ITEM 1. BUSINESS (Dollars in thousands)
Introduction
Olympus Communications, L.P. ("Olympus" and, collectively with its subsidiaries, the "Company") is a joint venture limited partnership between ACP Holdings, Inc., a wholly-owned subsidiary of Adelphia Communications Corporation (together with its subsidiaries, "Adelphia") and subsidiaries of FPL Group, Inc. (together with its subsidiaries, "FPL Group") with 50% of the outstanding voting interest held by Adelphia and 50% held by FPL Group. On January 28, 1999, the partners entered into an agreement in which Adelphia will acquire FPL Group's partnership interests in Olympus no later than July 11, 1999. See "Recent Development of the System" for additional information about this transaction. The Company's operations consist of providing telecommunications services primarily over its networks, which are commonly referred to as broadband networks because they can transmit large quantities of voice, video and data by way of digital or analog signals. Adelphia is a leader in the telecommunications industry with cable television and local telephone operations. As of December 31, 1998, Adelphia owned and managed cable television systems (including Olympus) with broadband networks that passed in front of 3,252,830 homes and served 2,304,325 basic subscribers.
The Company operates one of the largest contiguous cable systems located in some of the fastest growing markets in Florida. As of December 31, 1998, the Company's cable system (the "System") passed in front of 943,602 homes and served 641,575 basic subscribers. In addition to traditional analog cable television, the Company offers a wide range of telecommunication services including digital cable television, high speed data and Internet access, electronic security monitoring, paging and telephony.
The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements. Certain information included in this Annual Report on Form 10-K, including Management's Discussion and Analysis of Financial Condition and Results of Operations, is forward-looking, such as information relating to the effects of future regulation, future capital commitments and the effects of competition. Such forward-looking information involves important risks and uncertainties that could significantly affect expected results in the future from those expressed in any forward-looking statements made by, or on behalf of, the Company. These "forward looking statements" can be identified by the use of forward-looking terminology such as "believes", "expects", "may", "will," "should," "intends" or "anticipates" or the negative thereof or other variations thereon or comparable terminology or by discussions of strategy that involve risks and uncertainties. These risks and uncertainties include, but are not limited to, uncertainties relating to economic conditions, acquisitions and divestitures, government and regulatory policies, the pricing and availability of equipment, materials, inventories and programming, technological developments, the year 2000 issues and changes in the competitive environment in which the Company operates. Persons reading this Annual Report on Form 10-K are cautioned that forward-looking statements herein are only predictions, that no assurance can be given that the future results will be achieved, and that actual events or results may differ materially as a result of the risks and uncertainties facing the Company.
Business
Video Services
Cable television systems receive a variety of television, radio and data signals transmitted to receiving sites ("headends") by way of off-air antennas, microwave relay systems and satellite earth stations. Signals are then modulated, amplified and distributed primarily through fiber optic and coaxial cable to subscribers, who pay fees for the service. Cable television systems are generally constructed and operated pursuant to non-exclusive franchises awarded by state or local government authorities for specified periods of time.
Cable television systems typically offer subscribers a package of basic video services consisting of local and distant television broadcast signals, satellite-delivered non-broadcast channels (which offer programming such as news, sports, family entertainment, music, weather, shopping, etc.) and public, governmental and educational access channels.
In addition, premium service channels, which provide movies, live and taped concerts, sports events and other programming, are offered for an extra monthly charge. At December 31, 1998, over 98% of subscribers of the System were also offered pay-per-view programming, which allows the subscriber to order special events or movies and to pay on a per event basis. Local, regional and national advertising time is sold in the majority of the System, with commercial advertisements inserted on certain satellite-delivered non-broadcast channels.
Digital video services are now available to Olympus subscribers who lease or purchase a digital converter. Digital TV is a computerized method of defining, transmitting and storing information that makes up a television signal. Since digital signals can be "compressed," Olympus can transmit up to 12 channels in the space currently used to transmit just one analog channel. Digital TV converters are available to approximately 92% of Olympus' customers.
Olympus' digital TV subscribers may also receive "multichannel" premium services, such as HBO 1, 2, 3 and 4 from East and West Coast satellite feeds, enhanced Pay-Per-View options with eighteen movie channels, up to 40 channels of CD-quality music from Music Choice and an interactive on-screen program guide to help them navigate the new digital choices.
High Speed Data and Internet Access
Power Link, the Company's high-speed data service, which includes residential, institutional and business applications, constitutes an alternative to the traditional slower speed data offerings available through Internet Service Providers ("ISPs"). Power Link offers customers speeds comparable to those available through a T1 line, at costs that compare to a typical ISP plus a second telephone line.
The Company's deep fiber design allows the use of the expanded bandwidth potential of digital compression technology for cable data and video services. High speed cable data services are now available at speeds far in excess of that which is currently available via a 28.8 kilobit per second telephone modem. In addition, using a high speed cable modem and special ethernet card allows the user to bypass telephone lines, does not require the user to log on, and allows for multiple sessions or connections to multiple services simultaneously.
The Company currently offers high speed Internet access through the use of one way cable modems, which provides the high speeds of broadband on the data downstream and utilizes a telephone line return path. One way cable modems enable the Company to offer the high speed data service to the bulk of its customers, while completing the system buildout of two way broadband plant.
The Company also offers traditional dial up Internet access for those customers who initially prefer this method of Internet access to the higher speeds of our broadband network. This establishes the Company as a full service
Internet provider and creates a customer base that can be upgraded to the high speed service in the future.
Electronic Security Monitoring
The Company provided electronic security monitoring services and equipment to approximately 37,000 accounts in Florida as of December 31, 1998. The Company markets its services to both residential and commercial customers. The residential customers represent approximately 85% of its customers and the commercial market represents the remainder. The Company offers these customers video-telemetry systems, intercom and sound systems and other low voltage products.
The Company's strategy for marketing electronic security monitoring services and equipment is to leverage all of the distribution channels available through the Company's existing market presence including customer service and billing resources, cable channel advertising, marketing literature, and relationships with developers, builders and homeowners' associations.
Other Services
The Company offers wireless messaging services to its subscribers through an affiliate, Page Time, Inc., a wholly-owned subsidiary of Adelphia which provides one-way messaging services to the Company via resale arrangements with existing paging network operators. The Company had approximately 4,800 paging subscribers at December 31, 1998.
In December 1997, the Company also began selling long distance telephone service on a resale basis. Services offered include state-to-state and in-state long distance, as well as 800 service, international calling, calling card services and debit card services. The Company's sales effort is focused on the consumer market and emphasizes the simplicity and savings of one low monthly rate plus a competitive usage fee available 24 hours a day, 7 days a week.
Operating Strategy
The Company's strategy is to construct and operate a broadband network capable of offering a broad range of telecommunications services and providing superior customer service while maximizing operating efficiencies. The Company intends to continue as a cable television service provider as well as providing bundled communications services combining cable television service with high speed data and Internet access, electronic security monitoring, paging and telephony in South Florida. The Company expects to achieve these goals through strong internal growth and investment in and upgrade of its networks.
The Company's coverage areas encompass certain regions with attractive demographics, including above average income levels and strong population growth trends. Approximately 25% of the homes in the Company's market areas are located in planned communities that typically provide better cross-marketing opportunities. The Company had internal basic subscriber growth of 3.0% during the 12 months ended December 31, 1998, and expects that the markets it operates in will continue to provide opportunities for growth.
The Company considers technological innovation to be an important component of its service offerings and customer satisfaction. The Company intends to continue the upgrade of its network infrastructure to add channel capacity, increase digital transmission capabilities and further improve system reliability. As a result, the Company believes it will have one of the most advanced cable network infrastructures in the United States.
Management believes the technical level of its system and the concentration of its customer base contribute favorably to the Company's cash flow margin.
Recent Development of the System
The Company has focused on acquiring and developing systems in markets that have favorable historical growth trends. The Company believes that the strong household growth trends in its System's market areas are a key factor in positioning itself for future growth in basic subscribers.
On January 28, 1999, Adelphia entered into an agreement to acquire the Olympus partnership interests owned by FPL Group for approximately $108,000, subject to definitive terms to be negotiated by both parties. Upon the closing of this transaction, Adelphia will own 100% of Olympus. Closing of this transaction is expected to occur during the third quarter of 1999.
On December 4, 1998, Olympus consummated a series of transactions to restructure the ownership of Tele-Media Investment Partnership ("TMIP"). The restructuring resulted in Olympus exchanging its non-consolidated preferred limited partnership investment in TMIP for 100% ownership of a cable television system serving approximately 28,000 subscribers in Palm Beach County, Florida subject to $38,027 in debt and a 75% consolidated general partner interest in TMIP subject to $31,166 in debt. The restructured TMIP owns a cable television system serving approximately 34,000 subscribers located principally in Broward County, Florida and a 33.9% interest in an entity which owns cable television systems serving approximately 10,000 subscribers in Virginia. The acquisition was accounted for under the purchase method of accounting.
On November 30, 1998, Olympus acquired cable television systems from Time Warner for approximately $33,400. These systems serve approximately 20,000 subscribers in communities around Lake Okeechobee, Florida. The acquisition has been accounted for under the purchase method of accounting.
On July 15, 1998, Olympus acquired the Fort Myers cable television operations from Cable TV Fund 12-A, Ltd. This system was acquired for approximately $110,000 and serves approximately 46,000 subscribers located in and around Fort Myers, Florida. The acquisition was accounted for under the purchase method of accounting.
On June 30, 1998, Olympus sold its Madeira Beach, Florida cable television system, serving approximately 6,000 subscribers, to Cable One, Inc. for approximately $10,500.
The following table indicates the growth of the Company's System by summarizing the number of homes passed by cable and the number of basic subscribers for each of the five years in the period ended December 31, 1998. The table also indicates the numerical growth in subscribers attributable to acquisitions and the numerical and percentage growth attributable to internal growth. For the period January 1, 1994 through December 31, 1998, 62% of aggregate internal basic subscriber growth for the Company's System was derived from internal growth in homes passed, while the remaining 38% of such aggregate growth was derived from penetration increases.
Financial Information
The financial data regarding the Company's revenues, results of operations and identifiable assets for each of the Company's last three fiscal years is set forth in, and incorporated herein by reference to, Item 8, Financial Statements and Supplementary Data of this Form 10-K.
Technological Developments
The Company has made a substantial commitment to the technological development of the System and has actively sought to upgrade the technical capabilities of its cable plant in a cost efficient manner. System development will allow the Company to increase the plant capacity, provide two-way communication and other digital services and at the same time further increase the reliability of the plant.
The design of the current System upgrade, when completed, will deploy on average one fiber optic node for every two System plant miles or approximately one fiber node for every 180 homes passed compared to the industry norm of 500 to 1000 homes passed per fiber optic node. The entire System will be upgraded to 750 Mhz comprised of 550 Mhz analog (80 channels) and 200 Mhz digital (400 channels, assuming 12 to 1 compression). The upgraded system will be completely
addressable and provide two-way communication capability. The additional bandwidth will enable the Company to offer additional video programming services. The 200 Mhz of digital capacity can be allocated to the new service offerings such as two-way data, telephony and video-on-demand. The Company believes the combination of the 200 Mhz of digital capacity and the relatively low homes passed per fiber node will provide adequate capacity and flexibility to offer any and all of the existing and anticipated services into the foreseeable future with minimal additional capital expenditures.
The upgraded System, on average, will include only two active pieces of equipment between the headend and the home. Limiting the number of active pieces of equipment combined with the small number of homes per fiber node reduces the potential for mechanical failure and the number of customers affected by such a failure, all of which provides increased reliability to the customers.
Subscriber Services and Rates
The Company's revenues are derived principally from monthly subscription fees for various services. Rates to subscribers vary in accordance with the type of service selected. Although service offerings vary across franchise areas because of differences in plant capabilities, each of the areas typically offer services at monthly prices ranging as follows:
In addition, the Company derives revenue from telephony, with rates determined on a usage basis.
An installation fee, which the Company may wholly or partially waive during a promotional period, is usually charged to new subscribers. Subscribers are free to terminate services at any time without charge, but often are charged a fee for reconnection or change of service.
The Cable Communications Policy Act of 1984 (the "1984 Cable Act," as amended by the 1992 Cable Act), deregulated basic service rates for systems in communities meeting the FCC's definition of effective competition. Pursuant to the FCC's definition of effective competition adopted following enactment of the 1984 Cable Act, substantially all of the Company's franchises were rate deregulated. However, in June 1991, the FCC amended its effective competition standard, which increased the number of cable systems that could be subject to local rate regulation. The 1992 Cable Act contains a new definition of effective competition under which nearly all cable systems in the United States are subject to regulation of basic service rates. Additionally, the legislation (i) eliminates the 5% annual basic rate increase allowed by the 1984 Cable Act without local approval; (ii) allows the FCC to adjudicate the reasonableness of rates for non-basic service tiers, other than premium services, for cable systems not subject to effective competition in response to complaints filed by franchising authorities and/or cable subscribers; (iii) prohibits cable systems from requiring subscribers to purchase service tiers above basic service in order to purchase premium services if the system is technically capable of doing so; (iv) allows the FCC to impose restrictions on the retiering and rearrangement of cable services under certain circumstances; and (v) permits the FCC and franchising authorities more latitude in controlling rates and rejecting rate increase requests. The Telecommunications Act of 1996 (the "1996 Act") ends FCC regulation on nonbasic tier rates on March 31, 1999.
For a discussion of FCC rate regulation and related developments, see "Legislation and Regulation" and "Management's Discussion and Analysis of Financial Condition and Results of Operations - Regulatory and Competitive Matters."
Franchises
The 1984 Cable Act provides that cable operators may not offer cable service to a particular community without a franchise unless such operator was lawfully providing service to the community on July 1, 1984 and the franchising authority does not require a franchise. The System operates pursuant to franchises or other authorizations issued by governmental authorities, substantially all of which are nonexclusive. Such franchises or authorizations awarded by a governmental authority generally are not transferable without the consent of the authority. As of December 31, 1998, the Company held 157 franchises. Most of these franchises can be terminated prior to their stated expiration by the relevant governmental authority, after due process, for breach of material provisions of the franchise.
Under the terms of most of the Company's franchises, a franchise fee (generally ranging up to 5% of the gross revenues of the cable system) is payable to the governmental authority. For the past three years, franchise fee expense incurred by the Company has averaged approximately 4.2% of gross system revenues.
The franchises issued by the governmental authorities are subject to periodic renewal. In renewal hearings, the authorities generally consider, among other things, whether the franchise holder has provided adequate service and complied with the franchise terms. In connection with a renewal, the authority may impose different and more stringent terms, the impact of which cannot be predicted. To date, all of the Company's material franchises have been renewed or extended, at or effective upon their stated expiration, generally on modified terms. Such modified terms have not been materially adverse to the Company.
The Company believes that all of its material franchises are in good standing. From time to time, the Company notifies the franchising authorities of the Company's intent to seek renewal of the franchise in accordance with the procedures set forth in the 1984 Cable Act. The 1984 Cable Act process requires that the governmental authority consider the franchise holder's renewal proposal on its own merits in light of the franchise holder's past performance and the community's needs and interests, without regard to the presence of competing applications. See "Legislation and Regulation." The 1992 Cable Act alters the administrative process by which operators utilize their 1984 Cable Act franchise renewal rights. Such changes could make it easier in some instances for a franchising authority to deny renewal of a franchise.
Competition
Although the Company and the cable television industry have historically faced modest competition, the competitive landscape is changing and competition will increase. The Company believes that the increase in competition within its communities will occur gradually over a period of time.
At the present time, cable television systems compete with other communications and entertainment media, including off-air television broadcast signals which a viewer is able to receive directly using the viewer's own television set and antenna. The extent to which a cable system competes with over-the-air broadcasting depends upon the quality and quantity of the broadcast signals available by direct antenna reception compared to the quality and quantity of such signals and alternative services offered by a cable system. In many areas, television signals, which constitute a substantial part of basic service, can be received by viewers who use their own antennas. Local television reception for residents of apartment buildings or other multi-unit dwelling complexes may be aided by use of private master antenna services. Cable systems also face competition from alternative methods of distributing and receiving television signals and from other sources of entertainment such as live sporting events, movie theaters and home video products, including videotape recorders and cassette players. In recent years, the FCC has adopted policies providing for authorization of new technologies and more favorable operating environment for certain existing technologies that provide, or may provide, substantial additional competition for cable television systems. The extent to which cable television service is competitive depends in significant part upon the cable television system's ability to provide an even greater variety of programming than that available off-air or through competitive alternative delivery sources.
In addition, certain provisions of the 1992 Cable Act and the 1996 Act are expected to increase competition significantly in the cable industry. See "Legislation and Regulation."
The 1992 Cable Act prohibits the award of exclusive franchises, prohibits franchising authorities from unreasonably refusing to award additional franchises and permits them to operate cable systems themselves without franchises.
Individuals presently have the option to purchase earth stations, which allow the direct reception of satellite-delivered program services formerly available only to cable television subscribers. Most satellite-distributed program signals are being electronically scrambled to permit reception only with authorized decoding equipment, generally at a cost to the viewer. From time to time, legislation has been introduced in Congress which, if enacted into law, would prohibit the scrambling of certain satellite-distributed programs or would make satellite services available to private earth stations on terms comparable to those offered to cable systems. Broadcast television signals are being made available to owners of earth stations under the Satellite Home View Copyright Act of 1988, which became effective January 1, 1989 for a six-year period. This Act establishes a statutory compulsory license for certain transmissions made by satellite owners to home satellite dishes for which carriers are required to pay a royalty fee to the Copyright Office. This Act has been extended by Congress until December 31, 1999. The 1992 Cable Act enhances the right of cable competitors to purchase nonbroadcast satellite-delivered programming. See "Legislation and Regulation - Federal Regulation."
Video programming is now being delivered to individuals by high-powered direct broadcast satellites ("DBS") utilizing video compression technology. This technology has the capability of providing more than 100 channels of programming over a single high-powered DBS satellite with significantly higher capacity available if multiple satellites are placed in the same orbital position. Video compression technology may also be used by cable operators in the future to similarly increase their channel capacity. DBS service can be received virtually anywhere in the United States through the installation of a small rooftop or side-mounted antenna, and it is more accessible than cable television service where a cable plant has not been constructed or where it is not cost effective to construct cable television facilities. DBS service is being heavily marketed on a nationwide basis by several service providers. One DBS service provider is proposing to deliver at least some local television stations via satellite, thus lessening the distinction between cable television and DBS service.
Cable communications systems also compete with wireless program distribution services such as multichannel, multipoint distribution service ("MMDS"), commonly called wireless cable systems, which use low-power microwave frequencies to transmit video programming over-the-air to subscribers. There are MMDS operators who are authorized to provide or are providing broadcast and satellite programming to subscribers in areas served by the Company's System. MMDS systems are less capital intensive, are not required to obtain local franchises or to pay franchise fees and are subject to fewer regulatory requirements than cable television systems. MMDS systems' ability to compete with cable television systems has previously been limited by channel capacity, the inability to obtain programming and regulatory delays. Recently, however, MMDS systems have developed digital compression technology, which provides for more channel capacity and better signal delivery. Although relatively few MMDS systems in the United States are currently in operation or under construction, virtually all markets have been licensed or tentatively licensed. A series of actions taken by the FCC, including reallocating certain frequencies to wireless services, are intended to facilitate the development of wireless cable television spectrum that will be used by wireless operators to provide additional channels of programming over longer distances. Several Regional Bell Operating Companies acquired interests in major MMDS companies. The Company is unable to predict whether wireless video services will have a material impact on its operations.
Additional competition may come from private cable television systems servicing condominiums, apartment complexes and certain other multiple unit residential developments. The operators of these private systems, known as satellite master antenna television ("SMATV") systems, often enter into exclusive agreements with apartment building owners or homeowners' associations which preclude franchised cable television operators from serving residents of
such private complexes. However, the 1984 Cable Act gives franchised cable operators the right to use existing compatible easements within their franchise areas upon nondiscriminatory terms and conditions. Accordingly, where there are preexisting compatible easements, cable operators may not be unfairly denied access or discriminated against with respect to the terms and conditions of access to those easements. There have been conflicting judicial decisions interpreting the scope of the access right granted by the 1984 Cable Act, particularly with respect to easements located entirely on private property. Further, while a franchised cable television system typically is obligated to extend service to all areas of a community regardless of population density or economic risk, a SMATV system may confine its operation to small areas that are easy to serve and more likely to be profitable. Under the 1996 Act, SMATV systems can interconnect non-commonly owned buildings without having to comply with local, state and federal regulatory requirements that are imposed upon cable systems providing similar services, as long as they do not use public rights-of-way. The U.S. Copyright Office has concluded that SMATV systems are "cable systems" for purposes of qualifying for the compulsory copyright license established for cable systems by federal law.
The FCC has authorized a new interactive television service, which will permit non-video transmission of information between an individual's home and entertainment and information service providers. This service will provide an alternative means for DBS systems and other video programming distributors, including television stations, to initiate the new interactive television services. This service may also be used by the cable television industry.
The FCC also has initiated a new rulemaking proceeding looking toward the allocation of frequencies in the 28 Ghz range for a new multi-channel wireless video service that could make 98 video channels available in a single market. The Company cannot predict at this time whether competitors will emerge utilizing such frequencies or whether such competition would have a material impact on the operations of cable television systems.
The FCC has recently allocated a sizable amount of spectrum in the 31 Ghz band for use by a new wireless service, Local Multipoint Distribution Service ("LMDS"), which among other uses, can deliver over 100 channels of digital programming directly to consumers' homes. The FCC auctioned this spectrum to the public during 1998, with cable operators and local telephone companies restricted in their participation in this auction. The extent to which the winning licenses in this service will use this spectrum in particular regions of the country to deliver multichannel video programming to subscribers, and therefore provide competition for franchised cable systems, is at this time uncertain.
The 1996 Act eliminates the restriction against ownership and operation of cable systems by local telephone companies within their local exchange service areas. Telephone companies are now free to enter the retail video distribution business through any means, such as DBS, MMDS, SMATV or as traditional franchised cable system operators. Alternatively, the 1996 Act authorizes local telephone companies to operate "open video systems" without obtaining a local cable franchise, although telephone companies operating such systems can be required to make payments to local governmental bodies in lieu of cable franchise fees. Up to two-thirds of the channel capacity of an "open video system" must be available to programmers unaffiliated with the local telephone company. The open video system concept replaces the FCC's video dialtone rules. The 1996 Act also includes numerous provisions designed to make it easier for cable operators and others to compete directly with local exchange telephone carriers. With certain limited exceptions, neither a local exchange carrier nor a cable operator can acquire more than 10% of the other entity operating within its own service area.
Advances in communications technology, as well as changes in the marketplace and the regulatory and legislative environment, are constantly occurring. Thus, it is not possible to predict the effect that ongoing or future developments might have on the cable industry. The ability of cable systems to compete with present, emerging and future distribution media will depend to a great extent on obtaining attractive programming. The availability and exclusive use of a sufficient amount of quality programming may in turn be affected by developments in regulation or copyright law. See "Legislation and Regulation."
The cable television industry competes with radio, television and print media for advertising revenues. As the cable television industry continues to develop programming designed specifically for distribution by cable, advertising
revenues may increase. Premium programming provided by cable systems is subject to the same competitive factors that exist for other programming discussed above. The continued profitability of premium services may depend largely upon the continued availability of attractive programming at competitive prices.
Telecommunications services which the Company intends to offer in Florida will compete with services offered by Bell South Corporation and by other current and potential market entrants, including other Competitive Local Exchange Carriers ("CLECs"), AT&T, MCI WorldCom, Sprint and other interexchange or Long Distance Carriers ("IXCs"), cable television companies, microwave carriers, wireless telecommunications providers and private networks built by large end users. A number of potential markets are already served by one or more CLECs. In addition, the major IXCs are expected to offer local telecommunications services in various markets. MCI WorldCom has announced that it will invest more than $2,000,000 in fiber optic rings and local switching equipment in major metropolitan markets throughout the United States, and AT&T has filed applications with state regulatory authorities for authority to provide local telecommunications services in all 50 states.
Employees
At December 31, 1998, there were 945 full-time employees of the Company, none of which were covered by collective bargaining agreements. The Company considers its relations with its employees to be good.
Legislation and Regulation
The cable television industry is regulated by the FCC, some state governments and most local governments. In addition, various legislative and regulatory proposals under consideration from time to time by Congress and various federal agencies may materially affect the cable television industry. The following is a summary of federal laws and regulations affecting the growth and operation of the cable television industry and a description of certain state and local laws.
Cable Television/Federal Laws and Regulations
Cable Communications Policy Act of 1984
The 1984 Cable Act became effective on December 29, 1984. This federal statute, which amended the Communications Act of 1934 (the "Communications Act"), created uniform national standards and guidelines for the regulation of cable television systems. Violations by a cable television system operator of provisions of the Communications Act, as well as of FCC regulations, can subject the operator to substantial monetary penalties and other sanctions. Among other things, the 1984 Cable Act affirmed the right of franchising authorities (state or local, depending on the practice in individual states) to award one or more franchises within their jurisdictions. It also prohibited non-grandfathered cable television systems from operating without a franchise in such jurisdictions. In connection with new franchises, the 1984 Cable Act provides that in granting or renewing franchises, franchising authorities may establish requirements for cable-related facilities and equipment, but may not establish or enforce requirements for video programming or information services other than in broad categories.
Cable Television Consumer Protection and Competition Act of 1992
On October 5, 1992, Congress enacted the 1992 Cable Act. This legislation effected significant changes to the legislative and regulatory environment in which the cable industry operates. It amended the 1984 Cable Act in many respects. The 1992 Cable Act became effective on December 4, 1992, although certain provisions, most notably those dealing with rate regulation and retransmission consent, became effective at later dates. The legislation also required the FCC to initiate a number of rulemaking proceedings to implement various provisions of the statute. The 1992 Cable Act allows for a greater degree of regulation on the cable industry with respect to, among other things: (i) cable system rates for both basic and certain nonbasic services; (ii) programming access and exclusivity arrangements; (iii) access to cable channels by unaffiliated programming services; (iv) leased access terms and conditions; (v) horizontal and vertical ownership of cable systems; (vi) customer service requirements; (vii) franchise renewals; (viii) television broadcast signal carriage and retransmission consent; (ix) technical standards; (x) subscriber privacy; (xi) consumer protection issues; (xii) cable equipment compatibility;
(xiii) obscene or indecent programming; and (xiv) requiring subscribers to subscribe to tiers of service other than basic service as a condition of purchasing premium services. Additionally, the legislation encourages competition with existing cable systems by: allowing municipalities to own and operate their own cable systems without having to obtain a franchise; preventing franchising authorities from granting exclusive franchises or unreasonably refusing to award additional franchises covering an existing cable system's service area; and prohibiting the common ownership of cable systems and co-located MMDS or SMATV systems. The 1992 Cable Act also precludes video programmers affiliated with cable television companies from favoring cable operators over competitors and requires such programmers to sell their programming to other multichannel video distributors. This provision may limit the ability of cable program suppliers to offer exclusive programming arrangements to cable television companies. A number of provisions in the 1992 Cable Act relating to, among other things, rate regulation, have had a negative impact on the cable industry and the Company's business.
Telecommunications Acts of 1996
The 1996 Act significantly revised the federal regulatory structure. As it pertains to cable television, the 1996 Act, among other things, (i) eliminates the regulation of certain nonbasic programming services in 1999; (ii) expands the definition of effective competition, the existence of which displaces rate regulation; (iii) eliminates the restriction against the ownership and operation of cable systems by telephone companies within their local exchange service areas; and (iv) liberalizes certain of the FCC's cross-ownership restrictions. The FCC has been conducting a number of rulemaking proceedings in order to implement many of the provisions of the 1996 Act.
FCC Regulation
The FCC, the principal federal regulatory agency with jurisdiction over cable television, has promulgated regulations covering such areas as the registration of cable systems, cross-ownership between cable systems and other communications businesses, carriage of television broadcast programming, consumer education and lockbox enforcement, origination cablecasting and sponsorship identification, children's programming, the regulation of basic cable service rates in areas where cable systems are not subject to effective competition, signal leakage and frequency use, technical performance, maintenance of various records, equal employment opportunity, and antenna structure notification, marking and lighting. The FCC has the authority to enforce these regulations through the imposition of substantial fines, the issuance of cease and desist orders and/or the imposition of other administrative sanctions, such as the revocation of FCC licenses needed to operate certain transmission facilities often used in connection with cable operations. Furthermore, the 1992 Cable Act required the FCC to adopt implementing regulations covering, among other things, cable rates, signal carriage, consumer protection and customer service, leased access, indecent programming, programmer access to cable television systems, programming agreements, technical standards, consumer electronics equipment compatibility, ownership of home wiring, program exclusivity, equal employment opportunity, and various aspects of direct broadcast satellite system ownership and operation. The 1996 Act requires certain changes to various provisions of these regulations. A brief summary of the most material federal regulations as adopted to date follows.
Rate Regulation
The 1984 Cable Act codified existing FCC preemption of rate regulation for premium channels and optional nonbasic program tiers. The 1984 Cable Act also deregulated basic cable rates for cable television systems determined by the FCC to be subject to effective competition. The 1992 Cable Act substantially changed the statutory and FCC rate regulation standards. The 1992 Cable Act replaced the FCC's old standard for determining effective competition, under which most cable systems were not subject to local rate regulation, with a statutory provision that has resulted in nearly all cable television systems becoming subject to local rate regulation of basic service. The 1996 Act expands the definition of effective competition to cover situations where a local telephone company or its affiliate, or any multichannel video provider using telephone company facilities, offers comparable video service by any means except DBS. Satisfaction of this test deregulates both basic and nonbasic tiers. The 1996
Act ends FCC regulation of nonbasic tier rates on March 31, 1999.
The FCC's regulations set standards for the regulation of basic and nonbasic cable service rates (other than per-channel or per-program services). The FCC's original rules became effective on September 1, 1993. The rules have been amended several times. The rate regulations adopt a benchmark price cap system for measuring the reasonableness of existing basic and nonbasic service rates, and a formula for evaluating future rate increases. Alternatively, cable operators have the opportunity to make cost-of-service showings that, in some cases, may justify rates above the applicable benchmarks. The rules also require that charges for cable-related equipment (e.g., converter boxes and remote control devices) and installation services be unbundled from the provision of cable service and based upon actual costs plus a reasonable profit. Local franchising authorities and/or the FCC are empowered to order a reduction of existing rates that exceed the benchmark level for either basic and/or non-basic cable services and associated equipment, and refunds could be required. The retroactive refund period for basic cable service rates is limited to one year. In general, the reductions for basic and nonbasic cable service rates require an aggregate reduction of up to 17 percent, adjusted forward for inflation and certain other factors, from the rates in force as of September 30, 1992. The regulations also provide that future rate increases may not exceed an inflation-indexed amount, plus increases in certain costs beyond the cable operator's control, such as taxes, franchise fees and increased programming costs. Cost-based adjustments to these capped rates can also be made in the event a cable operator adds or deletes programming channels or completes a significant system rebuild or upgrade. A significant number of franchising authorities have become certified by the FCC to regulate the rates charged by the Company for basic cable service and for associated equipment. Complaints have also been filed with the FCC seeking review of the rates charged for nonbasic cable service. The Company's ability to implement rate increases consistent with its past practices will likely be limited by the regulations that the FCC has adopted.
Carriage of Broadcast Television Signals
The 1992 Cable Act contains new mandatory carriage requirements. These new rules allow commercial television broadcast stations which are "local" to a cable system (i.e., the system is located in the station's Area of Dominant Influence), to elect every three years whether to require the cable system to carry the station, subject to certain exceptions, or whether the cable system will have to negotiate for "retransmission consent" to carry the station. Local, noncommercial television stations are also given mandatory carriage rights, subject to certain exceptions, within the larger of (i) a 50 mile radius from the station's city of license or (ii) the station's Grade B contour (a measure of signal strength). Unlike commercial stations, noncommercial stations are not given the option to negotiate retransmission consent for the carriage of their signal. In addition, cable systems will have to obtain retransmission consent for the carriage of all "distant" commercial broadcast stations, except for certain "superstations" (i.e., commercial satellite-delivered independent stations such as WTBS). The statutory must-carry provisions for noncommercial stations became effective on December 4, 1992. Must-carry rules for both commercial and noncommercial stations and retransmission consent rules for commercial stations were adopted by the FCC on March 11, 1993. The most recent election between must-carry and retransmission consent for local commercial television broadcast stations was on October 1, 1996. The next election between must-carry and retransmission consent for local commercial television broadcast stations will be October 1, 1999.
Channel Set-Asides
The 1984 Cable Act permits local franchising authorities to require cable operators to set aside certain channels for public, educational and governmental access programming. The Company believes that none of the System's franchises contain unusually onerous access requirements. The 1984 Cable Act further requires cable systems with thirty-six or more activated channels to designate a portion of their channel capacity for commercial leased access by unaffiliated third parties. The 1992 Cable Act requires leased access rates to be set according to a formula determined by the FCC. The FCC revised the existing rate formula in a way that would significantly lower the rates cable operators could charge. It is possible that such leased access will result in competition to services offered by the Company on the other channels of its cable systems.
Competing Franchises
Because of inconsistent court rulings, it is not possible at the present time to predict the constitutionally permissible bounds of cable franchising and particular franchise requirements. However, the 1992 Cable Act, among other things, prohibits franchising authorities from unreasonably refusing to grant franchises to competing cable systems and permits franchising authorities to operate their own cable systems without franchises.
Cross-Ownership
The 1996 Act repealed the restrictions on local exchange telephone companies ("LECs") from providing video programming directly to customers within their local exchange telephone service areas, except in rural areas or by specific waiver of FCC rules. The 1996 Act also authorized LECs to operate "open video systems" without obtaining a local cable franchise, although LECs operating such systems can be required to make payments to local governmental bodies in lieu of cable franchise fees. Where demand exceeds channel capacity, up to two-thirds of the channels on an "open video system" must be available to programmers unaffiliated with the LEC.
The 1996 Act eliminated the FCC rule prohibiting common ownership between a cable system and a national broadcast television network. The 1996 Act also eliminated the statutory ban covering certain common ownership interests, operation or control between a television station and cable system within the station's Grade B signal coverage area. However, the parallel FCC rules against cable/television station cross-ownership remains in place, subject to review by the FCC within two years. Finally, the 1992 Cable Act prohibits common ownership, control or interest in cable television systems and MMDS facilities or SMATV systems having overlapping service areas, except in limited circumstances. The 1996 Act exempts cable systems facing "effective competition" from the MMDS and SMATV cross-ownership restrictions.
Pursuant to the 1992 Cable Act, the FCC has imposed limits on the number of cable systems that a single cable operator can own. In general, no cable operator can have an attributable interest in cable systems that pass more than 30% of all homes nationwide. Attributable interests for these purposes include voting interests of 5% or more (unless there is another single holder of more than 50% of the voting stock), officerships, directorships and general partnership interests. The FCC has stayed the effectiveness of these rules pending the outcome of the appeal from the U.S. District Court decision holding the multiple ownership limit provision of the 1992 Cable Act unconstitutional.
The FCC has also adopted rules that limit the number of channels on a cable system that can be occupied by programming in which the cable system's owner has an attributable interest. The limit is 40% of all activated channels.
Franchise Transfers
The 1992 Cable Act requires franchising authorities to act on any franchise transfer request submitted after December 4, 1992 within 120 days after receipt of all information required by FCC regulations and by the franchising authority. Approval is deemed to be granted if the franchising authority fails to act within such period.
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 recently revised such standards and made them applicable to all classes of channels that carry downstream NTSC video programming. Local franchising authorities are permitted to enforce the FCC's new technical standards. The FCC also has adopted additional standards applicable to cable television systems using frequencies in the 108-137 Mhz and 225-400 Mhz bands in order to prevent harmful interference with aeronautical navigation and safety radio services, and has also established limits on cable system signal leakage. Periodic testing by cable operators for compliance with these technical standards and signal leakage limits is required. The Company believes that the System is in compliance with these standards in all material respects. The 1992 Cable Act requires the FCC to update periodically its technical standards to take into account changes in technology.
The FCC has adopted regulations to implement the requirements of the 1992 Cable Act designed to improve the compatibility of cable systems and consumer electronics equipment.
Pole Attachments
The FCC currently regulates the rates and conditions imposed by certain public utilities for use of their poles, unless under the Federal Pole Attachments Act state public service commissions are able to demonstrate that they regulate rates, terms and conditions of the cable television pole attachments. A number of states (including Massachusetts, Michigan, New Jersey, New York, Ohio and Vermont) and the District of Columbia have certified to the FCC that they regulate the rates, terms and conditions for pole attachments. In the absence of state regulation, the FCC administers such pole attachment rates through use of a formula, which it has devised and from time to time revises. The 1996 Act directs the FCC to adopt a new rate formula for any attaching party, including cable systems, which offers telecommunications services. This new formula will result in significantly higher attachment rates for cable systems that choose to offer such services.
Other Matters
FCC regulation also includes matters regarding a cable system's carriage of local sports programming; restrictions on origination and cablecasting by cable system operators; application of the fairness doctrine and rules governing political broadcasts; customer service; home wiring; and limitations on advertising contained in nonbroadcast children's programming.
Copyright
Cable television systems are subject to federal 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 this 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.
Various bills have been introduced into Congress over the past several years that would eliminate or modify the cable television compulsory license. The FCC has recommended to Congress that it repeal the cable industry's compulsory copyright license. The FCC determined that the statutory compulsory copyright license for local and distant broadcast signals no longer serves the public interest and that private negotiations between the applicable parties would better serve the public. Without the compulsory license, cable operators might need to negotiate rights from the copyright owners for each program carried on each broadcast station in the channel lineup. Such negotiated agreements could increase the cost to cable operators of carrying broadcast signals. The 1992 Cable Act's retransmission consent provisions expressly provide that retransmission consent agreements between television broadcast stations and cable operators do not obviate the need for cable operators to obtain a copyright license for the programming carried on each broadcaster's signal.
Copyrighted music performed in programming supplied to cable television systems by pay cable networks (such as HBO) and basic cable networks (such as USA Network) has generally been licensed by the networks through private agreements with the American Society of Composers and Publishers ("ASCAP") and BMI, Inc. ("BMI"), the two major performing rights organizations in the United States. As a result of extensive litigation, ASCAP and BMI are both now required to offer "through to the viewer" licenses to the cable networks which would cover the retransmission of the cable networks' programming by cable systems to their subscribers.
Copyrighted music performed by cable systems themselves on local origination channels, PEG channels and in locally inserted advertising and cross promotional announcements must also be licensed. A blanket license is available from BMI. Cable industry negotiations with ASCAP are still in progress.
Cable Television/State and Local Regulation Because a cable television system uses local streets and rights-of-way, cable television systems are subject to state and local regulation, typically imposed through the franchising process. State and/or local officials are usually involved in franchise selection, system design and construction, safety, service rates, consumer relations, billing practices and community related programming and services.
Cable television systems generally are operated pursuant to nonexclusive franchises, permits or licenses granted by a municipality or other state or local government entity. Franchises generally are granted for fixed terms and in many cases are terminable if the franchise operator fails to comply with material provisions. The 1984 Cable Act established renewal procedures and criteria designed to protect incumbent franchises against arbitrary denials of renewal. While these formal procedures are not mandatory unless timely invoked by either the cable operator or the franchising authority, they can provide substantial protection to incumbent franchisees. Even after the formal renewal procedures are invoked, franchising authorities and cable operators remain free to negotiate a renewal outside the formal process. Nevertheless, renewal is by no means assured, as the franchisee must meet certain statutory standards. Even if a franchise is renewed, a franchising authority may impose new and more onerous requirements such as upgrading facilities and equipment, although the municipality must take into account the cost of meeting such requirements. The 1992 Cable Act makes several changes to the process under which a cable operator seeks to enforce its renewal rights which could make it easier in some cases for a franchising authority to deny renewal.
Franchises usually call for the payment of fees, often based on a percentage of the system's gross subscriber revenues, to the granting authority. Although franchising authorities may impose franchise fees under the 1984 Cable Act, such payments cannot exceed 5% of a cable system's annual gross revenues. In those communities in which franchise fees are required, the Company currently pays franchise fees ranging up to 5% of gross revenues. Franchising authorities are also empowered in awarding new franchises or renewing existing franchises to require cable operators to provide cable-related facilities and equipment and to enforce compliance with voluntary commitments. In the case of franchises in effect prior to the effective date of the 1984 Cable Act, franchising authorities may enforce requirements contained in the franchise relating to facilities, equipment and services, whether or not cable-related. The 1984 Cable Act, under certain limited circumstances, permits a cable operator to obtain modifications or franchise obligations.
Upon receipt of a franchise, the cable system owner usually is subject to a broad range of obligations to the issuing authority directly affecting the business of the system. The terms and conditions of franchises vary materially from jurisdiction to jurisdiction, and even from city to city within the same state, historically ranging from reasonable to highly restrictive or burdensome. The 1984 Cable Act places certain limitations on a franchising authority's ability to control the operation of a cable system operator and the courts have from time to time reviewed the constitutionality of several general franchise requirements, including franchise fees and access channel requirements, often with inconsistent results. On the other hand, the 1992 Cable Act prohibits exclusive franchises, and allows franchising authorities to exercise greater control over the operation of franchised cable systems, especially in the area of customer service and rate regulation. The 1992 Cable Act also allows franchising authorities to operate their own multichannel video distribution system without having to obtain a franchise and permits states or local franchising authorities to adopt certain restrictions on the ownership of cable systems. Moreover, franchising authorities are immunized from monetary damage awards arising from regulation of cable systems or decisions made on franchise grants, renewals, transfers and amendments.
The specific terms and conditions of a franchise and the laws and regulations under which it was granted directly affect the profitability of the
cable television system. Cable franchises generally contain provisions governing charges for basic cable television services, fees to be paid to the franchising authority, length of the franchise term, renewal, sale or transfer of the franchise, territory of the franchise, design and technical performance of the system, use and occupancy of public streets and number and types of cable services provided. The 1996 Act prohibits a franchising authority from either requiring or limiting a cable operator's provision of telecommunications services.
Various proposals have been introduced at the state and local levels with regard to the regulation of cable television systems, and a number of states have adopted legislation subjecting cable television systems to the jurisdiction of centralized state governmental agencies, some of which impose regulation of a character similar to that of a public utility. Attempts in other states to regulate cable television systems are continuing and can be expected to increase. Such proposals and legislation may be preempted by federal statute and/or FCC regulation. To date, Florida has not enacted such state level regulation. However, the Company cannot predict whether Florida will engage in such regulation in the future.
The foregoing does not purport to describe all present and proposed federal, state and local regulations and legislation relating to the cable television industry. Other existing federal regulations, copyright licensing and, in many jurisdictions, state and local franchise requirements currently are the subject of a variety of judicial proceedings, legislative hearings and administrative and legislative proposals which could change, in varying degrees, the manner in which cable television systems operate. Neither the outcome of these proceedings nor their impact upon the cable television industry or the System can be predicted at this time.
Telephony and Telecommunications/Federal Laws and Regulations
The 1996 Act also alters federal, state and local laws and regulations regarding telecommunications providers and services, including the Company, and creates a favorable environment in which the Company may provide telephone and other telecommunications services and facilities. The following is a summary of the key provisions of the 1996 Act that could materially affect the telecommunications business of the Company.
The 1996 Act was intended to promote the provision of competitive telephone services and facilities by cable television companies and others. The 1996 Act declares that no state or local laws or regulations may prohibit or have the effect of prohibiting the ability of any entity to provide any interstate or intrastate telecommunications service. States are authorized to impose "competitively neutral" requirements regarding universal service, public safety and welfare, service quality, and consumer protection. The 1996 Act further provides that cable operators and affiliates providing telecommunications services are not required to obtain a separate franchise from local franchising authorities ("LFAs") for such services. An LFA may not order a cable operator or affiliate to discontinue providing telecommunications services or discontinue operating its cable system on the basis that it has failed to obtain a separate franchise or renewal for the provision of telecommunications services. The 1996 Act prohibits LFAs from requiring cable operators to provide telecommunications service or facilities as a condition of the grant of a franchise, franchise renewal, or franchise transfer, except that LFAs may seek "institutional networks" as part of such franchise negotiations.
The 1996 Act provides that, when cable operators provide telecommunications services, LFAs may require reasonable, competitively neutral compensation for management of the public rights-of-way. The LFA must publicly disclose such compensation requirements.
The Company believes that it qualifies as a connecting carrier under federal law and therefore does not need FCC certification to provide intrastate service. In the event that it is determined that the Company must seek FCC certification, the Company believes that such certification will be granted by the FCC in a timely manner. The Company may be required to file certain tariffs and reports with the FCC.
Interconnection and Other Telecommunications Carrier Obligations
To facilitate the entry of new telecommunications providers (including cable operators), the 1996 Act imposes interconnection obligations on all telecommunications carriers. All carriers must interconnect their networks with other carriers and must not deploy network features and functions that interfere with interoperability. LECs also have a set of separate identified obligations beyond those that apply to new entrants: (i) good faith negotiation with those seeking interconnection, (ii) unbundling, equal access and non-discrimination requirements, (iii) resale of services, including "resale at wholesale rates," (iv) notice of changes in the network that would affect interconnection and interoperability and (v) physical collocation unless shown that practical technical reasons, or space limitations, make physical collocation impractical.
Under the 1996 Act, individual interconnection rates must be just and reasonable, based on cost, and may include a reasonable profit. Traffic termination charges shall be "mutual and reciprocal." The 1996 Act permits carriers to agree on a "bill and keep" system, but does not require such a system.
The 1996 Act contemplates that interconnection agreements will be negotiated by the parties and submitted to a state public service commission ("SPSC") for approval. A SPSC may become involved, at the request of either party, if negotiations fail. If the state regulator refuses to act, the FCC may determine the matter. If the SPSC acts, an aggrieved party's remedy is to file a case in federal district court. The 1996 Act provides for a rural exemption to interconnection requests, but also provides that the exception does not apply where a cable operator makes an interconnection request of a rural LEC within the operator's franchise area.
The 1996 Act requires that all telecommunications providers (including cable operators that provide telecommunications services) must contribute equitably to a Universal Service Fund ("USF"), and the FCC may exempt an interstate carrier or class of carriers if their contribution would be minimal under the USF formula. The 1996 Act allows states to determine which intrastate telecommunications providers contribute to the USF. The 1996 Act prohibits geographic end user rate de-averaging to protect rural subscribers' rates.
FCC Interconnection Order
The FCC recently released its First Report and Order to effectuate the interconnection provisions of the 1996 Act. In general, the FCC's First Report and Order appears favorable to the promotion of competition at the local level. To summarize, the FCC first has asserted broad federal jurisdiction over interconnection issues and the power to bind both state and local governments. The FCC also has established procedures for the negotiation, arbitration and resolution of interconnection agreements. It also has stated that new entrants essentially always benefit from the terms of subsequent interconnection agreements entered into by a given LEC with third parties and cannot waive their "most favored nation" rights in this respect. The FCC also has specified the manner in which actual physical interconnection must be made available to new entrants and, in this connection, has specified the manner in which rates charged to new entrants for physical interconnection must be calculated. The FCC also has set forth the manner in which LECs must make essential network elements available to new entrants for resale, again including the manner in which actual rates are to be calculated.
In July 1997, the United States Court of Appeals for the Eighth Circuit vacated in part the FCC's local competition rules. That court concluded that the FCC did not have the authority to establish rules to govern the pricing of interconnection, network elements, and resale services provided by incumbent local exchange carriers. In addition, it found certain other FCC rules to be unlawful. On January 25, 1999, the Supreme Court issued an opinion in which it reversed portions of the court of appeals decision. The Supreme Court held that the FCC has authority under the Communications Act to establish rules, including pricing rules, to implement the local competition provisions of the Telecommunications Act of 1996, even with respect to intrastate services. The Supreme Court did not address the merits of the FCC's 1996 pricing rules. In addition, the Supreme Court affirmed several of the other rules which had been promulgated by the FCC, but which had been found unlawful by the court of appeals. These included a rule allowing requesting carriers to select provisions from among different interconnection agreements approved by state commissions (the so-called "pick-and-choose" rule) and a rule allowing requesting carriers to obtain from incumbent local exchange carriers assembled combinations of unbundled network elements (sometimes called unbundled network element platforms). The Supreme Court vacated a FCC rule identifying specific network elements which incumbent local exchange carriers must make available to requesting carriers on the basis that the FCC had failed to consider 1) whether such network elements were necessary, and 2) whether the failure to make network elements available would impair the ability of requesting carriers to provide the services they seek to offer. The FCC has indicated that it will conduct further proceedings to comply with the Supreme Court's opinion regarding the availability of network elements. Whether incumbent local exchange carriers will be required to make available combined platforms of network elements will depend on how the FCC implements the "necessary" and "impair" standards governing network element availability in light of the Supreme Court opinion.
Internet Services/Federal Laws and Regulations
Transmitting indecent material via the Internet was made criminal by the 1996 Act. However, on-line access providers are exempted from criminal liability for simply providing interconnection service; they are also granted an affirmative defense from criminal or other action where in "good faith" they
restrict access to indecent materials. These provisions have been challenged in federal court. The 1996 Act further exempts on-line access providers from civil liability for actions taken in good faith to restrict access to obscene, excessively violent or otherwise objectionable material.
Telephony and Telecommunications/State Law and Regulation
In 1995, the Florida Legislature amended Chapter 362 of Florida Statutes by enacting "An Act Relating to Local Exchange Telecommunications Companies" ("Florida Act") (Chapter 362, Fl. Stat. (1995)). This new law substantially altered Florida law regarding telecommunications providers and services, such as Olympus. The following is a summary of the key provisions of the Florida Act and associated Florida Public Service Commission ("PSC") actions that could materially affect Olympus' telecommunications business.
The Florida Act
The Florida Act vests in the PSC virtually exclusive jurisdiction over intrastate telecommunications matters. The Florida Act limits municipalities to taxation of certain telecommunications services or management of long distance carriers' occupation of local rights-of-way. The Florida Act further directs the PSC to employ flexible regulatory treatment to ensure the widest possible range of telecommunications services, and provides that new entrants such as the Company are subject to a lesser level of regulatory oversight than LECs.
PSC Actions
Pursuant to the Florida Act (and the 1996 Act and the FCC's First Report and Order), the PSC is conducting several proceedings to address competitive issues. To summarize, pursuant to the Florida Act, the PSC has adopted rules requiring certification of CLEC Interexchange Telecommunications Service Providers; Operator Service Providers; Alternative Access Vendor Services and Shared Tenant Services Providers. The Florida Act provides that the PSC shall grant certification to applicants upon a showing of sufficient technical, financial, and managerial capability to provide service in the geographic area proposed to be served. The Company believes that Olympus meets the statutory requirements for PSC certification for any type of intrastate telecommunications service provider, and that any such application process should be completed expeditiously. In addition, like the 1996 Act, the Florida Act requires LECs to interconnect with certified CLECs. Approximately fourteen interconnection agreements have been reached between LECs and CLECs to date, while approximately five CLECs have requested PSC arbitration of stalled agreements. The PSC is obligated under the Florida Act to arbitrate any disputes in no more than 120 days from date of request. As well, the PSC has ordered BellSouth, the state's largest LEC, to unbundle eight network elements for resale by CLECs, and the PSC has ordered favorable interim rates for these elements. The PSC has not yet adopted an order resolving wholesale discounts associated with local service resale.
Based on the foregoing, the Company believes that the Florida Act and actions of the PSC to date reflect a generally favorable legal and regulatory environment for new entrants, such as Olympus, to intrastate telecommunications in Florida.
ITEM 2.
ITEM 2. PROPERTIES The Company's principal physical assets consist of cable television operating plant and equipment, including signal receiving, encoding and decoding devices, headends and distribution systems and subscriber house drop equipment for each of its cable television systems. The signal receiving apparatus typically includes a tower, antenna, ancillary electronic equipment and earth stations for reception of satellite signals. Headends, consisting of associated electronic equipment necessary for the reception, amplification and modulation of signals, are located near the receiving devices. The Company's distribution system consists primarily of coaxial and fiber optic cables and related electronic equipment. Subscriber devices consist of decoding converters. The physical components of cable television systems require maintenance and periodic upgrading to keep pace with technological advances.
The Company's cables and related equipment are generally attached to utility poles under pole rental agreements with local public utilities, although in some areas the distribution cable is buried in underground ducts or trenches. See "Legislation and Regulation-FCC Regulation."
The Company owns or leases parcels of real property for signal reception sites (antenna towers and headends), microwave facilities and business offices in each of its market areas, and owns most of its service vehicles.
Substantially all of the assets of Olympus' subsidiaries are subject to encumbrances as collateral in connection with the Company's credit arrangements, either directly with a security interest or indirectly through a pledge of the stock or partnership interests in the respective subsidiaries. See Note 3 to the Olympus Communications, L.P. consolidated financial statements. The Company believes that its properties, both owned and leased, are in good operating condition and are suitable and adequate for the Company's business operations.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS There are no material pending legal proceedings, other than routine litigation incidental to the business, of which the Company or any of its subsidiaries is a part or to which any of their property is subject.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year 1998.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Not applicable.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
(Dollars in thousands)
The selected consolidated financial data as of and for each of the five years in the period ended December 31, 1998 have been derived from the audited consolidated financial statements of the Company. These data should be read in conjunction with the consolidated financial statements and related notes thereto, for each of the three years in the period ended December 31, 1998 and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this Annual Report on Form 10-K. The Statement of Operations Data with respect to the years ended December 31, 1994 and 1995, and the balance sheet data at December 31, 1994, 1995, and 1996 have been derived from audited consolidated financial statements of the Company not included herein.
iTEM 7.
iTEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Dollars in thousands)
RESULTS OF OPERATIONS
General
Olympus is a joint venture limited partnership formed under the laws of Delaware with 50% of the outstanding voting interests held by ACP Holdings, Inc., a wholly-owned subsidiary of Adelphia and managing general partner of Olympus. The remaining 50% of the voting interest is held by various wholly owned subsidiaries of FPL Group. Adelphia and FPL Group also held, as of December 31, 1998, $366,861 and $183,430, respectively, aggregate principal amount of non-voting Preferred Limited Partnership ("PLP") interests in the Company, which provide for a 16.5% per annum priority return. On January 28, 1999, the partners entered into an agreement in which Adelphia will acquire FPL Group's partnership interests in Olympus no later than July 11, 1999.
Olympus Capital Corporation, a wholly owned subsidiary of the Company, was formed solely for the purpose of serving as a co-issuer with Olympus Communications, L.P. of the 10 5/8% Senior Notes due 2006. Olympus Capital Corporation has no substantial assets or liabilities and no operations of any kind and the Indenture, pursuant to which such Senior Notes were issued, limits Olympus Capital Corporation's ability to acquire or hold any significant assets or other properties or engage in any business activities other than in connection with the issuance of the Senior Notes.
Olympus earned substantially all of its revenues in each of the last three fiscal years from monthly subscriber fees for basic, satellite, premium and ancillary services (such as installations and equipment rentals), local and national advertising sales, pay-per-view programming, high speed data services, home shopping networks and electronic security monitoring services.
Comparison of the Years Ended December 31, 1996, 1997 and 1998
The changes in the Company's results of operations for the year ended December 31, 1997 compared with the year ended December 31, 1996, were primarily the result of acquisitions, expanding existing cable television operations and the impact of subscriber rate increases implemented during June 1996 and 1997. The changes for the year ended December 31, 1998, compared with the prior year, were primarily the result of acquisitions, expanding existing cable television operations, the impact of subscriber rate increases which became effective June 1, 1997 and 1998, growth in advertising revenues and vendor price increases for the Company's programming. Refer to Liquidity and Capital Resources - Acquisitions for a discussion of acquisitions. The high level of depreciation and amortization associated with acquisitions and the continuing program of upgrading and expansion of the System, and interest and placement costs associated with financing activities will continue to have a negative impact on the reported results of operations. The Company expects to report net losses for the foreseeable future. The following table is derived from the Company's consolidated financial statements that are included in this Annual Report on Form 10-K and sets forth the historical percentage relationship to revenues of the components of operating income contained in such financial statements for the periods indicated.
Revenues
The primary revenue sources, reflected as a percentage of total revenues, were as follows:
Total revenues for the year ended December 31, 1997 increased 10.3% from the prior year, primarily due to acquisitions, basic subscriber growth and the positive impact of rate increases implemented during June 1996 and 1997, partially offset by price reductions on certain services and a decrease in premium programming services and advertising revenues. Revenues increased approximately 22.3% for the year ended December 31, 1998 compared with the prior year, primarily due to acquisitions, basic subscriber growth, growth in advertising revenues, and the positive impact of rate increases on June 1, 1997 and June 1, 1998. These increases were partially offset by price reductions on certain services and a decrease in premium programming services.
The increases (decreases) were attributable to the following:
Direct Operating and Programming Expenses. Direct operating and programming expenses, which are mainly basic and premium programming costs and technical expenses, increased 17.1% and 29.8% for the years ended December 31, 1997 and 1998, respectively, compared with the respective prior years. Such increases were primarily due to increased basic and premium programming costs and increased costs associated with providing cable modem and electronic security monitoring services as well as increased operating expenses from acquired systems. Net acquired and sold systems accounted for approximately 25% and 20% of the increase for the years ended December 31, 1997 and 1998, respectively.
Selling, General and Administrative Expenses. These expenses, which are mainly comprised of costs related to system offices, customer service representatives, and sales and administrative employees, increased 11.0% and 17.3% for the years ended December 31, 1997 and 1998, respectively, compared with the respective prior years. The increases were primarily due to incremental costs associated with acquisitions, costs associated with subscriber growth and increased advertising expenses. Net acquired and sold systems accounted for approximately 35% and 34% of the increase for each of the years ended December 31, 1997 and 1998, respectively. Selling, general and administrative expenses remained constant as a percentage of revenues for the year ended December 31, 1997 and decreased for the year ended December 31, 1998 when compared with the respective prior year, which reflects the impact of rate increases and the successful integration of acquired systems with existing operations.
Depreciation and Amortization. Depreciation and amortization was higher for the years ended December 31, 1997 and 1998 compared with the respective prior year, primarily due to increased depreciation and amortization related to acquisitions and increased capital expenditures.
Management Fees to Managing Affiliate. Pursuant to the terms of the Company's Partnership Agreement, the Company pays to Adelphia, on a quarterly basis, an amount representing an allocation of the corporate overhead of Adelphia with respect to the Company for such period, which allocation is based upon the ratio of the Company's cable subscribers to the total cable subscribers owned or managed by Adelphia. Management fees were relatively flat as a percentage of revenues for the year ended December 31, 1997 as compared to the prior year. Such fees increased as a percentage of revenues for the year ended December 31, 1998 as compared to the prior year primarily due to increased corporate expenditures.
Interest Expense. For the years ended December 31, 1997 and 1998, interest expense increased 23.1% and 6.1% compared to the respective prior year. The increase in interest expense during 1997 was primarily attributable to an increase in the average interest rate on outstanding debt due to the issuance of $200,000 of 10 5/8% Senior Notes on November 12, 1996 and an increase in the average amount of debt outstanding during 1997 as compared with the prior year. The increase in interest expense during 1998 as compared to the prior year was primarily attributable to an increase in the average amount of debt outstanding as compared to the prior year primarily due to acquisitions.
Interest Expense-Affiliates. The Company is charged interest on advances due to Adelphia and other affiliates. Such advances were used by the Company for acquisitions, capital expenditures, repayment of debt and working capital. Interest expense-affiliates was flat for the year ended December 31, 1997 as
compared with the prior year. Interest expense-affiliates increased for the year ended December 31, 1998 as compared with the prior year primarily due to increased affiliate payables related to acquisitions.
Gain on Sale of Assets. The Company exchanged its limited partnership investment in TMIP for interests in cable television systems in the December 4, 1998 TMIP restructuring. As a result of this exchange, the Company recognized a gain of approximately $7,200, representing the excess of fair value of the assets received over the carrying value of the investment exchanged.
Liquidity and Capital Resources
The cable television business is capital intensive and typically requires continual financing for the construction, modernization, maintenance, expansion and acquisition of cable systems. During the three years in the period ended December 31, 1998, the Company committed substantial capital resources for these purposes. These expenditures were funded through long-term borrowings and advances from affiliates and internally generated funds. The Company's aggregate outstanding borrowings as of December 31, 1998 were $726,982. The Company's ability to generate cash to meet its future needs will depend generally on its results of operations and the continued availability of external financing.
Capital Expenditures
Capital expenditures for the years ended December 31, 1996, 1997 and 1998 were $28,117, $37,867 and $59,672 respectively. The increases in capital expenditures for the years ended December 31, 1997 and 1998 compared to the respective prior years were primarily due to the impact of acquired systems and increased investment related to the rebuilding of the Company's cable plant. The Company expects capital expenditures for 1999 to range from $60,000 to $75,000.
Financing Activities
The Company's ability to generate cash adequate to meet its future needs will depend generally on its results of operations and the continued availability of financing from both its owners and external sources. During the three year period ended December 31, 1998, the Company funded its working capital requirements, capital expenditures, and acquisitions through long-term borrowings primarily from banks and affiliates, issuance of debt securities by Olympus, advances from affiliates and internally generated funds. The Company generally has funded the principal and interest obligations on its long-term borrowings by refinancing the principal with new loans, and by paying the interest out of internally generated funds.
Most of Olympus' directly-owned subsidiaries have their own senior credit agreements. Typically, borrowings under these agreements are collateralized by the assets of the borrowing subsidiary and its subsidiaries and, in some cases, are guaranteed by such subsidiary's subsidiaries. At December 31, 1997 and 1998, an aggregate of $427,000 and $519,443, respectively, in borrowings were outstanding under these agreements. These agreements limit, among other things, additional borrowings, investments, transactions with affiliates and other subsidiaries, and the payment of dividends and fees by the subsidiaries. The agreements also require maintenance of certain financial ratios by the subsidiaries. Management believes that the borrowers were in compliance with the agreements' covenants at December 31, 1998. At December 31, 1998, approximately $160,605 of the net assets of subsidiaries would be permitted to be transferred to Olympus in the form of distributions, dividends and loans without the prior approval of the lenders based upon the results of operations of such subsidiaries for the quarter ended December 31, 1998. The subsidiaries are permitted to pay management fees to Olympus or other subsidiaries. Such fees are limited to a percentage of the subsidiaries' revenues.
A subsidiary of Olympus is a co-borrower with an affiliate under a $200,000 credit agreement. The subsidiary is permitted to borrow up to $39,500 of the available credit, none of which was included in subsidiary debt as of December 31, 1997 and 1998. In conjunction with the acquisition of the partnership interests of National Cable Acquisition Associates, L.P. ("National") in 1997 and the TMIP restructuring in 1998, subsidiaries of Olympus assumed the obligation for a total of $187,000 of a $350,000 credit agreement of Hilton Head Communications, L.P. ("Hilton Head"), $118,000 and $135,000 of which was included in subsidiary debt as of December 31, 1997 and 1998, respectively. Each
of these subsidiaries is liable for all borrowings under the respective credit agreements, although the lenders have no recourse against Olympus other than against Olympus' interest in and the assets of the respective subsidiaries.
The amount of borrowings available to Olympus under revolving credit agreements is generally based upon the subsidiaries achieving certain levels of operating performance. Olympus had commitments from banks for additional borrowings of up to $62,750, which included $52,750 also available to affiliates at December 31, 1998, which expire through 2003. Olympus pays commitment fees of .375% of unused principal.
Subsidiary debt is due at various dates through 2003. Interest rates are based upon one or more of the following rates at the option of the borrowers: prime rate plus 0% to 1%; certificate of deposit rate plus .875% to 2.25%; or LIBOR plus .625% to 2%. At December 31, 1997 and 1998, the weighted average interest rate on subsidiary debt was 7.18% and 6.51%, respectively. Interest is payable quarterly. The rates on 8.6% of Olympus' subsidiary debt were fixed for at least one year through interest rate swap agreements.
On November 12, 1996, Olympus issued $200,000 of 10 5/8% Senior Notes (the "Senior Notes"). Interest is payable semi-annually. The Senior Notes are unsecured and are due November 15, 2006. Olympus may redeem up to $70,000 of the Senior Notes at 110.625% of principal through November 6, 1999. Commencing November 15, 2001, Olympus may redeem the Senior Notes in whole or in part at 105.3125% of principal declining annually to par on November 15, 2004. Holders of the Senior Notes have the right to require Olympus to redeem their Senior Notes at 101% of principal upon a Change of Control (as defined in the Indenture). The pending acquisition by Adelphia of the Olympus partnership interests owned by the FPL Group would constitute a Change of Control in accordance with the Indenture and, upon the closing of the transaction, Olympus would be required to offer to repurchase all of the Senior Notes. The Senior Note Holders' option expires 30 days from Olympus' mailing of the purchase offer notices. Olympus intends to fund any redemptions through additional borrowings and advances from Adelphia. The Indenture stipulates, among other things, limitations on additional borrowings, payment of dividends or distributions, repurchase of equity interests, transactions with affiliates and the sale of assets.
Olympus has interest rate swap agreements with banks to reduce the impact of changes in interest rates on its bank debt. Olympus enters into pay-fixed agreements to effectively convert a portion of its variable-rate debt to fixed-rate debt. Olympus is exposed to credit loss in the event of nonperformance by the banks. Olympus does not expect any such nonperformance. At December 31, 1997, Olympus would have received approximately $615 and at December 31, 1998, Olympus would have been required to pay approximately $1,327, to settle its interest rate swap agreements, representing the difference between fair value and carrying cost of these agreements at the respective dates.
Acquisitions
On December 4, 1998, Olympus consummated a series of transactions to restructure the ownership of TMIP. The restructuring resulted in Olympus exchanging its nonconsolidated preferred limited partnership investment in TMIP for 100% ownership of a cable television system serving approximately 28,000 subscribers in Palm Beach County, Florida subject to $38,027 in debt and a 75% consolidated general partner interest in TMIP subject to $31,166 in debt. The restructured TMIP owns a cable television system serving approximately 34,000 subscribers located principally in Broward County, Florida and a 33.9% interest in an entity which owns cable television systems serving approximately 10,000 subscribers in Virginia. The acquisition was accounted for under the purchase method of accounting.
On November 30, 1998, Olympus acquired cable television systems from Time Warner for approximately $33,400. These systems serve approximately 20,000 subscribers in communities around Lake Okeechobee, Florida. The acquisition has been accounted for under the purchase method of accounting.
On July 15, 1998, Olympus acquired the Fort Myers cable television operations from Cable TV Fund 12-A, Ltd. This system was acquired for approximately $110,000 and serves approximately 46,000 subscribers located in and around Fort Myers, Florida. The acquisition was accounted for under the purchase method of accounting.
In 1997, Olympus completed the acquisition of all of the partnership interests of National from Hilton Head, an entity controlled by the family of John Rigas (principal shareholder of Adelphia), for a purchase price of approximately $118,000. National provided cable service to approximately 57,000 subscribers in Palm Beach County, Florida at the date of acquisition and also owned limited partnership interests in TMIP. The acquisition was accounted for under the purchase method of accounting and National's operations were consolidated with Olympus for financial reporting purposes effective as of October 1, 1997.
On January 5, 1996, Olympus acquired all of the southeast Florida cable systems of the Leadership Cable division of Fairbanks Communications, Inc., ("Leadership Cable") which at the acquisition date served approximately 50,000 cable and security subscribers for a purchase price of $95,800. Leadership Cable provides cable service and security services in and around West Palm Beach, Florida. The purchase price consisted of $40,000 in cash and a $70,000 non-interest bearing discount seller note. This note was recorded at $55,800 at acquisition and accreted to the $70,000 face amount. The acquisition was accounted for under the purchase method of accounting.
Resources
The Company plans to continue to explore and consider new commitments, arrangements or transactions to refinance existing debt, increase the Company's liquidity or decrease the Company's leverage. These could include, among other things, the future issuance by the Company, or its subsidiaries of public or private equity or debt and the negotiation of new or amended credit facilities. These could also include entering into acquisitions, joint ventures or other investment or financing activities, although no assurance can be given that any such transactions will be consummated. The Company's ability to borrow under current credit facilities and to enter into refinancings and new financings is limited by covenants contained in its subsidiaries' credit agreements, including covenants under which the ability to incur indebtedness is in part a function of applicable ratios of total debt to cash flow.
The Company believes that cash and cash equivalents, internally generated funds, borrowings under existing credit facilities, advances from Adelphia or other affiliates and future financing sources will be sufficient to meet its short-term and long-term liquidity and capital requirements. Although in the past the Company has been able to refinance its indebtedness or obtain new financing, there can be no assurance that the Company will be able to do so in the future or that the terms of such financings would be favorable.
Management believes that the telecommunications industry, including the cable television and telephone industries, continues to be in a period of consolidation characterized by mergers, joint ventures, acquisitions, sales of all or part of cable companies or their assets, and other partnering and investment transactions of various structures and sizes involving cable or other telecommunications companies. The Company continues to evaluate new opportunities that allow for the expansion of its business through the acquisition of additional cable television systems in geographic proximity to its existing regional markets or in locations that can serve as a basis for new market areas. The Company, like other cable television companies, has participated from time to time and is participating in preliminary discussions with third parties regarding a variety of potential transactions, and the Company has considered and expects to continue to consider and explore potential transactions of various types with other cable and telecommunications companies. However, no assurances can be given as to whether any such transaction may be consummated or, if so, when.
Recent Accounting Pronouncements
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities," has been issued and is effective for fiscal quarters of fiscal years beginning after June 15, 1999. SFAS No. 133 establishes accounting and reporting standards for derivative instruments and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. Management of the Company has not completed its evaluation of the impact of SFAS No. 133 on the Company's consolidated financial statements.
Inflation
In the three years in the period ended December 31, 1998, the Company believes that inflation did not have a significant effect on its results of operations. Periods of high inflation could have an adverse effect to the extent that increased borrowing costs for floating-rate debt may not be offset by increases in subscriber rates. At December 31, 1998, after giving effect to interest rate hedging agreements, approximately $481,482 of the Company's total debt was subject to floating interest rates.
Regulatory and Competitive Matters
The cable television operations of the Company may be adversely affected by changes and developments in governmental regulation, competitive forces and technology. The cable television industry and the Company are subject to extensive regulation at the federal, state and local levels. The 1992 Cable Act significantly expanded the scope of regulation of certain subscriber rates and a number of other matters in the cable industry, such as mandatory carriage of local broadcast stations and retransmission consent, and increased the administrative costs of complying with such regulations. The FCC has adopted rate regulations that establish, on a system-by-system basis, maximum allowable rates for (i) basic and cable programming services (other than programming offered on a per-channel or per-program basis), based upon a benchmark methodology, and (ii) associated equipment and installation services based upon cost plus a reasonable profit. Under the FCC rules, franchising authorities are authorized to regulate rates for basic services and associated equipment and installation services, and the FCC will regulate rates for regulated cable programming services in response to complaints filed with the agency. The Telecommunications Act of 1996 (the "1996 Act") ends FCC regulation of cable programming service tier rates on March 31, 1999.
Rates for basic and cable programming services are set pursuant to a benchmark formula. Alternatively, a cable operator may elect to use a cost-of-service methodology to show that rates for basic and cable programming services are reasonable. Refunds with interest will be required to be paid by cable operators who are required to reduce regulated rates. The FCC has reserved the right to reduce or increase the benchmarks it has established. The rate regulations also limit increases in regulated rates to an inflation indexed amount plus increases in certain costs such as taxes, franchise fees, costs associated with specific franchise requirements and increased programming costs. Cost-based adjustments to these capped rates can also be made in the event a cable operator adds or deletes channels or completes a significant system rebuild or upgrade. Because of the limitation on rate increases for regulated services, future revenue growth from cable services will rely to a much greater extent than has been true in the past on increased revenues from unregulated services and new subscribers than from increases in previously unregulated rates.
The FCC has adopted regulations implementing all of the requirements of the 1992 Cable Act. The FCC is also likely to continue to modify, clarify or refine the rate regulations. Olympus cannot predict the effect of the 1996 Act on future rulemaking proceedings or changes to the rate regulations.
Cable television companies operate under franchises granted by local authorities, which are subject to renewal and renegotiation from time to time. Because such franchises are generally non-exclusive, there is a potential for competition with the systems from other operators of cable television systems, including public systems operated by municipal franchising authorities themselves, and from other distribution systems capable of delivering television programming to homes. The 1992 Cable Act and the 1996 Act contain provisions that encourage competition from such other sources. The Company cannot predict the extent to which competition will materialize from other cable television operators, local telephone companies, other distribution systems for delivering television programming to the home, or other potential competitors, or, if such competition materializes, the extent of its effect on the Company.
The 1996 Act repealed the prohibition on local telephone exchange carriers ("LECs") from providing video programming directly to customers within their local exchange areas other than in rural areas or by specific waiver of FCC rules. The 1996 Act also authorized LECs to operate "open video systems" ("OVS") without obtaining a local cable franchise, although LECs operating such a system can be required to make payments to local governmental bodies in lieu of cable franchise fees. Where demand exceeds capacity, up to two-thirds of the channels on an OVS must be available to programmers unaffiliated with the LEC. The
statute states that the OVS scheme supplants the FCC's "video dialtone" rules. The FCC has promulgated rules to implement the OVS concept, and New Jersey Bell Telephone Company has been granted permission to convert its video dialtone authorization in Dover Township, New Jersey to an OVS authorization.
The Company believes that the provision of video programming by telephone companies in competition with the Company's existing operations could have an adverse effect on the Company's financial condition and results of operations. At this time, the impact of any such effect is not known or estimable.
The Company also competes with DBS service providers. DBS has been available to consumers since 1994. A single DBS satellite can provide more than 100 channels of programming. DBS service can be received virtually anywhere in the United States through the installation of a small outdoor antenna. DBS service is being heavily marketed on a nationwide basis by several service providers. At this time, any impact of DBS competition on the Company's future results is not known or estimable.
Year 2000 Issues
The year 2000 issue refers to the inability of computerized systems and technologies to recognize and process dates beyond December 31, 1999. The Company is evaluating the impact of the year 2000 issue on its business applications and its products and services. The evaluation includes a review of the Company's information technology systems, cable network equipment and other embedded technologies. A significant portion of the Company's computerized systems and technologies have been developed, installed or upgraded in recent years and are generally more likely to be year 2000 ready. The Company is also evaluating the potential impact as a result of its reliance on third-party systems that may have year 2000 issues.
Computerized business applications that could be adversely affected by the year 2000 issue include:
- - information processing and financial reporting systems, - - customer billing systems, - - customer service systems, - - telecommunication transmission and reception systems, and - - facility systems.
System failure or miscalculation could result in an inability to process transactions, send invoices, accept customer orders or provide customers with products and services. Customers could also experience a temporary inability to receive or use the Company's products and services.
The Company has developed a program to assess and address the year 2000 issue. This program consists of the following phases:
- - inventorying and assessing the impact on affected technology and systems, - - developing solutions for affected technology and systems, - - modifying or replacing affected technology and systems, - - testing and verifying solutions, - - implementing solutions, and - - developing contingency plans.
The Company has substantially completed inventorying and assessing the affected computerized systems and technologies. The Company is in various stages of its year 2000 compliance program with respect to the remaining phases as it relates to the affected systems and technologies.
The Company has engaged a consulting firm familiar with its financial reporting systems. This firm has developed and tested year 2000 solutions that the Company is in the process of implementing. The Company expects its financial reporting systems to be year 2000 compliant by June 1999.
A third-party billing vendor currently facilitates customer billing. The Company is currently in the process of testing an in-house service ordering, provisioning, maintenance and billing system that would replace the third-party billing vendor. The Company expects to have this new system implemented by
September 1999. On a contingency basis, the third-party vendor has provided a written statement that it will certify it is fully year 2000 compliant by June 1999.
Telecommunication plant rebuilds and upgrades in recent years have minimized the potential impact of the year 2000 issue on the Company's facilities, customer service, telecommunication transmission and reception systems. The Company is engaged in a comprehensive internal inventory and assessment of all hardware components and component controlling software throughout its telecommunication networks. The Company expects to implement any hardware and software modifications, upgrades or replacements resulting from the internal review by June 1999.
Costs incurred through December 31, 1998 directly related to addressing the year 2000 issue are approximately $50. The Company has also redeployed internal resources to meet the goals of its year 2000 program. The Company currently estimates the total cost of its year 2000 remediation program to be approximately $750. Although the Company will continue to incur substantial capital expenditures in the ordinary course of meeting its telecommunications system upgrade goals through the year 2000, it will not specifically accelerate its expenditures to facilitate year 2000 readiness, and accordingly such expenditures are not included in the above estimate.
The Company is communicating with others with whom it does significant business to determine their year 2000 readiness and to determine the extent to which the Company is vulnerable to year 2000 issues related to those third parties. The Company purchases much of its technology from third parties. There can be no assurance that the systems of other companies on which the Company's systems rely will be year 2000 ready or timely converted into systems compatible with the Company systems. The Company's failure or a third-party's failure to become year 2000 ready or the Company's inability to become compatible with third parties with which the Company has a material relationship, may have a material adverse effect on the Company, including significant service interruption or outages; however, the Company cannot currently estimate the extent of any such adverse effects.
The Company is in the process of identifying secondary sources to supply its systems or services in the event it becomes probable that any of its systems will not be year 2000 ready prior to the end of 1999. The Company is also in the process of identifying secondary vendors and service providers to replace those vendors and service providers whose failure to be year 2000 ready could lead to a significant delay in the Company's ability to provide its service to its customers.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company uses fixed and variable rate debt to fund its working capital requirements, capital expenditures and acquisitions. These debt arrangements expose the Company to market risk related to changes in interest rates. The Company has entered into interest rate swap agreements with banks to reduce the impact of changes in interest rates by effectively converting a portion of its variable rate debt to fixed rate debt. As of December 31, 1998, the Company had interest rate swap agreements covering notional principal of $40,000 that expire during 2000 and that fix the interest rate at an average of 7.68%. The Company does not enter into any interest rate swap agreements for trading purposes. The Company is exposed to credit loss in the event of non-performance by the banks. No such non-performance is expected. The table below summarizes the fair values and contract terms of the Company's financial instruments subject to interest rate risk as of December 31, 1998.
Interest rates on variable debt are estimated by us using the average implied forward London Interbank Offer Rate ("LIBOR") rates for the year of maturity based on the yield curve in effect at December 31, 1998, plus the borrowing margin in effect at December 31, 1998. Average receive rates on the variable to fixed swaps are estimated by us using the average implied forward LIBOR rates for the year of maturity based on the yield curve in effect at December 31, 1998.
INDEPENDENT AUDITORS' REPORT
Olympus Communications, L.P.:
We have audited the accompanying consolidated balance sheets of Olympus Communications, L.P. and subsidiaries as of December 31, 1997 and 1998, and the related consolidated statements of operations, partners' equity (deficiency), and cash flows for each of the three years in the period ended December 31, 1998. Our audits also included the financial statement schedules listed in the Index at Item 14. These financial statements and financial statement schedules are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Olympus Communications, L.P. and subsidiaries at December 31, 1997 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998 in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.
DELOITTE & TOUCHE LLP
Pittsburgh, Pennsylvania March 19, 1999
OLYMPUS COMMUNICATIONS, L.P. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands)
1. The Partnership and Basis of Presentation: Olympus Communications, L.P. and subsidiaries ("Olympus") is a joint venture limited partnership formed under the laws of Delaware with 50% of the outstanding voting interests held by ACP Holdings, Inc., ("ACP Holdings"), a wholly-owned subsidiary of Adelphia Communications Corporation ("Adelphia") and managing general partner of Olympus. The remaining 50% of the voting interests are held by various Telesat entities ("Telesat") which are wholly-owned subsidiaries of FPL Group, Inc. ("FPL"). On January 28, 1999, the partners entered into an agreement for Adelphia to acquire Telesat's partnership interests in Olympus. Refer to Note 11 for additional information about this transaction. Olympus' operations consist primarily of selling video programming that is distributed to subscribers in Florida for a monthly fee through a network of fiber optic and coaxial cables.
The consolidated financial statements include the accounts of Olympus and its substantially wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.
On January 5, 1996, Olympus acquired all of the southeast Florida cable systems of the Leadership Cable division of Fairbanks Communications, Inc. ("Leadership Cable"), which at the acquisition date served approximately 50,000 cable and security subscribers, for a purchase price of $95,800. Leadership Cable provides cable service and security services in and around West Palm Beach, Florida. The purchase price consisted of $40,000 in cash and a $70,000 non-interest bearing discount seller note. This note was recorded at $55,800 at acquisition and accreted to the $70,000 face amount (see Note 3). The acquisition was accounted for under the purchase method of accounting.
On March 28, 1996, ACP Holdings, Telesat, Olympus, Adelphia and certain shareholders of Adelphia entered into an agreement which amended certain aspects of an investment agreement and the Olympus Partnership Agreement. The amendment provided for the repayment of certain amounts owed to Telesat totaling $20,000, the release of certain obligations of Telesat to Olympus and the reduction of Telesat's PLP and accrued priority return balances by $20,000. The amendment further provided for a $40,000 distribution to Adelphia as a reduction of its PLP interest and accrued priority return balances. These repayments and distributions were made on March 29, 1996 and were funded through internally generated funds and borrowings by a subsidiary of Olympus.
Effective April 1, 1997, Olympus acquired certain cable systems of Tele-Media Company of Southeast Florida, Inc. for an aggregate price of $8,500. These systems served approximately 5,000 subscribers at the date of acquisition located in and around Osceola County, Florida. The acquisition was accounted for under the purchase method of accounting.
On June 20, 1997, Olympus acquired the Peninsula Cable systems from Booth American Company for an aggregate price of $10,500. These systems served approximately 6,000 subscribers at the date of acquisition located in and around Madeira Beach, Florida. The acquisition was accounted for under the purchase method of accounting.
In 1997, Olympus completed the acquisition of all of the partnership interests of National Cable Acquisition Associates, L.P. ("National") from Hilton Head Communications, L.P. ("Hilton Head"), an entity controlled by the family of John Rigas (principal shareholder of Adelphia), for a purchase price of approximately $118,000. National provided cable service to approximately 57,000 subscribers in Palm Beach County, Florida at the date of acquisition and also owned limited partnership interests in Tele-Media Investment Partnership, L.P. ("TMIP"). The acquisition was accounted for under the purchase method of accounting and National's operations were consolidated with Olympus for financial reporting purposes effective as of October 1, 1997. The purchase price was paid through the assumption of liabilities.
On June 30, 1998, Olympus sold its Madeira Beach, Florida cable television system, serving approximately 6,000 subscribers, to Cable One, Inc. for approximately $10,500.
On July 15, 1998, Olympus acquired the Fort Myers cable television operations from Cable TV Fund 12-A, Ltd. This system was acquired for approximately $110,000 and serves approximately 46,000 subscribers located in and around Fort Myers, Florida. The acquisition was accounted for under the purchase method of accounting.
On November 30, 1998, Olympus acquired cable television systems from Time Warner for approximately $33,400. These systems serve approximately 20,000 subscribers in communities around Lake Okeechobee, Florida. The acquisition has been accounted for under the purchase method of accounting.
On December 4, 1998, Olympus consummated a series of transactions to restructure the ownership of TMIP. The restructuring resulted in Olympus exchanging its nonconsolidated preferred limited partnership investment in TMIP for 100% ownership of a cable television system serving approximately 28,000 subscribers in Palm Beach County, Florida subject to $38,027 in debt and a 75% consolidated general partner interest in TMIP subject to $31,166 in debt. The restructured TMIP owns a cable television system serving approximately 34,000 subscribers located principally in Broward County, Florida and a 33.9% interest in an entity which owns cable television systems serving approximately 10,000 subscribers in Virginia. The acquisition was accounted for under the purchase method of accounting.
The following unaudited financial information assumes that all of the aforementioned acquisition/disposal transactions had occurred on January 1, 1996.
2. Summary of Significant Accounting Policies: Subscriber Revenues
Subscriber revenues are recorded in the month the service is provided.
Subscriber Receivables
An allowance for doubtful accounts of $622 and $716 is recorded as a reduction of subscriber receivables at December 31, 1997 and 1998, respectively.
Programming Expense
Adelphia allocates charges from programmers to affiliates (including Olympus) based on the number of subscribers to each programming service.
Property, Plant and Equipment
Property, plant and equipment are comprised of the following:
Depreciation is computed on the straight-line method using estimated useful lives of 5 to 12 years for operating plant and equipment and 3 to 20 years for support equipment and buildings. Additions to property, plant and equipment are recorded at cost, which includes amounts for material, applicable labor, and interest.
Intangible Assets
Intangible assets, net of accumulated amortization, are comprised of the following:
A portion of the aggregate purchase price of cable television systems acquired has been allocated to purchased franchises, purchased subscriber lists and goodwill. Purchased franchises and goodwill are amortized on the straight-line method over periods of up to 40 years. Purchased subscriber lists are amortized on the straight-line method over the average periods that the listed subscribers are expected to receive service from the date of acquisition, which range from 7 to 10 years. Accumulated amortization of intangible assets amounted to $125,178 and $144,548 at December 31, 1997 and 1998, respectively.
Other Assets
The unamortized amount of deferred debt financing costs included in prepaid expenses and other assets was $9,450 and $8,806 at December 31, 1997 and 1998, respectively. Such costs are amortized over the term of the related debt.
At December 31, 1997, prepaid expenses and other assets also included the Company's limited partnership investment in TMIP of $14,310. Income of $906 and $1,838 from this investment is included in revenues for the years ended December 31, 1997 and 1998, respectively. This investment was exchanged for interests in cable television systems in the December 4, 1998 TMIP restructuring transaction described in Note 1. As a result of this exchange, the Company recognized a gain of approximately $7,200, representing the excess of fair value of the assets received over the carrying value of the investment exchanged.
Asset Impairments
Olympus periodically reviews the carrying value of its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of assets may not be recoverable. Measurement of any impairment would include a comparison of estimated future operating cash flows anticipated to be generated during the remaining life of the assets with their net carrying value. An impairment loss would be recognized as the amount by which the carrying value of the assets exceeds their fair value.
Noncash Financing and Investing Activities
Capital leases entered into during 1996, 1997 and 1998 totaled $1,147, $415 and $5,709, respectively. Business acquisitions for 1997 and 1998 include the acquisition of National and the TMIP restructuring, respectively (see Note 1).
Basic and Diluted Net Loss Per General and Limited Partners' Unit After Priority Return
Basic and diluted net loss per general and limited partners' unit after priority return is based upon the weighted average number of general and limited partner units outstanding of 10.0 for all periods presented.
Cash and Cash Equivalents
Olympus considers all highly liquid investments with original maturities of three months or less to be cash equivalents.
Derivative Financial Instruments
Net settlement amounts under interest rate swap agreements are recorded as adjustments to interest expense during the period incurred.
Franchise Expense
The typical term of the Company's franchise agreements upon renewal is 10 years. Franchise fees range from 3% to 5% of subscriber revenue and are expensed currently.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Recent Accounting Pronouncements
Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities," has been issued and is effective for fiscal quarters of fiscal years beginning after June 15, 1999. SFAS No. 133 establishes accounting and reporting standards for derivative
instruments and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. Management of the Company has not completed its evaluation of the impact of SFAS No. 133 on the Company's consolidated financial statements.
3. Debt: Subsidiary Debt
Subsidiary debt is comprised of amounts due under credit agreements with banks.
The amount of borrowings available to Olympus under revolving credit agreements is generally based upon the subsidiaries achieving certain levels of operating performance. Olympus had commitments from banks for additional borrowings of up to $62,750, which included $52,750 also available to affiliates at December 31, 1998, which expire through 2003. Olympus pays commitment fees of .375% of unused principal.
Borrowings under these credit arrangements of subsidiaries are collateralized by substantially all of the assets of the respective subsidiaries. These agreements limit, among other things, additional borrowings, investments, transactions with affiliates and other subsidiaries, and the payment of dividends and fees by the subsidiaries. The agreements also require maintenance of certain financial ratios by the subsidiaries. Management believes that the borrowers were in compliance with the agreements' covenants at December 31, 1998. At December 31, 1998, approximately $160,605 of the net assets of subsidiaries would be permitted to be transferred to Olympus in the form of distributions, dividends and loans without the prior approval of the lenders based upon the results of operations of such subsidiaries for the quarter ended December 31, 1998. The subsidiaries are permitted to pay management fees to Olympus or other subsidiaries. Such fees are limited to a percentage of the subsidiaries' revenues.
A subsidiary of Olympus is a co-borrower with an affiliate under a $200,000 credit agreement. The subsidiary is permitted to borrow up to $39,500 of the available credit, none of which was included in subsidiary debt as of December 31, 1997 and 1998. In conjunction with the acquisition of the partnership interests of National and the TMIP restructuring, another subsidiary of Olympus assumed the obligation for $187,000 of a $350,000 credit agreement of Hilton Head, $118,000 and $135,000 of which was included in subsidiary debt as of December 31, 1997 and 1998, respectively. Each of these subsidiaries is liable for all borrowings under the respective credit agreements, although the lenders have no recourse against Olympus other than against Olympus' interest in the respective subsidiaries.
Subsidiary debt is due at various dates through 2003. Interest rates are based upon one or more of the following rates at the option of the borrowers: prime rate plus 0% to 1%; certificate of deposit rate plus .875% to 2.25%; or LIBOR plus .625% to 2%. At December 31, 1997 and 1998, the weighted average interest rate on subsidiary debt was 7.18% and 6.51%, respectively. Interest is payable quarterly. The rates on 8.6% of Olympus' subsidiary debt were fixed for at least one year through interest rate swap agreements.
The following table sets forth the mandatory reductions in principal under all agreements for indebtedness at December 31 of each of the next five years based on amounts outstanding at December 31, 1998:
Olympus intends to fund its debt maturities through borrowings under new credit agreements and internally generated funds. Changing conditions in the financial markets may have an impact on how Olympus will refinance its debt in the future.
Parent Debt
On November 12, 1996, Olympus issued $200,000 of 10 5/8% Senior Notes (the "Senior Notes"). Net proceeds, after payment of transaction costs, of approximately $195,000 were used to reduce amounts outstanding on Olympus' subsidiary debt. Interest is payable semi-annually. The Senior Notes are unsecured and are due November 15, 2006. Olympus may redeem up to $70,000 of the Senior Notes at 110.625% of principal through November 6, 1999. Commencing November 15, 2001, Olympus may redeem the Senior Notes in whole or in part at 105.3125% of principal declining annually to par on November 15, 2004. Holders of the Senior Notes have the right to require Olympus to redeem their Senior Notes at 101% of principal upon a Change of Control (as defined in the Indenture). The pending acquisition by Adelphia of the Olympus partnership interests owned by Telesat (see Note 11) would constitute a Change of Control in accordance with the Indenture and, upon the closing of the transaction, Olympus would be required to offer to repurchase all of the Senior Notes. The Senior Note Holders' option expires 30 days from Olympus' mailing of the purchase offer notices. Olympus intends to fund any redemptions through additional borrowings and advances from Adelphia. The Indenture also stipulates, among other things, limitations on additional borrowings, payment of dividends or distributions, repurchase of equity interests, transactions with affiliates and the sale of assets.
Other Debt
As of December 31, 1997 and 1998, other debt consists, in part, of purchase money indebtedness and capital leases incurred in connection with the acquisition of, and are collateralized by, certain equipment. The interest rate on such debt is based on the Federal Funds rate plus 1.4% or the U.S. Treasury rate plus approximately 2.8%. As of December 31, 1997 and 1998, other debt also includes $45,000 and $1,000 regarding the seller note from the acquisition of Leadership Cable on January 5, 1996.
Interest Rate Swaps and Caps
Olympus has entered into interest rate swap agreements and interest rate cap agreements with banks and an affiliate (see Note 9) to reduce the impact of changes in interest rates on its bank debt and its Senior Notes. Olympus enters into pay-fixed agreements to effectively convert a portion of its variable-rate debt to fixed-rate debt. Olympus enters into receive-fixed agreements to effectively convert a portion of its fixed-rate Senior Notes to variable-rate debt which is indexed to LIBOR. Interest rate cap agreements are used to reduce the impact of increases in interest rates on variable rate debt. Olympus is exposed to credit loss in the event of nonperformance by the banks and the affiliate. Olympus does not expect any such nonperformance.
The following table summarizes the notional amounts outstanding and weighted average interest rate data for all swaps and caps which expire during 2000.
4. Limited Partners' Interests and General Partners' Equity (Deficiency): Olympus' equity includes Preferred Limited Partner, Senior Limited Partner, General and Limited Partner Interests. Refer to Note 11 for information regarding the pending acquisition by Adelphia of the Olympus partnership interests owned by Telesat.
The Preferred Limited Partner interests are nonvoting, do not participate in the profits and losses of Olympus and provide for a priority return of 16.5% per annum (payable quarterly). In the event that any priority return is not paid when due, such unpaid amounts accrue additional return at a rate of 16.5% per annum.
The Senior Limited Partner interests held by Telesat are nonvoting, senior to claims represented by all other partner interests and provide for a priority return of 16.5% per annum (payable quarterly). In the event that any priority return is not paid when due, such unpaid amounts accrue additional return at a rate of 16.5% per annum.
Allocation of Profits, Losses and Distributions
Profits and losses of Olympus for income tax purposes are allocated 99% to the limited partner of Olympus and 1% to the managing general partner of Olympus until the aggregate profits allocated to the limited partner equals the aggregate losses allocated to the limited partner, at which time the managing general partner receives two-thirds, and the limited partner of Olympus receives one-third of the net income and losses of Olympus. As specified in the partnership agreement, allocations will be made in the following order to the holders of the: (i) Senior Limited Partner Interests; (ii) Special Limited Partner Interests, if any; and (iii) Preferred Limited Partner Interests. Such allocations will equal a return of their capital plus 16.5% per annum priority return less any priority return previously paid. After such allocations, distributions by Olympus will be made in the following order: (1) 99% of any remaining amount will be distributed two-thirds to the managing general partner and any partner holding voting units acquired directly or indirectly from the managing partner, pro rata, and one-third to partners holding the remaining voting units; and (2) thereafter pro rata to all partners holding voting units. At December 31, 1998, 10 voting units were outstanding of which five were held by ACP Holdings, the managing general partner, and five were held by Telesat, a general and limited partner.
5. Commitments and Contingencies: Olympus rents office space, tower sites, and space on utility poles under leases with terms that are generally less than one year or under agreements that are generally cancelable on short notice. Total rental expense under all operating leases aggregated $1,495, $1,614 and $1,974 for 1996, 1997 and 1998, respectively.
In connection with certain obligations under existing franchise agreements, Olympus obtains surety bonds guaranteeing performance to municipalities and public utilities. Payment is required only in the event of nonperformance. Management believes Olympus has fulfilled all of its obligations such that no payments under surety bonds have been required.
Through July 26, 1996, Olympus had a program to self insure for casualty and business interruption insurance. This program was part of an aggregate agreement between Olympus and its subsidiaries in which Olympus provided insurance for casualty and business interruption claims of up to $10,000 and $20,000 per claim, respectively, for each subsidiary. Effective July 26, 1996, Olympus is insured by an outside party for casualty and business interruption.
The cable television industry and Olympus are subject to extensive regulation at the federal, state and local levels. Pursuant to the Cable Television Consumer Protection and Competition Act of 1992 (the "1992 Cable Act"), which significantly expanded the scope of regulation of certain subscriber rates and a number of other matters in the cable industry, the FCC has adopted rate regulations that establish, on a system-by-system basis, maximum allowable rates for (i) basic and cable programming services (other than programming offered on a per-channel or per-program basis), based upon a benchmark methodology or, in the alternative, a cost of service showing and (ii) associated equipment and installation services based upon cost plus a reasonable profit. Under the FCC rules, franchising authorities are authorized to regulate rates for basic services and associated equipment and installation services, and the FCC will regulate rates for regulated cable programming services in response to complaints filed with the agency. The original rate regulations became effective on September 1, 1993. Several amendments to the rate regulations have subsequently been added.
The FCC has adopted regulations implementing virtually all of the requirements of the 1992 Cable Act. The FCC is also likely to continue to modify, clarify or refine the rate regulations. The Telecommunications Act of 1996 (the "1996 Act") deregulates the rates for cable programming services on March 31, 1999. Olympus cannot predict the effect or outcome of the future rulemaking proceedings, changes to the rate regulations or litigation.
6. Employee Benefit Plans: Olympus participates in an Adelphia savings plan (401(k)) which provides that eligible full-time employees may contribute from 2% to 20% of their pre-tax compensation subject to certain limitations. Olympus matches contributions not exceeding 1.5% of each participant's pre-tax compensation. During the years ended 1996, 1997 and 1998 no significant matching contributions were made by Olympus.
7. Taxes on Income: Certain subsidiaries of Olympus are corporations that file separate federal and state income tax returns. At December 31, 1998, these subsidiaries had net operating loss carryforwards for federal income tax purposes of approximately $185,500 expiring through 2012. The partnership investments of Olympus are tax entities in which the filing of returns and related tax liabilities are the responsibility of the individual owners.
Deferred income taxes reflect the net tax effects of: (a) temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes, and (b) operating loss and tax credit carryforwards.
The tax effects of significant items comprising Olympus' net deferred tax liability as of December 31, 1997 and 1998 are as follows:
The net change in the valuation allowance for the year ended December 31, 1998 was an increase of $2,642.
The income tax benefit (expense) for the years ended December 31, 1996, 1997 and 1998 is as follows:
Reconciliations between the statutory federal income tax rate and Olympus' effective income tax rate as a percentage of loss before income taxes are as follows:
8. Disclosures about Fair Value of Financial Instruments: Included in Olympus' financial instrument portfolio are cash, notes payable to banks, Senior Notes and interest rate swaps and caps. The carrying values of the notes payable to banks approximate their fair values at December 31, 1998. The fair value of the Senior Notes exceeded their carrying cost by approximately $22,000 and $28,000 at December 31, 1997 and 1998, respectively. At December 31, 1997, Olympus would have received approximately $615 and at December 31, 1998, Olympus would have been required to pay approximately $1,327 to settle its interest rate swap and cap agreements, representing the difference between fair value and carrying cost of these agreements. The fair values of the debt and interest rate swaps and caps were based upon quoted market prices of similar instruments or on rates available to Olympus for instruments of the same remaining maturities.
9. Transactions with Related Parties: Olympus has an agreement with a subsidiary of Adelphia which provides for the payment of management fees by Olympus. The amount and payment of these fees is subject to restrictions contained in the partnership agreements.
Olympus has periodically received funds from and advanced funds to Adelphia and other affiliates. Olympus was charged $6,600 of interest on such net payables for each of 1996 and 1997, and $9,582 for 1998.
At December 31, 1997, Olympus had interest rate swaps with an affiliate for a notional amount of $140,000 for Receive Fixed Swaps. These swaps expired during 1998. The net effect of these interest rate swaps was to decrease interest expense by $2,554, $2,308 and $2,033 in 1996, 1997 and 1998, respectively.
Effective October 1, 1997, Olympus completed the acquisition of all of the partnership interests of National from Hilton Head, an entity controlled by the family of John Rigas (principal shareholder of Adelphia), for a purchase price of approximately $118,000 (see Note 1).
10. Quarterly Financial Data (unaudited): The following tables summarize the financial results of Olympus for each of the quarters in the years ended December 31, 1997 and 1998.
11. Subsequent Event: On January 28, 1999, Adelphia entered into an agreement to acquire the Olympus partnership interests owned by Telesat for approximately $108,000, subject to definitive terms to be negotiated by both parties. Upon the closing of this transaction, Adelphia will own 100% of Olympus. Closing of this transaction is expected to occur during the third quarter of 1999.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Executive Officers of the Registrant
The directors and executive officers of the Adelphia subsidiary which is the managing general partner of the Company, ACP Holdings, Inc. ("ACP Holdings") are:
John J. Rigas is Chairman of ACP Holdings and is the founder, Chairman, Chief Executive Officer and President of Adelphia. Mr. Rigas has owned and operated cable television systems since 1952. Among his business and community service activities, Mr. Rigas is Chairman of the Board of Directors of Citizens Bank Corp., Inc., Coudersport, Pennsylvania and a member of the Board of Directors of the Charles Cole Memorial Hospital. He is a director of the National Cable Television Association and a member of its Pioneer Association and a past President of the Pennsylvania Cable Television Association. He is also a member of the board of directors of C-SPAN and the Cable Advertising Bureau, and is a Trustee of St. Bonaventure University. He graduated from Rensselaer Polytechnic Institute with a B.S. in Management Engineering in 1950.
John J. Rigas is the father of Michael J. Rigas, Timothy J. Rigas and James P. Rigas, each of whom currently serves as a director and executive officer of ACP Holdings.
Michael J. Rigas is an Executive Vice President of ACP Holdings, Executive Vice President, Operations of Adelphia and a Vice President of Adelphia's other subsidiaries. He has been with Adelphia since 1981, and with ACP Holdings since its inception in 1989. From 1979 to 1981, he worked for Webster, Chamberlain & Bean, a Washington, D.C. law firm. Mr. Rigas graduated from Harvard University (magna cum laude) in 1976 and received his J.D. degree from Harvard Law School in 1979.
Timothy J. Rigas is an Executive Vice President and Treasurer of ACP Holdings, Executive Vice President, Chief Financial Officer and Treasurer of Adelphia, and a Vice President of Adelphia's other subsidiaries. He has been with Adelphia since 1979, and with ACP Holdings since its inception in 1989. Mr. Rigas graduated from the University of Pennsylvania, Wharton School, with a B.S. degree in Economics (cum laude) in 1978.
James P. Rigas is an Executive Vice President of ACP Holdings, Executive Vice President, Strategic Planning of Adelphia and a Vice President of Adelphia's other subsidiaries. He has been with Adelphia since 1986, and with ACP Holdings since its inception in 1989. Mr. Rigas graduated from Harvard University (magna cum laude) in 1980 and received a J.D. degree and an M.A. degree in Economics from Stanford University in 1984. From June 1984 to February 1986, he was a consultant with Bain & Co., a management consulting firm.
Daniel R. Milliard is Senior Vice President and Secretary of ACP Holdings, President and Secretary of Hyperion Telecommunications, Inc., a majority owned subsidiary of Adelphia, and Senior Vice President and Secretary of Adelphia and its subsidiaries. He has been with Adelphia since 1982. He served as outside general counsel to Adelphia's predecessors from 1979 to 1982, and with ACP Holdings since its inception in 1989. Mr. Milliard graduated from American University in 1970 with a B.S. degree in Business Administration. He received an M.A. degree in Business from Central Missouri State University in 1971 and received a Juris Doctor degree from the University of Tulsa School of Law in 1976. He is a director of Citizens Bank Corp., Inc. in Coudersport, Pennsylvania and is a member of the Board of Directors of the Charles Cole Memorial Hospital.
James R. Brown is Vice President of ACP Holdings and Vice President of Finance of Adelphia and its other subsidiaries. He has been with Adelphia since 1984. Mr. Brown graduated with a B.S. degree in Industrial and Management Engineering from Rensselaer Polytechnic Institute in 1984.
The Partnership Agreement of the Company establishes an Operating Committee, which is comprised equally of members designated by ACP Holdings, and FPL Group. The Operating Committee meets quarterly to review the business and operations of the Company. In addition, the Operating Committee reviews and evaluates the historic operating performance of the Company against its budget and the historic operating performance of the System under its management agreements.
ITEM 11. EXECUTIVE COMPENSATION Neither the Company nor ACP Holdings has any employment contracts in effect with the executive officers of ACP Holdings, including any compensatory plans or arrangements resulting from the resignation, retirement or other termination of such executive officers of ACP Holdings. Each of the executive officers of ACP Holdings is an executive officer of Adelphia. As executive officers of Adelphia, such individuals are parties to employment contracts with Adelphia and are compensated by Adelphia in accordance with the decisions of the Compensation Committee of the Board of Directors of Adelphia. Pursuant to the Partnership Agreement, the Company pays Adelphia a management fee representing an allocation of the corporate overhead of Adelphia, which includes a portion for executive salaries.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT ACP Holdings serves as the managing general partner of the Company and holds voting general partnership interests representing 50% of the voting interests of the Company. FPL Group through subsidiaries holds general and limited partnership interests representing the remaining 50% of the voting interests. The current ownership interests are subject to an agreement for Adelphia to acquire the Olympus partnership interests owned by FPL Group for approximately $108.0 million, subject to definitive terms to be negotiated by both parties. Upon the closing of this transaction, Adelphia will own 100% of Olympus. Closing of this transaction is expected to occur during the third quarter of 1999. Adelphia and FPL Group also held through their subsidiaries, as of December 31, 1998, $366.9 million Preferred Limited Partner ("PLP") interests and $183.4 million PLP interests, respectively, which provide for a 16.5% per annum priority return, and $283.4 million and $20.0 million in indebtedness and Senior Limited Partnership ("SLP") interests in the Company, respectively. The address of Adelphia and the Company is Main at Water Street, Coudersport, Pennsylvania 16915. The telephone number for both is 814-274-9830. The address of FPL Group, Cable GP, Inc. and Cable LP III, Inc. is 11760 Highway 1, Suite 600, North Palm Beach, Florida, 33408.
The Partnership Agreement
The Company is a limited partnership formed under the laws of the state of Delaware. The following summary of certain of the terms of the Second Amended and Restated Limited Partnership Agreement dated as of February 28, 1995, as amended by amendments dated as of September 1, 1995, March 29, 1996 and June 27, 1996 (the "Partnership Agreement") is qualified in its entirety by the Partnership Agreement, copies of which are available upon request therefor from the Company. Terms used in this summary and not otherwise defined shall have the meaning ascribed thereto in the Partnership Agreement.
The Company was formed for the general purpose of engaging in the media, telecommunications and communications business including, without limitation, the acquisition of cable television systems and interests engaged therein, the competitive access/alternate access business, electronic security monitoring and any other activity necessary, appropriate, desirable or incidental thereto, subject to obtaining Partner consents, if any, required under the terms of the Partnership Agreement. An objective and the intent of the Company and its Partners, through themselves and through the Company and their respective parent entities and affiliates is to seek, explore, identify and promote areas of potential further joint venturing, cooperation, investment, strategic alliance and enterprise among the Partners with respect to the media, telecommunications and communications business, including without limitation potential areas such as personal communication services, alternate access and other telephone services, and fiber optics applications generally, subject to obtaining Partner consents, if any, required under the terms of the Partnership Agreement.
ACP Holdings is the Managing General Partner and a Preferred Limited Partner of the Company. The Partnership Agreement provides that the Managing General Partner shall own at least fifty percent of the aggregate general and limited partnership voting interests ("Units") of the Company. ACP Holdings is also a Preferred Limited Partner of the Company holding non-voting PLP. In the aggregate, ACP Holdings owns 50% of the Units. Cable GP, Inc., which is beneficially owned by FPL Group, is a General Partner of the Company and Cable LP III, Inc., which is also beneficially owned by FPL Group, is a Limited Partner, a non-voting Senior Limited Partner and a Preferred Limited Partner of the Company holding non-voting PLP. In the aggregate, these FPL Group companies own 50% of the Units.
The Managing General Partner has the sole right to manage and control the affairs of the Company and its direct affiliates and is authorized and empowered to carry out and implement any and all of the purposes of the Company pursuant to the terms of the Partnership Agreement. The Company pays to Adelphia, on a quarterly basis, an amount representing an allocation of the corporate overhead of Adelphia and its subsidiaries with respect to the Company for such period, which allocation is based generally upon the ratio of the Company's cable subscribers to the total cable subscribers owned or managed by Adelphia. The Company is entitled to receive the benefits (on an average cost basis) of any programming or purchasing agreements available to Adelphia or one of its affiliates if such benefits are permitted to be passed through to the Company. The Company has also agreed not to contract with or enter into any contract with an electric utility without first making such opportunity available to FPL Group and its affiliates. Although the Partnership Agreement does not prohibit the Partners from engaging in or possessing an interest in other business ventures or activities of any nature and description, there are certain limitations on the activities of the Partners, including (i) prior to any Partner or its affiliates acquiring a direct or indirect beneficial ownership interest in a cable system (other than as a passive investor in a cable system of less than one percent of the outstanding equity interests in any publicly traded person) in the state of Florida or in any cable system outside of the state of Florida within 100 miles of any head-end site of the Company, such cable system shall be offered to the Company, (ii) any transaction between the Company and the Managing General Partner or its affiliates must be on terms at least as favorable to the Company as those available to unrelated parties, (iii) certain transactions (as described below) must be approved by a Majority-in-Interest of the Partners and (iv) certain transactions (as described below) must be approved by a Super Majority-in-Interest of the Partners. The following transactions require the approval of a Majority-in-Interest of the Partners (more than 75% of the Units) (i) any amendment to the Partnership Agreement, (ii) election of an additional or substitute Managing General Partner, (iii) dissolution or liquidation, (iv) incorporation, (v) borrowings or refinancings of borrowings in excess of $5,000,000, (vi) the issuance of any PLP or SLP interests, (vii) adoption or amendment of the annual operating budget or capital budget of the Company, subject to certain exceptions, (viii) transactions with Partners or their affiliates not otherwise specifically permitted by the Partnership Agreement, (ix) change or reorganization of the Company into any other legal form of organization, (x) loaning of funds of the Company or acting as a Guarantor except as permitted by the Partnership Agreement, (xi) admission of new partners, (xii) the selection of a new independent certified public accountant and (xiii) the acquisition of less than 95 percent of any other company or partnership. The approval of a Super Majority-in-Interest of the Partners (more than 85% of the Units) of the Company is required to approve (i) the filing on behalf of the Company of a petition in bankruptcy or insolvency, (ii) the sale, trade, exchange or other disposition of assets of the Company
other than in the ordinary course of business and other than transactions involving less than 5,000 cable subscribers per fiscal year, (iii) the purchase or other acquisition from a third-party owner of any CATV systems or subscribers other than line or plant extensions or other transactions involving less than 5,000 cable subscribers, (iv) any call for additional Capital Contributions beyond that expressly permitted by the Partnership Agreement and (v) the issuance of any partnership Units in the Company or General Partner, Limited Partner or Managing General Partner Interests.
The term of the Company is until December 31, 2019, although, on or after February 28, 2001, FPL Group partners may force a buy-out or sale of their partnership interests to ACP Holdings by delivering a written offer to buy or sell their Units. In addition, under certain circumstances prior to the end of such term, if a disagreement occurs over a Fundamental Issue, at the election of the Managing General Partner, the Partners have certain buy-sell rights regarding their partnership interests in the event that the dispute cannot be resolved. A "Fundamental Issue" under the Partnership Agreement includes any of the following matters for which the Managing General partner has sought required approval from the other Partners of Olympus but such approval has not been granted: material amendments to the Partnership Agreement; annual operating or capital budgets that have been proposed but not approved for at least one year; the election of a substitute or additional Managing General Partner; certain financings; a change to the Partnership's legal form of organization; the admission of a new partner to the Partnership; and significant sales or dispositions of assets.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Pursuant to the Partnership Agreement, the Company pays to Adelphia, on a quarterly basis, an amount representing an allocation of the corporate overhead of Adelphia and its subsidiaries with respect to the Company for such period, which allocation is based generally upon the ratio of the Company's cable subscribers to the total cable subscribers owned or managed by Adelphia. Amounts of such fees paid for 1998 were $13.2 million.
The Company has periodically received funds from and advanced funds to Adelphia and Doris Holdings, L.P. and Highland Holdings, partnerships controlled by the Rigas family. The Company was charged $9.6 million of interest on such net payables for 1998. Amounts outstanding to Adelphia and its affiliates were $283.4 million as of December 31, 1998.
The Company had interest rate swaps with Adelphia for a notional amount of $140.0 million which expired in 1998. The net effect of these interest rate swaps was to decrease interest expense by $2.0 million in 1998.
On March 29, 1996 Telesat Acquisition Limited Partnership ("Telesat"), a subsidiary of Olympus, and Global Acquisition Partners, L.P., a subsidiary of Adelphia, were added as co-borrowers to a $200 million credit facility of Highland Video Associates, L.P. ("Highland Video"), a partnership controlled by the Rigas family. Telesat is permitted to borrow up to $39.5 million of the available credit, none of which was included in subsidiary debt at December 31, 1998. The Company pledged its partnership interests in Telesat in favor of the banks at the time Telesat was added as a co-borrower.
National Cable Acquisition Associates, L.P. ("National"), a subsidiary of Olympus, assumed the obligation for $187.0 million of a $350.0 million credit agreement of Hilton Head Communications, L.P., an entity controlled by the family of John Rigas. Of this total, $118.0 million and $135.0 million was included in subsidiary debt at December 31, 1997 and 1998, respectively. National is liable for all borrowings under the credit agreement, although the lenders have no recourse against the Company other than the Company's interest in National.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K Financial Statements, schedules and exhibits not listed have been omitted where the required information is included in the consolidated financial statements or notes thereto, or is not applicable or required.
(a) (1) A listing of the consolidated financial statements, notes and independent auditors' report required by Item 8