years, Fair Value of Common Stock-$0.20, Dividend Yield-0%, Risk Free Interest Rate-3%.
Concurrent with the closing of the senior notes, the Company issued warrants to acquire 13,645,696 shares of common stock at $0.01 per share. The Company valued the warrants issued in connection with the senior notes at $2.6 million and recorded this amount in additional paid in capital. The assumptions used to value this warrant were as follows: Expected Life-12 years, Fair Value of Common Stock-$0.20, Dividend Yield-0%, Risk Free Interest Rate-3%. Amortization of debt discounts associated with the common stock warrants was approximately $0.8 million, $1.1 million and $1.2 million in 2005, 2006 and 2007, respectively.
Equity Incentive Plan
On October 25, 2006, the board of directors of the Company approved and adopted the Grande Communications Holdings, Inc. Second Amended and Restated 2000 Stock Incentive Plan (the “2000 Stock Incentive Plan”). The stockholders approved the 2000 Stock Incentive Plan at the annual stockholders meeting on December 6, 2006.
•
Stock Subject to the Plan. The number of shares of common stock available for issuance under the 2000 Stock Incentive Plan is the lesser of (i) 10% of all of the shares of capital stock on a fully diluted basis, as if all such shares of capital stock were converted to common stock or (ii) 82,000,000 shares of common stock. In addition, 30,000,000 shares of Series H preferred stock shall be available for issuance under the 2000 Stock Incentive Plan. Of the shares available for issuance under the 2000 Stock Incentive Plan, 30,000,000 shares of Series H preferred stock and 12,000,000 shares of common stock are designated as “Executive Compensation Shares”. The maximum number of shares that may be reserved for issue pursuant to incentive stock options under the 2000 Stock Incentive Plan may not exceed 82,000,000 shares of stock. As of December 31, 2007, approximately 29.0 million shares of common stock and approximately 2.2 million shares of Series H Preferred Stock were available for issuance under the 2000 Stock Incentive Plan (of which 2.3 million shares of common stock and 2.2 million shares of Series H preferred stock are available for issuance as Executive Compensation Shares).
•
Eligibility. Officers, employees, directors, consultants or advisers to the Company are eligible to participate in the plan. The 2000 Stock Incentive Plan provides that the Executive Compensation Shares may be issued to the Chief Executive Officer of Grande Communications Holdings, Inc. The Restated Certificate of Incorporation of Grande Communications Holdings, Inc., however, provides that the Executive Compensation Shares may only be issued to the Chief Executive Officer of the Company or any other independent director, officer or key employee, as approved by the board of directors from time to time.
•
Awards Under the Plan. The Company may award “incentive stock options” and “non-statutory stock options” under the 2000 Stock Incentive Plan (in either case the Company refers to such awards as the options(s)).
Incentive Stock Options. Incentive stock options awarded under the 2000 Stock Incentive Plan must have an exercise price of at least 100% of the fair market of the stock on the date of grant. In the case of an employee who owns more than 10% of voting power, the exercise price will be the greater of the aggregate par value of the stock and at least 110% of the fair market value of the stock on the date of grant.
Non-Statutory Stock Options. The Company can award non-statutory stock options to any person eligible under the 2000 Stock Incentive Plan. The minimum exercise price for non-statutory stock options under the 2000 Stock Incentive Plan is 85% of the fair market value of the stock on the date of grant, provided, however, that (i) if the grantee owns more than 10% of the voting power, the exercise price will be the greater of the aggregate par value of the stock and at least 110% of the fair market value of the stock on the date of grant, (ii) to the extent that the option is intended to comply with Section 409A of the Internal Revenue Code of 1986, as amended, the exercise price will be the greater of the aggregate par value of the stock and at least 100% of the fair market value of the stock on the date of grant.
•
Vesting. Options and restricted stock awards vest as determined by the board of directors and as stated in the individual’s Award Agreement. Vesting is subject to a participant’s continued employment or service with the Company. Vesting of such options are subject to acceleration upon a Change of Control, as defined in the 2000 Stock Incentive Plan, unless the board of directors exercises the right to cancel vested options or the option agreement provides otherwise. Generally, unless a specific option agreement provides otherwise, the options with respect to shares of stock that are not Executive Compensation Shares provide for a vesting of the total number of option shares over a four year period, commencing with vesting of 25% of the option shares on the first anniversary of the vesting start date, and an additional 25% for each of the three following anniversaries of that date. Generally, unless a specific option agreement provides otherwise, the options for Executive Compensation Shares vest as follows: (i) 25% of the total option shares on the first anniversary of the vesting start date, (ii) 2.1% of the option shares on the last day of each of the first 35 months after such first anniversary, and (iii) 1.5% of the option shares on the last day of the 36th month after such first anniversary.
Valuation assumptions
Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS 123(R) using the prospective transition method. Under that transition method, compensation cost recognized in 2006 and 2007 includes compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123(R). Prior to the adoption of SFAS 123(R), the Company used the minimum value method of measuring stock options for the pro forma disclosure under SFAS 123. No stock-based employee compensation cost was recognized in the Consolidated Statement of Operations for the year ended December 31, 2005, as all options granted under those plans had an exercise price equal to the fair value of the underlying common stock on the date of grant.
The fair value of each award granted from the Company’s stock option plan during the years ended December 31, 2006 and 2007 was estimated at the date of grant using the Black-Scholes-Merton option pricing model, assuming no expected dividends and the following weighted average assumptions:
Expected life of option: The Company’s expected life of option represents the period that the Company’s stock-based awards are expected to be outstanding and was determined based on the simplified method provided in Staff Accounting Bulletin No. 107 and historical experience of similar awards, giving consideration to the contractual terms of the stock-based awards, vesting schedules and historical option exercise behavior and employee termination.
Risk free interest rate: Based on the U.S. Treasury yield curve in effect at the time of the grant.
Expected volatility of stock: Based on the volatility of similar entities (referred to as guideline companies). In evaluating similarity, the Company considered factors such as industry, stage of life cycle, size and financial leverage.
Dividends: The Black-Scholes-Merton valuation model includes a single expected dividend yield as an input. The Company has not issued any dividends and is prohibited to issue dividends under the Indenture.
Estimated forfeitures: When estimating forfeitures, the Company considered historical forfeiture behavior, as well as other factors.
A summary of option activity under the 2000 Stock Incentive Plan during the year ended December 31, 2007 is presented in the following table. There was no intrinsic value associated with the stock options as of December 31, 2006 and 2007.
The following table summarizes information concerning option activity during the years ended December 31, 2005, 2006 and 2007:
(1)
Information presented for 2005 is prior to the adoption of SFAS 123(R). No stock-based employee compensation cost was recognized in the Consolidated Statement of Operations for the year ended December 31, 2005, as all options granted under those plans had an exercise price equal to the fair value of the underlying common stock on the date of grant.
On May 3, 2006, the compensation committee of the board of directors approved the repricing of all common stock options outstanding to current employees to an exercise price of $0.05 per share. The Company recognized no additional compensation expense as a result of this modification due to the options having no fair value.
Total compensation costs related to stock options were $0.4 and $0.6 million for the years ended December 31, 2006 and 2007, respectively. As of December 31, 2007, $1.0 million of unrecognized compensation costs related to non-vested option grants are expected to be recognized over the course of the following four years. Cash received on exercise of stock options was $11,799 and $4,240 for the years ended December 31, 2006 and 2007, respectively. Upon share option exercise, new shares are issued as opposed to treasury shares.
The following table illustrates the effect on net loss and loss per share if the Company had applied the fair value recognition provisions of Statement 123 to options granted under the Company’s stock option plan in the period presented prior to the adoption of SFAS 123(R).
For purposes of this pro forma disclosure, the value of the options was estimated using a Black-Scholes-Merton option-pricing formula and amortized to expense over the options’ vesting periods. The fair value of these options was estimated at the date of grant with the following weighted-average assumptions:
10. Commitments and Contingencies
Capital Leases
The Company has entered into significant capital leases for office buildings and billing software. In 2006 and 2007, the Company entered into capital leases to finance the purchase of various customer premise equipment and computer software and equipment. The leases expire in varying years through 2024. Capital leases consist of the following as of December 31, 2006 and 2007:
Scheduled payments for the capital leases as of December 31, 2007 are as follows (in thousands):
Operating Leases
The Company leases office space and other assets for varying periods. Leases that expire are generally expected to be renewed or replaced by other leases.
Certain of the Company’s operating leases provide for payments that, in some cases, increase over the life of the lease. In accordance with SFAS No. 13, Accounting for Leases, rental expense for the Company’s operating leases is recognized on a straight-line basis for all operating leases including those with escalation clauses. The aggregate of the minimum annual payments is expensed on a straight-line basis over the term of the related lease without consideration of renewal option periods. The lease agreements contain provisions that require the Company to pay for normal repairs and maintenance, property taxes, and insurance.
Future minimum rental payments required under the operating leases that have initial or remaining non-cancelable lease terms in excess of one year as of December 31, 2007, are as follows (in thousands):
Total rental expense for all operating leases was approximately $5.5 million, $5.8 million and $5.4 million for 2005, 2006 and 2007, respectively.
Franchise Agreements and Build-Outs
The State of Texas passed a law in late 2005 allowing cable operators to file for a state issued certificate of franchise authority (“SICFA”) for the provision of cable television and video services in Texas rather than negotiating with each individual municipality for such a right. On October 25, 2005, the Public Utility Commission of Texas, (“PUCT”), approved Grande’s application for a SICFA to provide cable TV service in twenty-seven municipalities and in eleven unincorporated areas of Texas. When the SICFA was approved, all of Grande’s municipal cable TV franchises were terminated.
Under the SICFA, among other things, Grande makes quarterly franchise fee payments to each municipality where it provides cable TV service of five percent of its gross cable service revenues and reports its subscriber count in each municipality. Franchise fees collected from the Company’s customers and remitted to local franchise authorities were approximately $2.2 million, $2.5 million, and $2.9 million during the years ended December 31, 2005, 2006, and 2007, respectively, and are reported as revenues and cost of revenues, respectively.
Legal Proceedings
The Company is subject to litigation in the normal course of business. However, there are no pending proceedings, which are currently anticipated to have a material adverse effect on the Company’s business, financial condition or results of operations.
Insurance
The Company carries a broad range of insurance coverage, including property, business, auto liability, general liability, directors and officers, workers’ compensation and an umbrella policy. The Company has not incurred significant claims or losses on any of these insurance policies.
The Company utilizes self-insurance with respect to employee medical coverage. Such self-insurance is provided in connection with a plan that includes certain stop-loss coverage on a per employee and total claims basis. The Company estimates the liability for claims based on Company experience. Additionally, the Company utilizes self-insurance for its distribution line equipment. Management believes that the risk of loss related to this equipment is not significant.
Maintenance Agreements
The Company has entered into numerous agreements for the maintenance of leased fiber optic capacity. Future amounts due under these agreements as of December 31, 2007 are as follows (in thousands):
Purchase Commitments
During January 2005, the Company entered into a minimum purchase agreement with a vendor for the purchase of $5.6 million of fiber optic equipment and installation and maintenance services through January 2008. During March 2008, the Company entered into Amendment No. 1 to the minimum purchase agreement extending the term of the purchase commitment through December 31, 2008. If the Company does not make the minimum purchases through the expiration or termination of this agreement, the Company will be required to pay a fee of 30% of the remaining unfulfilled amount. Purchases under this agreement were $1.5 million, $1.0 million, and $0.5 million during the years ended December 31, 2005, 2006, and 2007, respectively. Approximately $2.4 million remains outstanding as of December 31, 2007.
Employment Agreements
The Company has entered into employment agreements with four of the Company’s senior executives for an indefinite term, subject to continued employment with the Company. As of December 31, 2007, estimated benefits that would have been payable to the senior executives if an event triggering a termination without cause by the Company or for good reason by the senior executive had occurred was $1.1 million in the aggregate. During January 2008, one of the senior executives subject to an employment agreement voluntarily resigned and there were no severance payments or continued medical benefits associated with his voluntary resignation.
11. Concentration of Credit Risk
Certain financial instruments potentially subject the Company to concentrations of credit risk. These financial instruments consist primarily of trade receivables, cash and temporary cash investments.
The Company places its cash and temporary cash investments with high credit quality financial institutions and limits the amount of credit exposure to any one financial institution. The Company also periodically evaluates the creditworthiness of the institutions with which it invests. The Company does maintain invested balances in excess of federally insured limits.
The Company’s trade receivables reflect a customer base primarily centered in Texas. The Company routinely assesses the financial strength of its customers and generally does not require collateral. As a consequence, concentrations of credit risk are limited.
12. Employee Benefit Plan
The Company has a 401(k) plan for its employees. All employees over the age of 18 are eligible to participate in the plan. The Plan provides for discretionary matching by the Company. During 2005, 2006 and 2007, the Company made discretionary matching cash contributions to the plan of approximately $0.7 million in 2005 and 2006 and approximately $0.8 million in 2007.
13. Quarterly Financial Information-Unaudited
(1) The presentation of Texas gross margin tax has been reclassified to conform to current presentation. Texas gross margin tax is presented separately as income tax expense instead of being included in sales, general and administrative expense.