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Time Warner Cable 10-K 2007 Documents found in this filing:
Table of Contents
UNITED
STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
Form 10-K
For the fiscal year ended December 31, 2006
Commission file number
000-52471
TIME WARNER CABLE INC.
(Exact name of registrant as specified in its charter)
290 Harbor Drive
Stamford, Connecticut, 06902-7441 (Address of Principal Executive Offices) (Zip Code)
Registrant’s telephone number, including Area Code:
(203) 328-0600
Securities registered pursuant to Section 12(b) of the
Act:
Securities registered pursuant to Section 12(g) of the
Act:
Class A
common stock, par value $.01
(Title of Class)
Indicate by check mark if the registrant is a well-known
seasoned issuer, as defined in Rule 405 of the Securities
Act.
Yes o No þ
Indicate by check mark if the registrant is not required to file
reports pursuant to Section 13 or Section 15(d) of the
Exchange Act.
Yes o No þ
Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of
the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
Yes o No þ
Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of
Regulation S-K
is not contained herein, and will not be contained, to the best
of registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in
Part III of this
Form 10-K
or any amendment to this
Form 10-K. þ
Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, or a non-accelerated
filer. See definition of “accelerated filer and large
accelerated filer” in
Rule 12b-2
of the Exchange Act.
Indicate by check mark whether the registrant is a shell company
(as defined in
Rule 12b-2
of the Exchange
Act). Yes o No þ
The aggregate market value of the registrant’s voting stock
held by non-affiliates of the registrant as of June 30,
2006 was $0.
As of the close of business on February 16, 2007, there
were 901,913,430 shares of the registrant’s
Class A common stock and 75,000,000 shares of the
registrant’s Class B common stock outstanding.
TABLE OF CONTENTS
Table of Contents
PART I
Time Warner Cable Inc., together with its subsidiaries
(“TWC” or the “Company”), is the
second-largest cable operator in the U.S. and is an industry
leader in developing and launching innovative video, data and
voice services. As of December 31, 2006, TWC had cable
systems that passed approximately 26 million
U.S. homes in well-clustered locations and had
approximately 14.6 million customer relationships (after
giving effect to the distribution of the assets of Texas and
Kansas City Cable Partners, L.P. (“TKCCP”) to its
partners on January 1, 2007). Approximately 85% of these
homes passed were located in one of five principal geographic
areas: New York state, the Carolinas, Ohio, southern California
and Texas. As of February 1, 2007, Time Warner Cable was
the largest cable system operator in a number of large cities,
including New York City and Los Angeles.
As part of TWC’s strategy to expand its cable footprint and
improve the clustering of its cable systems, on July 31,
2006 Time Warner NY Cable LLC (“TW NY”), a subsidiary
of TWC, and Comcast Corporation (“Comcast”) completed
their respective acquisitions of assets comprising, in the
aggregate, substantially all of the cable systems of Adelphia
Communications Corporation (“Adelphia”). TW NY paid
for the Adelphia assets acquired by it with approximately
$8.9 billion in cash (after certain purchase price
adjustments) and shares of TWC’s Class A common stock,
par value $.01 per share (“TWC Class A common
stock”) representing approximately 16% of TWC’s
outstanding common stock. Immediately prior to the Adelphia
acquisition, TWC and its subsidiary, Time Warner Entertainment
Company, L.P. (“TWE”), redeemed Comcast’s
interests in TWC and TWE, respectively, with the result that
Comcast no longer has an interest in either company. In
addition, immediately after the acquisition of the Adelphia
assets, TW NY exchanged certain cable systems with subsidiaries
of Comcast. These transactions (referred to generally herein as
the “Transactions”) resulted in a net increase of
3.2 million basic video subscribers served by TWC’s
cable systems, consisting of approximately 4.0 million
subscribers in acquired systems and approximately
0.8 million subscribers in systems transferred to Comcast.
Cable systems acquired by TWC from Adelphia or from Comcast in
the Transactions are referred to herein as the “Acquired
Systems,” and systems owned or operated by TWC since prior
to the Transactions are referred to herein as the “Legacy
Systems.”
On February 13, 2007, Adelphia’s plan of
reorganization under Chapter 11 of title 11 of the
United States Code became effective and, under applicable
securities law regulations and provisions of the
U.S. bankruptcy code, TWC became a public company subject
to the requirements of the Securities Exchange Act of 1934 on
the same day. Under the terms of the plan, as of
February 20, 2007, approximately 75% of the shares of TWC
Class A common stock that Adelphia received as part of the
payment for its assets in July 2006 have been distributed to
Adelphia’s creditors. The remaining shares are expected to
be distributed during the coming months as remaining disputes
are resolved by the bankruptcy court, including 4% of such
shares that are being held in escrow in connection with the
asset acquisition. It is expected that the TWC Class A
common stock will begin to trade on the New York Stock Exchange
(“NYSE”) on or about March 1, 2007.
Time Warner Inc. (“Time Warner”) holds an 84% economic
interest in TWC (representing a 90.6% voting interest). The
financial results of TWC’s operations are consolidated by
Time Warner. See “TWC’s Governing
Documents — Management and Operation of TWC.”
As the marketplace for basic video services has matured, the
cable industry has responded by introducing new services,
including enhanced video services like high definition
television (“HDTV”) and
video-on-demand
(“VOD”), high-speed Internet access and Internet
protocol (“IP”)-based telephony. As of
December 31, 2006, approximately 7.3 million (or 54%)
of TWC’s 13.4 million basic video customers subscribed
to digital video services, 6.6 million (or 26%) of
high-speed data service-ready homes subscribed to a residential
high-speed data service such as TWC’s Road Runner service
and 1.9 million (or 11%) of voice service-ready homes
subscribed to Digital Phone, TWC’s newest service. TWC
launched Digital Phone broadly in the Legacy Systems during 2004
and it is available in some of the Acquired Systems on a limited
basis. As of December 31, 2006, in the Legacy Systems,
approximately 56% of TWC’s 9.5 million basic video
customers subscribed to digital video services and over 30% of
high-speed data service ready homes subscribed to a residential
high-speed data service. The customer data contained in this
Item 1 include subscribers in managed, but unconsolidated,
Kansas City Pool systems (as defined below), which were
distributed to
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TWC by TKCCP effective on January 1, 2007. For additional
information with respect to the distribution of the assets of
TKCCP to its partners on January 1, 2007, see
“Management’s Discussion and Analysis of Results of
Operations and Financial Condition — Recent
Developments” in the financial pages herein.
On July 31, 2006, TWC completed the following transactions
with Adelphia and Comcast:
For additional information regarding the Adelphia Acquisition,
the Redemptions and the Exchange, see “— The
Transactions.”
The Adelphia Acquisition was designed to be a taxable
acquisition of assets that would result in a tax basis in the
acquired assets equal to the purchase price TW NY paid. The
resulting
step-up in
the tax basis of the assets would increase future tax
deductions, reduce future net cash tax payments and thereby
increase TWC’s future cash flows. See
“Management’s Discussion and Analysis of Results of
Operations and Financial Condition — Recent
Developments — Tax Benefits from the
Transactions.”
TKCCP, a
50-50 joint
venture between TWC and Comcast, which, as of December 31,
2006, served approximately 1.6 million basic video
subscribers throughout Houston, Kansas City, south and west
Texas and New Mexico is in the process of being dissolved. In
connection with the pending dissolution, on January 1,
2007, TKCCP distributed its assets to its partners. TWC received
TKCCP’s cable systems in Kansas City, south and west Texas
and New Mexico (the “Kansas City Pool”), which
collectively served approximately 788,000 basic video
subscribers as of December 31, 2006, and Comcast received
the Houston cable systems (the “Houston Pool”).
Comcast has refinanced the debt of TKCCP. TWC has not and will
not assume any debt of TKCCP in connection with the distribution
of TKCCP’s assets or the dissolution. See
“Management’s Discussion and Analysis of Results of
Operations and Financial Condition — Recent
Developments — Dissolution of TKCCP.”
This Annual Report on
Form 10-K
includes certain “forward-looking statements” within
the meaning of the Private Securities Litigation Reform Act of
1995. These statements are based on management’s current
expectations and are subject to uncertainty and changes in
circumstances. Actual results may vary materially from the
expectations contained herein due to changes in economic,
business, competitive, technological
and/or
regulatory factors. For more detailed information about these
factors, and risk factors with respect to the Company’s
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operations, see Item 1A, “Risk Factors” below and
“Caution Concerning Forward-Looking Statements” in
“Management’s Discussion and Analysis of Results of
Operations and Financial Condition” in the financial
section of this Report. TWC is under no obligation to (and
expressly disclaims any obligation to) update or alter its
forward-looking statements, whether as a result of new
information, subsequent events or otherwise.
Although TWC and its predecessors have been in the cable
business for over 30 years in various legal forms, Time
Warner Cable Inc. was incorporated as a Delaware corporation on
March 21, 2003. TWC’s annual reports on
Form 10-K,
quarterly reports on
Form 10-Q,
current reports on
Form 8-K
and any amendments to such reports filed with or furnished to
the Securities and Exchange Commission (“SEC”)
pursuant to Section 13(a) or 15(d) of the Securities
Exchange Act of 1934 are available free of charge on the
Company’s website at www.timewarnercable.com as soon
as reasonably practicable after such reports are electronically
filed with the SEC.
The following chart illustrates TWC’s corporate structure
after giving effect to the dissolution of TKCCP (and the related
distribution of a portion of its assets to TWC) and the
distribution of shares of TWC Class A common stock by
Adelphia to certain of its creditors. The subscriber numbers,
long-term debt and preferred equity balances presented below are
approximate as of December 31, 2006. Certain intermediate
entities and certain preferred interests held by TWC or its
subsidiaries are not reflected. The subscriber counts within
each entity indicate the number of basic video subscribers
attributable to cable systems owned by such entity. Basic video
subscriber amounts reflect billable subscribers who receive
TWC’s basic video service.
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Products
and Services
TWC offers a variety of services over its broadband cable
systems, including video, high-speed data and voice services.
TWC markets its services separately and as “bundled”
packages of multiple services and features. Increasingly,
TWC’s customers subscribe to more than one of its services
for a single price reflected on a single consolidated monthly
bill.
TWC offers a full range of analog and digital video service
levels, including premium services such as HBO and Showtime, as
well as advanced services such as VOD, HDTV, and set-top boxes
equipped with digital video recorders (“DVRs”). The
following table presents selected statistical data regarding
TWC’s video services:
Analog services. Analog video service is
available in all of TWC’s operating areas. TWC typically
offers two levels or “tiers” of service —
Basic and Standard — which together offer, on average,
approximately 70 channels for viewing on “cable-ready”
television sets without the need for a separate set-top box.
TWC offers its Basic and Standard tiers for a fixed monthly fee.
The rates TWC can charge for its “Basic” tier and
certain video equipment are subject to regulation under federal
law. See “— Regulatory Matters.”
In certain areas, TWC’s Basic and Standard tiers also
include proprietary local programming devoted to the communities
TWC serves. For example, TWC provides
24-hour
local news channels in the following areas: NY1 News and NY1
Noticias in New York, NY; News 14 Carolina in Charlotte,
Greensboro and Raleigh, NC; R News in Rochester, NY; Capital
News 9 in Albany, NY; News 8 Austin in Austin, TX; and News 10
Now in Syracuse, NY. In most of these areas, these news channels
are available exclusively on TWC’s cable systems.
As of December 31, 2006, 51.4% of TWC’s homes passed,
or 13.4 million subscribers, subscribed to its basic
services and, in the Legacy Systems, 56.7% of TWC’s homes
passed, or 9.5 million subscribers, subscribed to its basic
services. Although basic video subscriber penetration levels
have generally been lower in the Acquired Systems, TWC believes
it has an opportunity to increase the number of basic video
subscribers in the Acquired Systems.
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Digital services. Subscribers to TWC’s
digital video services receive up to 250 digital video and audio
services (in digital format in most of the Legacy Systems) and
services that may include:
TWC’s analog and digital video subscribers pay a fixed
monthly fee for the level of service they receive. Subscribers
to premium channels are charged an additional monthly fee, with
discounts generally available for the purchase of packages of
more than one such service.
As of December 31, 2006, 54.2%, or approximately
7.3 million, of TWC’s basic video subscribers
subscribed to its digital video services and, in the Legacy
Systems, approximately 55.6%, or approximately 5.3 million,
of its basic video subscribers subscribed to its digital video
services. Although digital video penetration levels have been
lower in the Acquired Systems, TWC believes it has an
opportunity to increase the number of digital subscribers in the
Acquired Systems.
On-Demand services. TWC offers a number of
On-Demand services that enable users to view what they want,
when they want it. These services — which are provided
only to TWC’s digital video customers — feature
advanced functionality, such as the ability to pause, rewind and
fast-forward the programming using TWC’s VOD system. TWC
believes that access to On-Demand programming gives its existing
analog subscribers and potential new subscribers a compelling
reason to subscribe to its digital video service. TWC’s
On-Demand products and services include:
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TWC charges for most of the movies that are made available in
its
Movies-on-Demand
service on a per-use basis, but its subscription
video-on-demand
(“SVOD”) services are generally included in premium
packages or are made available as part of a separate package of
SVOD services.
DVRs. Set-top boxes equipped with digital
video recorders are available for a fixed monthly fee. These
set-top boxes enable customers to:
Initially introduced in 2002, TWC currently offers its DVR
product to its digital video subscribers in all of the Legacy
Systems. As of December 31, 2006, 34.0%, or approximately
2.5 million, of TWC’s digital video subscribers also
received a DVR set-top box. Although penetration levels for DVRs
have been lower in the Acquired Systems, TWC believes it has an
opportunity to increase the number of DVR subscribers in the
Acquired Systems. TWC charges an additional monthly fee for DVR
set-top boxes over and above the normal set-top box charge. The
monthly fee for DVR set-top boxes is subject to regulation. See
“— Regulatory Matters” below.
High definition services. TWC generally offers
approximately 15 channels of high definition television, or
HDTV, in each of its systems, mainly consisting of broadcast
signals and standard and premium cable networks, as well as HDTV
Movies-on-Demand
in most of the Legacy Systems. HDTV provides a significantly
clearer picture and improved audio quality. In most instances,
customers who already subscribe to the standard-definition
versions of these services, including in the case of broadcast
stations those customers who receive only Basic service, are not
charged for the high definition version of the channels. TWC
also offers a package of HDTV channels for an additional monthly
fee. Due to a number of factors, during the first quarter of
2007, TWC has experienced, and may continue to experience during
the near term, difficulty in obtaining sufficient quantities of
HDTV-capable set-top boxes to satisfy all consumer requests for
such boxes. For more information, see Item 1A, “Risk
Factors — Risks Related to Dependence on Third
Parties — TWC may not be able to obtain necessary
hardware, software and operational support.”
Interactive services. TWC’s two-way
digital cable infrastructure enables TWC to provide innovative
interactive features and services. Examples of interactive
services that TWC offers or is in the process of trialing or
rolling out include:
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TWC offers residential and commercial high-speed data services
to nearly 99% of its homes passed as of December 31, 2006.
TWC’s high-speed data services provide customers with a
fast, always-on connection to the Internet. Subscribers pay a
monthly flat fee based on the level of service received. Due to
their different characteristics, commercial and bulk subscribers
are charged at different rates from residential subscribers.
The following table presents some statistical data regarding
TWC’s high-speed data services:
High-speed data subscribers connect their personal computers or
other broadband ready devices to TWC’s cable systems using
a cable modem, which TWC provides at no charge or which
subscribers can purchase themselves if they wish. TWC’s
high-speed data service enables subscribers to connect to the
Internet at speeds much greater than traditional
dial-up
telephone modems. In contrast to
dial-up
services, subscribers to TWC’s high-speed data service do
not have to log in to their account each time they wish to
access the service and can remain connected without being
disconnected because of inactivity.
Road Runner. As of December 31, 2006, TWC
offered its Road Runner branded, high-speed data service to
residential subscribers in virtually all of the Legacy Systems
and approximately 80% of the Acquired Systems. TWC was providing
the same high-speed data service provided prior to the
Transactions in the rest of the Acquired Systems on a temporary
basis. TWC expects to transition these pre-existing high-speed
data services to Road Runner before the end of 2007.
TWC’s Road Runner service provides communication tools and
personalized services, including e-mail, PC security, parental
controls, news group, online radio and personal home pages.
Electronic messages can be personalized with photo attachments
or video clips. The Road Runner portal provides access to
content and media from local, national and international
providers and topic-specific channels including games, news,
sports, autos, kids, music, movie listings, and shopping sites.
TWC offers multiple tiers of Road Runner service, each with
different operating characteristics and a different monthly fee.
In recent years, TWC has steadily increased maximum download
speeds in response to competitive factors and TWC anticipates
that it will continue to be able to do so for the foreseeable
future.
Road Runner was a recipient of the SATMetrics award for highest
consumer “likelihood to recommend” in 2006, well ahead
of all other cable providers, digital subscriber line
(“DSL”) providers, and other Internet service
providers (“ISPs”). In addition to Road Runner, most
of TWC’s cable systems provide high-speed access to the
services of certain other on-line providers, including EarthLink.
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Time Warner Cable Business Class. TWC offers
commercial customers a variety of high-speed data services,
including Internet access, website hosting and managed security.
These services are offered to a broad range of businesses and
are marketed under the “Time Warner Cable Business
Class” brand. TWC expects that small to medium-sized
businesses will increasingly find the need to purchase
high-speed data services and intends to pursue opportunities in
this area.
In addition to the residential subscribers and commercial
accounts serviced through TWC’s cable systems, TWC provides
its Road Runner high-speed data service to third parties for a
fee.
Digital Phone. Digital Phone is the newest of
TWC’s core services, having been launched broadly across
the Legacy Systems in 2004. Most of TWC’s customers receive
a Digital Phone package that provides unlimited local, in-state
and U.S., Canada and Puerto Rico long-distance calling and a
number of calling features for a fixed monthly fee. During 2006,
TWC introduced a lower priced unlimited in-state only calling
plan to serve those of its customers that do not use
long-distance services extensively, as well as second line
service. TWC expects to introduce additional calling plans in
the future. TWC’s Digital Phone plans include, among
others, the following calling features:
As of December 31, 2006, Digital Phone had been launched in
all of the Legacy Systems and was available to nearly 94% of the
homes passed in those systems. At that time, TWC had
approximately 1.9 million Digital Phone customers and
penetration of voice service to serviceable homes was
approximately 11%. Since no comparable
IP-based
telephony service was available in the Acquired Systems at the
time of acquisition, the continued introduction of Digital Phone
in the Acquired Systems, separately and as part of a bundle, is
a high priority. As of December 31, 2006, Digital Phone was
available in some of the Acquired Systems on a limited basis.
TWC expects to roll out Digital Phone across the Acquired
Systems during 2007.
As an adjunct to TWC’s existing commercial high-speed data
business, TWC intends to introduce a commercial voice service to
small- to medium-sized businesses in most of the Legacy Systems
during 2007.
Digital Phone is delivered over the same system facilities TWC
uses to provide video and high-speed data services. TWC provides
customers with a voice-enabled cable modem that digitizes voice
signals and routes them as data packets, using IP technology,
over its own managed broadband cable systems. Calls to
destinations outside of TWC’s cable systems are routed to
the traditional public switched telephone network. Unlike
Internet phone providers, such as Vonage and Lingo, which
utilize the Internet to transport telephone calls, TWC’s
Digital Phone service uses only TWC’s own managed network
and the public switched telephone network to route calls. TWC
believes its managed approach to delivery of voice services
allows it to better monitor and maintain call and service
quality.
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TWC has agreements with Verizon Communications, Inc.
(“Verizon”) and Sprint Nextel Corporation
(“Sprint”) under which these companies assist TWC in
providing Digital Phone service by routing voice traffic to the
public switched telephone network, delivering enhanced 911
service and assisting in local number portability and long
distance traffic carriage. In July 2006, TWC agreed to expand
its multi-year relationship with Sprint as its primary provider
of these services, including in the Acquired Systems. See
Item 1A, “Risk Factors — Risks Related to
Dependence on Third Parties — TWC may not be able to
obtain necessary hardware, software and operational
support.”
Circuit-switched Telephone. In the Exchange,
TWC acquired customers in the Comcast Acquired Systems who
receive traditional, circuit-switched local and long distance
telephone services. TWC continues to provide traditional,
circuit-switched services to those subscribers and will continue
to do so for some period of time, while it will simultaneously
market its Digital Phone product to those customers. After some
period of time, TWC intends to discontinue the circuit-switched
offering in accordance with regulatory requirements, at which
time the only voice services provided by TWC in those systems
will be its Digital Phone service.
In addition to selling its services separately, TWC is focused
on marketing differentiated packages of multiple services and
features, or “bundles,” for a single price.
Increasingly, many of TWC’s customers subscribe to two or
three of its services. The bundle represents a discount from the
price of buying the services separately and the convenience of a
single monthly bill. TWC believes that these “Double
Play” and “Triple Play” offerings increase its
customers’ satisfaction with TWC, increase customer
retention and encourage subscription to additional features. In
the Legacy Systems as of December 31, 2006, 46.1% of
TWC’s customers, received at least two services. The table
below sets forth the number of TWC’s “Double
Play” and “Triple Play” customers as of the dates
indicated.
In support of TWC’s bundled services strategy, TWC is
developing features that operate across two or more of its
services. For example, TWC has begun to offer customers who
subscribe to both Time Warner Digital Cable and Digital Phone,
at no charge, a Caller ID on TV feature that displays incoming
call information on the customer’s television set. In July
2006, TWC introduced a new feature called
“PhotoShowTV” in its Oceanic division in Hawaii that
gives customers who subscribe to both Time Warner Digital Cable
and Road Runner high-speed online service the ability to create
and share their personal photo shows with TWC’s other Time
Warner Cable digital video customers using TWC’s VOD
technology.
TWC believes that continued innovation on its advanced cable
infrastructure may create additional business opportunities in
the future. One such opportunity is the offering of
IP-based
telephony service to commercial customers as an adjunct to
TWC’s existing commercial data business. TWC intends to
introduce a commercial voice service to small- to medium-sized
businesses in most of the Legacy Systems during 2007.
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In November 2005, TWC and several other cable companies,
together with Sprint, announced the formation of a joint venture
to develop integrated video entertainment, wireline and wireless
data and communications products and services. In 2006, TWC
began offering a service bundle that includes Sprint wireless
voice service in limited operating areas and will continue to
roll out this product during 2007. The package contains some
wireline/wireless integration, such as a common voice mail-box
for both the home and wireless phone. See Item 1A,
“Risk Factors — Risks Related to
Competition — TWC’s competitive position could
suffer if TWC is unable to develop a compelling wireless
offering.”
A separate joint venture formed by the same parties participated
in the Federal Communication Commission (the “FCC”)
Auction 66 for Advanced Wireless Spectrum (“AWS”), and
was the winning bidder of 137 licenses. These licenses cover
20 MHz of AWS in about 90% of the continental United States
and Hawaii. The FCC awarded these licenses to the venture on
November 29, 2006. There can be no assurance that the
venture will successfully develop mobile and related services.
Under the joint venture agreement, Sprint has the ability to
exit the venture upon 60 days’ notice and to require
that the venture purchase its interests for an amount equal to
Sprint’s capital contributions to that point. In addition,
under certain circumstances, the cable operators that are
members of the venture have the ability to exit the venture and
receive, subject to certain limitations and adjustments, AWS
licenses covering their operating areas.
TWC sells advertising time to a variety of national, regional
and local businesses. As part of the agreements under which TWC
acquires video programming, TWC typically receives an allocation
of scheduled advertising time in such programming, generally two
minutes per hour, into which its systems can insert commercials,
subject to limitations regarding subject matter. The clustering
of TWC’s systems expands the share of viewers that TWC
reaches within a local designated market area, which helps
TWC’s local advertising sales personnel to compete more
effectively with broadcast and other media. Following the
Transactions, TWC now has a strong presence in the
country’s two largest advertising markets, New York, New
York, and Los Angeles, California.
In addition, in many locations, contiguous cable system
operators have formed advertising “interconnects” to
deliver locally inserted commercials across wider geographic
areas, replicating the reach of the broadcast stations as much
as possible. As of December 31, 2006, TWC participated in
local advertising interconnects in 23 markets, including three
markets covered by the Acquired Systems. TWC’s local cable
news channels also provide TWC with opportunities to generate
advertising revenue.
TWC is exploring various means by which it could utilize its
advanced services, such as VOD and interactive TV to increase
advertising revenues. For example, in 2006 TWC launched Movie
Trailers on-Demand, an ad-supported VOD channel which provides
advertisers a way to reach customers as they are browsing movie
previews; DriverTV, an ad-supported VOD channel which provides
advertisers a way to reach customers interested in learning
about new cars; and Expo TV, an ad-supported VOD channel which
provides advertisers a way to reach customers interested in
viewing infomercial and local advertising. With TWC’s
interactive TV technology, TWC now offers advertisers new tools.
For example, in upstate New York, TWC provides overlays that
enable customers to request information, to
“telescope” from a traditional advertisement to a long
form VOD segment regarding the advertised product, to vote
on a hot topic or receive more specific additional information.
These tools can be used to provide advertisers with important
feedback about the impact of their advertising efforts.
TWC seeks to deepen its relationships with existing customers,
thereby increasing the amount of revenue it obtains from each
home it serves and increasing customer retention, as well as to
attract new customers. TWC’s marketing is focused on
conveying the benefits of its services — in
particular, the way its services can enhance and simplify
customers’ lives — to these target groups.
TWC’s marketing strategy focuses on bundles of video, data
and voice services, including premium services, offered in
differentiated but easy to understand packages. These bundles
provide discounted pricing as compared with the aggregate prices
for the services provided if they were purchased separately, in
addition to the convenience of a single bill. TWC generally
markets bundles with entry
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level pricing, which provide its customer care representatives
the opportunity to offer additional services or upgraded levels
of existing services that are relevant to targeted customer
groups.
To support these efforts, TWC utilizes its brand and the brand
statement, The Power of
Youtm,
in conjunction with a variety of integrated marketing,
promotional and sales campaigns and techniques. TWC’s
advertising is intended to let its diverse base of subscribers
and prospects know that it is a customer-centric
company — one that empowers customers by providing
maximum choice, convenience and value — and that TWC
is committed to exceeding expectations through innovative
product offerings and superior customer service. TWC’s
message is supported across broadcast, its own cable systems,
print, radio and other outlets including outdoor advertising,
direct mail,
e-mail,
on-line advertising, local grassroots efforts and
non-traditional media.
TWC also employs a wide range of direct channels to reach its
customers, including outbound telemarketing and
door-to-door
sales. In addition, TWC uses customer care channels and inbound
call centers to increase awareness of its products and services
offered. Creative promotional offers are also a key part of
TWC’s strategy, and an area where TWC works with third
parties such as consumer electronics manufacturers and cable
programmers. TWC also is developing new sales channels through
agreements with local and national retail stores, where
TWC’s satellite competitors have a strong presence.
TWC has been developing and implementing a number of
technology-based tools and capabilities. These initiatives
include the development of customized data storage and flexible
access tools. This infrastructure will ensure that critical
customer information is in the hands of customer service
representatives as they interact with customers and prospects
and on an aggregate basis to help TWC develop marketing programs.
Each of TWC’s local operations has a marketing and sales
function responsible for selecting the relevant marketing
communications, pricing and promotional offers for the products
and services being sold and the consumer segments being
targeted. The marketing and sales strategy is developed in
coordination with its regional and corporate marketing teams,
with execution by the local operating division.
TWC also maintains a sales presence in a number of retail
locations across the markets it serves. This retail presence
enables both new and existing customers to learn more about TWC,
and purchase its products and services. TWC maintains dedicated
customer service centers that allow for the resolution of
billing and service issues as well as facilitate the sale of new
products and services. TWC’s centers are located in its
local administrative offices or operations centers, independent
facilities or kiosks or booths within larger retail
establishments, such as shopping malls.
TWC believes that superior customer care can help increase
customer satisfaction, promote customer loyalty and lasting
customer relationships, and increase the penetration of its
services. TWC is committed to putting its customers at the
center of everything it does and is making significant
investments in technology and people to support this commitment.
TWC’s customer call centers use a range of software and
systems to try to ensure the most efficient and effective
customer care possible. For instance, many of TWC’s
customer call centers utilize workforce and call flow management
systems to route the millions of calls it receives each month to
available representatives and to maximize existing resources.
Customer representatives have access to desktop tools to provide
the information TWC’s customers need, reducing call
handling time. These desktop tools provide the representative
with timely, valuable information regarding the customer then
calling (e.g., notifying the representative if the customer has
called previously on the same issue or helping to identify a new
service in which the customer might be interested). TWC uses
quality assurance software that monitors both the
representative’s customer interactions and the desktop
tools the representative selects during each call.
Many of TWC’s divisions are utilizing interactive voice
recognition systems and on-line customer care systems to allow
customers to obtain information they require without the need to
speak with a customer care representative. Most customers who
wish or need to speak with a representative will talk to a
locally-based representative, which enables TWC to respond to
local customer needs and preferences. However, some specialized
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care functions, such as advanced technical support for
TWC’s high-speed data service, are handled regionally or
nationally.
In order to enhance customer convenience and satisfaction, TWC
has implemented a number of customer care initiatives. Depending
on location, these may include:
TWC also provides “Answers on Demand,” which allows
customers to select discrete help topics from a menu and then
view interactive videos that answer their questions. Customers
can access Answers on Demand either on-line or on their
television set (using TWC’s VOD technology).
TWC’s cable systems employ a flexible and extensible
network architecture known as “hybrid fiber coax,” or
“HFC.” TWC transmits signals on these systems via
laser-fed fiber optic cable from origination points known as
“headends” and “hubs” to a group of
distribution “nodes,” and use coaxial cable to deliver
these signals from the individual nodes to the homes they serve.
TWC pioneered this architecture and received an Emmy award in
1994 for its HFC development efforts. HFC architecture allows
the delivery of two-way video and broadband transmissions, which
is essential to providing advanced video services, like VOD,
Road Runner high-speed data services and Digital Phone.
HFC architecture is the cornerstone technology in TWC’s
digital cable systems. HFC architecture provides TWC with
numerous benefits, including the following:
As of December 31, 2006, almost all of the homes passed in
the Legacy Systems and, according to TWC’s estimates,
approximately 94% of the homes passed in the Acquired Systems
were served by plant that had been upgraded to provide at least
750MHz of capacity. Carriage of analog programming
(approximately 70 channels per system) uses about two thirds of
a typical system’s capacity leaving capacity for digital
video, high-speed data and voice products. Digital signals,
including video, high-speed data and voice signals, can be
carried more efficiently than analog signals. Generally 10 to 12
digital channels or their equivalent can be broadcast using the
same amount of capacity required to broadcast just one analog
channel. TWC is in the process of upgrading the plant in the
Acquired Systems to TWC’s Legacy Systems’ standards.
TWC believes that its network architecture is sufficiently
flexible and extensible to support TWC’s current
requirements. However, in order for TWC to continue to innovate
and deliver new services to its customers, as well as meet
competitive imperatives, TWC anticipates that it will need to
increase the amount of usable bandwidth available to TWC in most
of its systems over the next few years. TWC believes that this
can be achieved largely
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through the maximization and careful management of its
systems’ existing bandwidth, without costly upgrades. For
example, to accommodate increasing numbers of HDTV channels and
other demands for greater capacity in TWC’s network, in
certain areas TWC has begun deployment of a technology known as
switched digital video (“SDV”). SDV ensures that only
those channels that are being watched within a given grouping of
households are being transmitted to those households. Since it
is generally the case that not all channels are being watched at
all times by a given group of households, this frees up capacity
that can then be made available for other uses. This expansion
of network capacity does not rely on extensive upgrade
construction. Instead, TWC invests in switching equipment in its
headends and hubs and, as necessary, segments its plant to
ensure that switches and lasers are shared among fewer
households. As a result of this process, capacity is made
available for new services, including HDTV channels.
In most systems, TWC delivers its services via laser-fed fiber
optic cable from the headend, either directly or via a hub, to a
group of nodes, and uses coaxial cable to deliver these signals
and services from individual nodes to the homes they serve. A
typical hub provides service to approximately 20,000 homes, and
TWC’s average node provides service to approximately 500
homes.
National and regional video services are generally delivered to
TWC through satellites that are owned or leased by the relevant
programmer. These services’ signals are transmitted to
downlink facilities located at TWC’s headends. Local video
signals, including local broadcast signals, are picked up by
antennae or are delivered to TWC’s headends via fiber
connection. VOD content is received using a variety of these
methods and generally stored on servers located at each
system’s headend.
TWC delivers high-speed data services to its subscribers through
its HFC network, its regional fiber networks that are either
owned by TWC or leased from third parties, including, in some
instances, AOL LLC (formerly America Online, Inc.,
“AOL”), a subsidiary of Time Warner, and through
backbone networks that provide connectivity to the Internet and
are operated by third parties, including AOL. TWC pays fees for
leased circuits based on the amount of capacity used and pays
for Internet connectivity based either on a fixed fee for a
specified amount of available capacity or on the amount of data
traffic received from and sent over the provider’s backbone
network. TWC provides all major high-speed data customer service
applications and monitors its IP network, through its operation
of two national data centers, eight regional data centers and
two network operations centers, including one acquired in the
Adelphia Acquisition.
TWC delivers Digital Phone voice services to its customers over
the same system facilities used to provide video and high-speed
data services. TWC provides Digital Phone customers with a
voice-enabled cable modem that digitizes voice signals and
routes them as data packets, using “Internet
protocol,” a common standard for the packaging of data for
transmission, over the cable system to one of TWC’s
regional data centers. At the regional data center, a
“softswitch” routes the data packets as appropriate
based on the call’s destination. Calls destined for end
users outside of TWC’s network are routed through devices
called “session border controllers” in the session
initiation protocol format and delivered to TWC’s wholesale
service providers. Such calls are then routed to a traditional
public telephone switch, operated by one of TWC’s wholesale
service providers, and then to their final destination (e.g., a
residential or business end-user, a 911 dispatcher, or an
operator). Calls placed outside of TWC’s network and
intended for TWC’s subscribers follow a reverse route.
Calls entirely within TWC’s network are generally routed by
the softswitch to the appropriate end user without the use of a
traditional public telephone switch.
TWC’s Basic and Standard tier subscribers generally do not
require a set-top box to view their video services. However,
because TWC’s digital signals and signals for premium
programming are secured, TWC’s digital video customers
receiving one-way (i.e., non-interactive) programming, such as
premium channels and digital cable networks, can only receive
such channels if they have a digital set-top box or if they have
a “digital cable ready” television or similar device
equipped with a CableCARD (discussed below). Customers receiving
TWC’s two-way video services, such as VOD and TWC’s
interactive program guide, must have a digital set-top box that
TWC
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provides to receive these services. Each of TWC’s cable
systems uses one of only two “conditional access”
systems to secure signals from unauthorized receipt, the
intellectual property rights to which are controlled by set-top
box manufacturers. In part as a result of the proprietary nature
of these conditional access schemes, TWC currently purchases
set-top boxes from a limited number of suppliers. For more
information, see Item 1A, “Risk Factors — Risks
Related to Dependence on Third Parties — TWC may not
be able to obtain necessary hardware, software and operational
support.” The cable industry has recently entered into
agreements with certain consumer electronics manufacturers under
which they will shortly complete development of a limited number
of “interactive digital cable ready” televisions
(i.e., sets capable of utilizing its two-way services without
the need for a set-top box). TWC has begun ordering some set-top
boxes from some of these manufacturers as well. TWC’s
purchasing agreements generally provide TWC with “most
favored nation” treatment under which the suppliers must
offer TWC favorable price terms, subject to some limitations.
Historically, TWC has also relied primarily on set-top box
suppliers to create the applications and interfaces TWC makes
available to its customers. Although TWC believes that its
current applications and interfaces are compelling to customers,
the lack of compatibility among set-top box operating systems
has in the past hindered applications development. This is
beginning to change somewhat, as third parties have begun to
develop interactive applications, such as gaming and polling
applications, notwithstanding the lack of common platform among
set-top box schemes. Over the last few years, TWC has been
developing its own interactive program guide and user interface,
which TWC began to deploy during 2006.
As described below under “— Set-top
Box Developments,” as current technological and
compatibility issues for set-top box applications are resolved
and a common platform for set-top box applications emerges, TWC
expects that applications developers will devote more time and
resources to the creation of innovative digital platform
products, which should enable TWC to offer new features to its
subscribers in the future.
There have been a number of market and regulatory developments
in recent years that may impact the costs and benefits to TWC of
providing customers with set-top boxes.
“Plug and play.” In December 2002,
cable operators and consumer-electronics companies entered into
a standard-setting agreement, known as the “plug and play
agreement,” relating to interoperability between cable
systems and reception equipment. The FCC promulgated rules to
implement the agreement, under which cable systems with
activated spectrum of 750MHz or higher must, among other things,
support “digital cable ready” consumer electronic
devices (e.g., televisions) equipped with a slot for a
CableCARD. The CableCARD performs certain security functions
normally handled by the kinds of set-top boxes TWC leases to
customers. By inserting a cable-operator provided CableCARD into
this slot, the device is able to tune and receive encrypted (or
“scrambled”) digital signals without the need for a
separate set-top box.
The plug and play agreement and the FCC rules address only
“unidirectional” devices (i.e., devices capable of
utilizing only cable operators’ one-way transmission
services) and not devices capable of carrying two-way services,
such as interactive program guides and VOD. As a result, those
of TWC’s customers who use a CableCARD equipped television
set, and who do not have a set-top box, cannot access these
advanced services. If a significant number of TWC’s
subscribers decline set-top boxes in favor of one-way devices
purchased at retail, it could have an adverse effect on
TWC’s business. For more information, see Item 1A,
“Risk Factors — Risks Related to Dependence on
Third Parties — The adoption of, or the failure to
adopt, certain consumer electronics devices may negatively
impact TWC’s offerings of new and enhanced services.”
Cable operators, consumer-electronics companies and other market
participants have been holding discussions that may lead to a
similar set of interoperability agreements covering digital
devices capable of carrying cable operators’ two-way,
interactive products and services. Although efforts to reach an
inter-industry agreement on two-way interoperability standards
have not yielded results, as noted above, certain consumer
electronics manufacturers have entered into direct agreements
with the cable industry under which they will shortly complete
development of a limited number of two-way capable television
sets.
If two-way interoperability standards can be agreed upon, or if
other efforts to enable consumer electronics devices to securely
receive and utilize TWC’s two-way services are successful,
TWC’s business could be benefited.
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First, consumer electronic companies could manufacture set-top
boxes without the need to license TWC’s current
suppliers’ conditional access technology, which could lead
to greater competition and innovation. Second, if customers
widely adopted such devices sold at retail, it would likely
reduce TWC’s set-top box capital expenditures and the need
for installation appointments in homes already wired for cable.
However, TWC could suffer a decline in set-top box revenues.
Furthermore, in the long term, as interoperability for two-way
devices evolves, consumer electronics companies may be more
willing to develop products that make enhanced use of digital
cable’s capabilities, expanding the range of services TWC
could offer.
Under another set of FCC regulations, which are scheduled to go
into effect on July 1, 2007, cable operators must cease
placing into service new set-top boxes with security functions
built into the box. In other words, beginning on that date, new
set-top boxes deployed by cable operators will be required to
utilize a CableCARD or similar means of separating security
functions from other set-top box functions. See
“— Regulatory Matters — Communications
Act and FCC Regulation — Other regulatory requirements
of the Communications Act and the FCC” below. The provision
of set-top boxes that accept a CableCARD, or similar separate
security device, will significantly increase
per-unit
set-top box costs as compared with the set-top boxes TWC
currently buys, which utilize integrated security. See
Item 1A, “Risk Factors—Risks Related to
Government Regulation — The FCC’s set-top box
rules could impose significant additional costs on TWC.”
The FCC has also ordered the cable industry to investigate and
report on the possibility of implementing a downloadable
security system that would be accessible to all set-top devices.
If the implementation of such a system proves technologically
feasible, this may eliminate the need for consumers to lease
separate conditional-access security devices.
Open cable application platform. CableLabs, a
nonprofit research and development consortium founded by members
of the cable industry, has put forward a set of hardware and
software specifications known as OpenCable, which represent an
effort to achieve compatibility across cable network interfaces.
The OpenCable software specification, which is known as
“open cable application platform,” or
“OCAP,” is intended to create a common platform for
set-top box applications regardless of what operating system the
box uses. The OpenCable specification is consistent with the
CableCARD specification promulgated under the FCC’s plug
and play rules and the encryption technology that allows the
CableCARD to securely communicate with the host device. If
widely adopted, OCAP could spur innovation in applications for
set-top boxes and cable-ready consumer electronics devices.
Furthermore, the availability of multi-platform set-top box
applications should, together with the move toward separable
conditional access systems, help to make set-top boxes more
fungible, resulting in increased competition among manufacturers.
TWC believes that offering a wide variety of programming is an
important factor influencing a subscriber’s decision to
subscribe to and retain TWC’s video services. TWC devotes
considerable resources to obtaining access to a wide range of
programming that it believes will appeal to both existing and
potential subscribers.
Cable television networks. The terms and
conditions of carriage of cable programming services are
generally established through written affiliation agreements
between programmers, including affiliates of Time Warner, and
TWC. Most cable programming services are available to TWC for a
fixed monthly per subscriber fee, which sometimes includes a
volume discount pricing structure. However, payments to the
providers of some premium channels, may be based on a percentage
of TWC’s gross receipts from subscriptions to the channels.
For home shopping channels, TWC does not pay and generally
receives a percentage of the amount spent on home shopping
purchases that is attributable to TWC’s subscribers and in
some instances receive minimum guarantees.
TWC’s programming contracts usually continue for a fixed
period of time, generally from three to seven years. TWC
believes that its ability to provide compelling programming
packages is best served when TWC has maximum flexibility to
determine on which systems and tiers a programming service will
be carried. Sometimes, TWC’s flexibility is limited by the
affiliation agreement. It is often necessary to agree to carry a
particular programming service in certain of TWC’s cable
systems
and/or carry
the service on a specific tier. In some cases, it is necessary
for TWC to agree to distribute a programming service to a
minimum number of subscribers or to a minimum percentage of its
subscribers.
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Broadcast television signals. Generally, TWC
carries all local full power analog broadcast stations serving
the areas in which TWC provides cable service. In most areas,
TWC also carries the digital broadcast signals of a number of
these stations. In some cases, TWC carries these stations under
the FCC “must-carry” rules. In other cases, TWC must
negotiate with the stations’ owners for the right to
retransmit these stations’ signals. For more information,
see “— Regulatory Matters” below. Currently,
TWC has multi-year retransmission consent agreements in place
with most of the retransmission consent stations it carries. In
other cases, TWC is carrying stations under short-term
arrangements while it negotiates new long-term agreements.
Pay-Per-View
and On-Demand content. Generally, TWC obtains
rights to carry movies on an on-demand basis, as well as
Pay-Per-View
events, through iN Demand, a company in which TWC holds a
minority interest. iN Demand negotiates with motion picture
studios to obtain the relevant distribution rights. In some
instances, TWC has contracted directly with the motion picture
studios for the rights to carry their movies on an on-demand
basis.
Movies-on-Demand
content is generally provided to TWC under a revenue-sharing
arrangement, although in some cases there are minimum guaranteed
payments required.
TWC’s ability to get access to current hit films in a
timely fashion is hampered to some extent by the traditional
sequence of Hollywood’s distribution “windows.”
Typically, after theatrical release, films are made available to
home video distributors on an exclusive basis for a set period
of time, currently about 45 days. It is only after home
video has enjoyed its exclusive window that
Movies-on-Demand
and
Pay-Per-View
distributors can gain access to the content. It is possible that
subscriber purchases of
Movies-on-Demand
would increase if TWC was able to provide hit films during the
home video window. However, despite efforts to do so, TWC has
been unable to obtain the right to offer current hit films
during this window.
In line with TWC’s goal of offering a wide variety of
programming that will appeal to both existing and potential
subscribers, TWC is trying to maximize the quantity and quality
of all of its video offerings, especially its VOD offerings. As
additional VOD content becomes available TWC evaluates it to
determine if it meets TWC’s standards and to the extent it
does, TWC begins offering it to TWC’s digital subscribers.
TWC obtains SVOD and other “free on-demand” content
directly from the relevant content providers.
Set-top boxes. TWC purchases set-top boxes,
and CableCARDs (which enable some digital televisions and other
devices to receive certain non-interactive digital services
without a set-top box) from a limited number of suppliers. TWC
leases these devices to subscribers at monthly rates. TWC’s
video equipment fees are regulated. Under FCC rules, cable
operators are allowed to set equipment rates for set-top boxes,
CableCARDs and remote controls on the basis of actual capital
costs, plus an annual after-tax rate of return of 11.25%, on the
capital cost (net of depreciation). This rate of return allows
TWC to economically provide sophisticated customer premises
equipment to subscribers. Certain FCC regulations relating to
set-top box equipment, slated to come into effect in 2007, are
expected to increase TWC’s set-top box costs. See
“— Technology — Set-top Boxes”
above and “— Regulatory Matters” below.
TWC faces intense competition from a variety of alternative
information and entertainment delivery sources, principally from
direct-to-home
satellite video providers and certain regional telephone
companies, each of which offers or will shortly be able to offer
a broad range of services through increasingly varied
technologies. In addition, technological advances will likely
increase the number of alternatives available to TWC’s
customers from other providers and intensify the competitive
environment. See Item 1A, “Risk Factors —
Risks Related to Competition.”
Direct broadcast satellite. TWC’s video
services face competition from direct broadcast satellite
services, such as the Dish Network and DirecTV. DirecTV and Dish
Network offer satellite-delivered pre-packaged programming
services that can be received by relatively small and
inexpensive receiving dishes. The video services provided by
these satellite providers are comparable, in many respects, to
TWC’s analog and digital video services, and direct
broadcast satellite subscribers can obtain satellite receivers
with integrated digital video recorders from those providers as
well. Both major direct broadcast satellite providers have
entered into co-
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marketing arrangements with regional telephone companies that
allow these telephone companies to offer customers a bundle of
video, telephone and DSL services, which competes with
TWC’s “Triple Play” of video, high-speed data and
Digital Phone services.
Incumbent local telephone
companies. TWC’s high-speed data and Digital
Phone services face competition from the DSL and traditional
phone offerings of incumbent local telephone companies in most
TWC operating areas. In some cases, DSL providers have partnered
with ISPs such as AOL, which may enhance DSL’s competitive
position. In addition, some incumbent local telephone companies,
such as AT&T Inc. (“AT&T”) and Verizon, have
undertaken fiber-optic upgrades of their networks. The
technologies they are using, such as
fiber-to-the-node
(“FTTN”) and
fiber-to-the-home
(“FTTH”), are capable of carrying two-way video,
high-speed data with substantial bandwidth and
IP-based
telephony services, each of which is similar to the comparable
services TWC offers. These networks allow for the marketing of
service bundles of video, data and voice services and these
companies also have the ability to include wireless services
provided by owned or affiliated companies in bundles that they
may offer.
Cable overbuilds. TWC operates its cable
systems under non-exclusive franchises granted by state or local
authorities. The existence of more than one cable system,
including municipality-owned systems, operating in the same
territory is referred to as an “overbuild.” In some of
TWC’s operating areas, other operators have overbuilt
TWC’s systems
and/or offer
video, data and voice services in competition with TWC.
Satellite Master Antenna Television
(“SMATV”). Additional competition comes
from private cable television systems servicing condominiums,
apartment complexes and certain other multiple dwelling units,
often on an exclusive basis, with local broadcast signals and
many of the same satellite-delivered program services offered by
franchised cable systems. Some SMATV operators now offer voice
and high-speed data services as well.
Wireless Cable/Multi-channel Microwave Distribution Services
(“MMDS”). TWC faces competition from
wireless cable operators, including digital wireless operators,
who use terrestrial microwave technology to distribute video
programming and some of which now offer voice and high-speed
data services.
Aside from competing with the video, data and voice services
offered by direct broadcast satellite providers, local incumbent
telephone companies, cable overbuilders and some SMATVs and
MMDSs, each of TWC’s services also faces competition from
other companies that provide services on a stand-alone basis.
Video competition. TWC’s video services
face competition on a stand-alone basis from a number of
different sources, including:
TWC’s VOD services compete with online movie services,
which are delivered over broadband Internet connections, and
with video stores and home video products.
“Online” competition. TWC’s
high-speed data services face or may face competition from a
variety of companies that offer other forms of online services,
including low cost
dial-up
services over ordinary telephone lines, and developing
technologies, such as Internet service via power lines,
satellite and various wireless services (e.g., Wi-Fi), including
those of local municipalities.
Digital Phone competition. TWC’s Digital
Phone service also competes with wireless phone providers and
national providers of Internet-based phone products such as
Vonage. The increase in the number of different technologies
capable of carrying voice services has intensified the
competitive environment in which TWC’s Digital Phone
service operates.
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Additional competition. In addition to
multi-channel video providers, cable systems compete with all
other sources of news, information and entertainment, including
over-the-air
television broadcast reception, live events, movie theaters and
the Internet. In general, TWC also faces competition from other
media for advertising dollars. To the extent that TWC’s
products and services converge with theirs, TWC competes with
the manufacturers of consumer electronics products. For
instance, TWC’s digital video recorders compete with
similar devices manufactured by consumer electronics companies.
Franchise process. Under the Cable Television
Consumer Protection and Competition Act of 1992, franchising
authorities are prohibited from unreasonably refusing to award
additional franchises. In December 2006, the FCC adopted an
order intended to make it easier for competitors to obtain
franchises, by defining when the actions of county- and
municipal-level franchising authorities will be deemed to be
unreasonable as part of the franchising process. The order,
among other things, establishes deadlines for franchising
authorities to act on competitive franchise applications;
prohibits franchising authorities from placing unreasonable
build-out demands on competitive applicants; and prohibits
franchising authorities from requiring competitive applicants to
undertake certain obligations concerning the provision of
public, educational, and governmental access programming.
Furthermore, legislation supported by regional telephone
companies has been proposed at the state and federal level and
enacted in a number of states to allow these companies to enter
the video distribution business without obtaining local
franchise approval and often on substantially more favorable
terms than those afforded TWC and other existing cable
operators. Legislation of this kind has been enacted in
California, New Jersey, North Carolina, South Carolina and
Texas. See Item 1A, “Risk Factors — Risks
Related to Government Regulation.”
As of February 1, 2007, TWC had approximately 43,000
employees, including approximately 1,700 part-time
employees. Approximately 5.0% of TWC’s employees are
represented by labor unions. TWC considers its relations with
its employees to be good.
Regulatory
Matters
TWC’s business is subject, in part, to regulation by the
FCC and by most local and some state governments where TWC has
cable systems. In addition, TWC’s business is operated
subject to compliance with the terms of the Memorandum Opinion
and Order issued by the FCC in July 2006 in connection with the
regulatory clearance of the Transactions (the
“Adelphia/Comcast Transactions Order”). In addition,
various legislative and regulatory proposals under consideration
from time to time by the United States Congress
(“Congress”) and various federal agencies have in the
past materially affected TWC and may do so in the future.
The following is a summary of the terms of the Adelphia/Comcast
Transactions Order as well as current significant federal, state
and local laws and regulations affecting the growth and
operation of TWC’s businesses. The summary of the
Adelphia/Comcast Transactions Order herein does not purport to
be complete and is subject to, and is qualified in its entirety
by reference to, the provisions of the Adelphia/Comcast
Transactions Order.
In the Adelphia/Comcast Transactions Order, the FCC imposed
conditions on TWC related to regional sports networks
(“RSNs”), as defined in the Adelphia/Comcast
Transactions Order, and the resolution of disputes pursuant to
the FCC’s leased access regulations. In particular, the
Adelphia/Comcast Transactions Order provides that:
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The application and scope of these conditions, which will expire
in July 2012, have not yet been tested. TWC retains the right to
obtain FCC and judicial review of any arbitration awards made
pursuant to these conditions.
Communications
Act and FCC Regulation
The Communications Act of 1934, as amended (the
“Communications Act”) and the regulations and policies
of the FCC affect significant aspects of TWC’s cable system
operations, including video subscriber rates; carriage of
broadcast television stations, as well as the way TWC sells its
program packages to subscribers; the use of cable systems by
franchising authorities and other third parties; cable system
ownership; offering of voice and high-speed data services; and
use of utility poles and conduits.
“Net neutrality” legislative and regulatory
proposals. In the
2005-2006
Congressional term, several “net neutrality”-type
provisions were introduced as part of broader Communications Act
reform legislation. These provisions would have limited to a
greater or lesser extent the ability of broadband providers to
adopt pricing models and network management policies that would
differentiate based on different uses of the Internet. None of
these provisions was adopted. Similar legislation has been
introduced in the current Congressional term.
In September 2005, the FCC issued a non-binding policy statement
regarding net neutrality (the “Net Neutrality Policy
Statement”). The FCC indicated that the statement was
intended to offer “guidance and insight” into its
approach to the Internet and broadband related issues. The
principles contained in the statement set forth the FCC’s
view that consumers are entitled to access and use the lawful
Internet content and applications of their choice, to connect
lawful devices of their choosing that do not harm the broadband
provider’s network and are entitled to competition among
network, application, service and content providers. The FCC
statement also noted that these principles are subject to
“reasonable network management.” Subsequently, the FCC
has made these principles binding as to certain
telecommunications companies in orders adopted in connection
with mergers undertaken by those companies. To date, the FCC has
declined to adopt any such regulations that would be applicable
to TWC.
Several parties are seeking to persuade the FCC to adopt net
neutrality-type regulations in a number of proceedings that are
currently pending before the agency. These include pending FCC
rulemakings regarding
IP-enabled
services and broadband Internet access services.
TWC is unable to predict the likelihood that legislative or
additional regulatory proposals regarding net neutrality will be
adopted. For a discussion of “net neutrality” and the
impact such proposals could have on TWC if adopted, see the
discussion in Item 1A, “Risk Factors — Risks
Related to Government Regulation — “Net
neutrality” legislation or regulation could limit
TWC’s ability to operate its high-speed data business
profitably, to manage its broadband facilities efficiently and
to make upgrades to those facilities sufficient to respond to
growing bandwidth usage by its high-speed data customers.”
Subscriber rates. The Communications Act and
the FCC’s rules regulate rates for basic cable service and
equipment in communities that are not subject to “effective
competition,” as defined by federal law. Where there is no
effective competition, federal law authorizes franchising
authorities to regulate the monthly rates charged by the
operator for the minimum level of video programming service,
referred to as basic service, which generally includes local
broadcast channels and public access or educational and
government channels required by the franchise. This kind of
regulation also applies to the installation, sale and lease of
equipment used by subscribers to receive basic service, such as
set-top boxes and remote control units. In many localities, TWC
is no longer subject to this rate regulation, either because the
local franchising authority has not become certified by the FCC
to regulate these rates or because the FCC has found that there
is effective competition.
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Carriage of broadcast television stations and other
programming regulation. The Communications Act
and the FCC’s regulations contain broadcast signal carriage
requirements that allow local commercial television broadcast
stations to elect once every three years to require a cable
system to carry their stations, subject to some exceptions, or
to negotiate with cable systems the terms by which the cable
systems may carry their stations, commonly called
“retransmission consent.” The most recent election by
broadcasters became effective on January 1, 2006.
The Communications Act and the FCC’s regulations require a
cable operator to devote up to one-third of its activated
channel capacity for the mandatory carriage of local commercial
television stations. The Communications Act and the FCC’s
regulations give local non-commercial television stations
mandatory carriage rights, but non-commercial stations do not
have the option to negotiate retransmission consent for the
carriage of their signals by cable systems. Additionally, cable
systems must obtain retransmission consent for all
“distant” commercial television stations (i.e., those
television stations outside the designated market area to which
a community is assigned) except for commercial
satellite-delivered independent “superstations” and
some low-power television stations.
FCC regulations require TWC to carry the signals of both
commercial and non-commercial local digital-only broadcast
stations and the digital signals of local broadcast stations
that return their analog spectrum to the government and convert
to a digital broadcast format. The FCC’s rules give
digital-only broadcast stations discretion to elect whether the
operator will carry the station’s primary signal in a
digital or converted analog format, and the rules also permit
broadcasters with both analog and digital signals to tie the
carriage of their digital signals to the carriage of their
analog signals as a retransmission consent condition.
The Communications Act also permits franchising authorities to
negotiate with cable operators for channels for public,
educational and governmental access programming. It also
requires a cable system with 36 or more activated channels to
designate a significant portion of its channel capacity for
commercial leased access by third parties to provide programming
that may compete with services offered by the cable operator.
The FCC regulates various aspects of such third party commercial
use of channel capacity on TWC’s cable systems, including
the rates and some terms and conditions of the commercial use.
In connection with certain changes in TWC’s programming
line-up, the
Communications Act and FCC regulations also require TWC to give
various kinds of advance notice. Under certain circumstances,
TWC must give as much as 30 days’ advance notice to
subscribers, programmers and franchising authorities. Under
certain circumstances, notice may have to be given in the form
of bill inserts, on-screen announcements
and/or
newspaper advertisements. Giving notice can be expensive and,
given long lead times, may limit TWC’s ability to implement
programming changes quickly. Direct broadcast satellite
operators and other non-cable programming distributors are not
subject to analogous duties.
High-speed Internet access. From time to time,
industry groups, telephone companies and ISPs have sought local,
state and federal regulations that would require cable operators
to sell capacity on their systems to ISPs under a common carrier
regulatory scheme. Cable operators have successfully challenged
regulations requiring this “forced access,” although
courts that have considered these cases have employed varying
legal rationales in rejecting these regulations.
In 2002, the FCC released an order in which it determined that
cable-modem service constitutes an “information
service” rather than a “cable service” or a
“telecommunications service,” as those terms are used
in the Communications Act. That determination was sustained by
the U.S. Supreme Court. According to the FCC, an
“information service” classification may permit but
does not require it to impose “multiple ISP”
requirements. In 2002, the FCC initiated a rulemaking proceeding
to consider whether it may and should do so and whether local
franchising authorities should be permitted to do so. As of
February 1, 2007, this rulemaking proceeding was still
pending. As noted above, in 2005, the FCC adopted a Net
Neutrality Policy Statement intended to offer guidance on its
approach to the Internet and broadband access. Among other
things, the Policy Statement stated that consumers are entitled
to competition among network, service and content providers, and
to access the lawful content and services of their choice,
subject to the needs of law enforcement. The FCC may in the
future adopt specific regulations to implement the Policy
Statement.
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Ownership limitations. There are various rules
prohibiting joint ownership of cable systems and other kinds of
communications facilities. Local telephone companies generally
may not acquire more than a small equity interest in an existing
cable system in the telephone company’s service area, and
cable operators generally may not acquire more than a small
equity interest in a local telephone company providing service
within the cable operator’s franchise area. In addition,
cable operators may not have more than a small interest in MMDS
facilities or SMATV systems in their service areas. Finally, the
FCC has been exploring whether it should prohibit cable
operators from holding ownership interests in satellite
operators.
The Communications Act also required the FCC to adopt
“reasonable limits” on the number of subscribers a
cable operator may reach through systems in which it holds an
ownership interest. In September 1993, the FCC adopted a rule
that was later amended to prohibit any cable operator from
serving more than 30% of all cable, satellite and other
multi-channel subscribers nationwide. The Communications Act
also required the FCC to adopt “reasonable limits” on
the number of channels that cable operators may fill with
programming services in which they hold an ownership interest.
In September 1993, the FCC imposed a limit of 40% of a cable
operator’s first 75 activated channels. In March 2001, a
federal appeals court struck down both limits and remanded the
issue to the FCC for further review. The FCC initiated a
rulemaking in 2001 to consider adopting a new horizontal
ownership limit and announced a follow-on proceeding to consider
the issue anew. As of February 1, 2007, the FCC was
continuing to explore whether it should re-impose any limits.
TWC believes that it is unlikely that the FCC will adopt limits
more stringent than those struck down.
Pole attachment regulation. The Communications
Act requires that utilities provide cable systems and
telecommunications carriers with nondiscriminatory access to any
pole, conduit or
right-of-way
controlled by investor-owned utilities. The Communications Act
also requires the FCC to regulate the rates, terms and
conditions imposed by these utilities for cable systems’
use of utility pole and conduit space unless state authorities
demonstrate to the FCC that they adequately regulate pole
attachment rates, as is the case in some states in which TWC
operates. In the absence of state regulation, the FCC
administers pole attachment rates on a formula basis. The
FCC’s original rate formula governs the maximum rate
utilities may charge for attachments to their poles and conduit
by cable operators providing cable services. The FCC also
adopted a second rate formula that became effective in February
2001 and governs the maximum rate investor-owned utilities may
charge for attachments to their poles and conduit by companies
providing telecommunications services. The U.S. Supreme
Court has upheld the FCC’s jurisdiction to regulate the
rates, terms and conditions of cable operators’ pole
attachments that are being used to provide both cable service
and high-speed data service.
Set-top box regulation. Certain regulatory
requirements are also applicable to set-top boxes. Currently,
many cable subscribers rent from their cable operator a set-top
box that performs both signal-reception functions and
conditional-access security functions. The lease rates cable
operators charge for this equipment are subject to rate
regulation to the same extent as basic cable service. In 1996,
Congress enacted a statute seeking to allow subscribers to use
set-top boxes obtained from third party retailers. The most
important of the FCC’s implementing regulations requires
cable operators to offer separate equipment providing only the
security function (so that subscribers can purchase set-top
boxes or other navigational devices from other sources) and to
cease placing into service new set-top boxes that have
integrated security. The regulations requiring cable operators
to cease distributing new set-top boxes with integrated security
are currently scheduled to go into effect on July 1, 2007.
TWC expects to incur approximately $50 million in
incremental set-top box costs during 2007 as a result of these
regulations. In addition, the FCC ordered the cable industry to
investigate and report on the possibility of implementing a
downloadable security system that would be accessible to all
set-top devices. If the implementation of such a system proves
technologically feasible, this may eliminate the need for
consumers to lease separate conditional-access security devices.
On August 16, 2006, the National Cable and
Telecommunications Association (the “NCTA”) filed with
the FCC a request that these rules be waived for all cable
operators, including TWC, until a downloadable security solution
is available or December 31, 2009, whichever is earlier. As
of February 1, 2007, this request was still pending. No
assurance can be given that the FCC will grant this or any other
waiver request.
In December 2002, cable operators and consumer-electronics
companies entered into a standard-setting agreement relating to
reception equipment that uses a conditional-access security
card — a
CableCARDtm —
provided by the cable operator to receive one-way cable
services. To implement the agreement, the FCC adopted
regulations that (i) establish a voluntary labeling system
for such one-way devices; (ii) require most cable systems
to
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support these devices; and (iii) adopt various
content-encoding rules, including a ban on the use of
“selectable output controls.” The FCC has issued a
notice of proposed rulemaking to consider additional changes.
Cable operators, consumer-electronics companies and other market
participants are holding discussions that may lead to a similar
set of interoperability agreements covering digital devices
capable of carrying cable operators’ two-way and
interactive products and services.
Other regulatory requirements of the Communications Act and
the FCC. The Communications Act also includes
provisions regulating customer service, subscriber privacy,
marketing practices, equal employment opportunity, technical
standards and equipment compatibility, antenna structure
notification, marking, lighting, emergency alert system
requirements and the collection from cable operators of annual
regulatory fees, which are calculated based on the number of
subscribers served and the types of FCC licenses held.
Separately, the FCC has adopted cable inside wiring rules to
provide specific procedures for the disposition of residential
home wiring and internal building wiring where a subscriber
terminates service or where an incumbent cable operator is
forced by a building owner to terminate service in a multiple
dwelling unit building. The FCC has also adopted rules providing
that, in the event that an incumbent cable operator sells the
inside wiring, it must make the wiring available to the multiple
dwelling unit owner or the alternative cable service provider
during the
24-hour
period prior to the actual service termination by the incumbent,
in order to avoid service interruption.
Compulsory copyright licenses for carriage of broadcast
stations and music performance
licenses. TWC’s cable systems provide
subscribers with, among other things, local and distant
television broadcast stations. TWC generally does not obtain a
license to use the copyrighted performances contained in these
stations’ programming directly from program owners.
Instead, TWC obtains this license pursuant to a compulsory
license provided by federal law, which requires TWC to make
payments to a copyright pool. The elimination or substantial
modification of the cable compulsory license could adversely
affect TWC’s ability to obtain suitable programming and
could substantially increase the cost of programming that
remains available for distribution to its subscribers.
When TWC obtains programming from third parties, it generally
obtains licenses that include any necessary authorizations to
transmit the music included in it. When TWC creates its own
programming and provides various other programming or related
content, including local origination programming and advertising
that TWC inserts into cable-programming networks, TWC is
required to obtain any necessary music performance licenses
directly from the rights holders. These rights are generally
controlled by three music performance rights organizations, each
with rights to the music of various composers. TWC generally has
obtained the necessary licenses, either through negotiated
licenses or through procedures established by consent decrees
entered into by some of the music performance rights
organizations.
Cable operators operate their systems under non-exclusive
franchises. Franchises are awarded, and cable operators are
regulated, by state franchising authorities, local franchising
authorities, or both. TWC believes it generally has good
relations with state and local cable regulators.
Franchise agreements typically require payment of franchise fees
and contain regulatory provisions addressing, among other
things, upgrades, service quality, cable service to schools and
other public institutions, insurance and indemnity bonds. The
terms and conditions of cable franchises vary from jurisdiction
to jurisdiction. The Communications Act provides protections
against many unreasonable terms. In particular, the
Communications Act imposes a ceiling on franchise fees of five
percent of revenues derived from cable service. TWC generally
passes the franchise fee on to its subscribers, listing it as a
separate item on the bill.
Franchise agreements usually have a term of ten to 15 years
from the date of grant, although some renewals may be for
shorter terms. Franchises usually are terminable only if the
cable operator fails to comply with material provisions. TWC has
not had a franchise terminated due to breach. After a franchise
agreement expires, a local franchising authority may seek to
impose new and more onerous requirements, including requirements
to upgrade facilities, to increase channel capacity and to
provide various new services. Federal law, however, provides
significant substantive and procedural protections for cable
operators seeking renewal of their franchises. In addition,
although TWC occasionally reaches the expiration date of a
franchise agreement without having a written
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renewal or extension, TWC generally has the right to continue to
operate, either by agreement with the local franchising
authority or by law, while continuing to negotiate a renewal. In
the past, substantially all of the material franchises relating
to TWC’s systems have been renewed by the relevant local
franchising authority, though sometimes only after significant
time and effort. During 2006, in adopting new regulations
intended to limit the ability of local franchising authorities
to delay or refuse the grant of competitive franchises (by, for
example, imposing deadlines on franchise negotiations), the FCC
announced the adoption of a Further Notice of Proposed
Rulemaking that concluded tentatively that these new regulations
should also apply to existing franchisees, including cable
operators, at the time of their next franchise renewal. The FCC
indicated it would issue an order in the Further Notice of
Proposed Rulemaking within six months from release of the final
order adopting the new regulations applicable to new entrants.
Despite TWC’s efforts and the protections of federal law,
it is possible that some of TWC’s franchises may not be
renewed, and TWC may be required to make significant additional
investments in its cable systems in response to requirements
imposed in the course of the franchise renewal process.
Local telephone companies may provide service as traditional
cable operators with local franchises or they may opt to provide
their programming over unfranchised “open video
systems.” Open video systems are subject to specified
requirements, including, but not limited to, a requirement that
they set aside a portion of their channel capacity for use by
unaffiliated program distributors on a non-discriminatory basis.
A federal appellate court overturned various parts of the
FCC’s open video rules, including the FCC’s preemption
of local franchising requirements for open video operators. The
FCC has modified its open video rules to comply with the federal
court’s decision.
As of February 1, 2007, it was unclear whether and to what
extent regulators will subject services like TWC’s Digital
Phone service (“Non-traditional Voice Services”) to
the regulations that apply to traditional, circuit-switched
telephone service provided by incumbent telephone companies. In
February 2004, the FCC opened a broad-based rulemaking
proceeding to consider these and other issues. That rulemaking
remains pending. In November 2004, the FCC issued an order
preempting state certification and tariffing requirements for
certain kinds of Non-traditional Voice Services. The validity of
this order has been appealed to a federal appellate court where,
as of February 20, 2007, a decision was still pending. The
FCC has, however, issued a series of orders resolving discrete
issues. For example, in May 2005, the FCC adopted rules
requiring Non-traditional Voice Service providers to supply E911
capabilities as a standard feature to their subscribers and to
obtain affirmative acknowledgement from all subscribers that
they have been advised of the circumstances under which E911
service may not be available. In August 2005, the FCC adopted an
order requiring certain types of Non-traditional Voice Services,
as well as facilities-based broadband Internet access service
providers, to assist law enforcement investigations through
compliance with the Communications Assistance For Law
Enforcement Act. In June 2006, the FCC adopted an order making
clear that Non-traditional Voice Service providers must make
contributions to the federal universal service fund. Certain
other issues remain unclear, however, including whether the
state and federal rules that apply to traditional,
circuit-switched telephone service also apply to Non-traditional
Voice Service providers and whether utility pole owners may
charge cable operators offering Non-traditional Voice Services
higher rates for pole rental than for traditional cable service
and cable-modem service. One state public utility commission,
for example, has determined that TWC’s Digital Phone
service is subject to traditional, circuit-switched telephone
regulations.
The
Transactions
The following provides a more detailed description of the
Transactions and contains summaries of the terms of the material
agreements that were entered into in connection with the
Transactions. This description does not purport to be complete
and is subject to, and is qualified in its entirety by reference
to, the applicable agreements.
As described in more detail below, under separate agreements (as
amended, the “TW NY Purchase Agreement” and
“Comcast Purchase Agreement,” respectively, and,
collectively, the “Purchase Agreements”), TW NY and
Comcast purchased substantially all of the cable assets of
Adelphia. The Purchase Agreements were entered
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into after Adelphia filed voluntary petitions for relief under
chapter 11 of title 11 of the United States Code (the
“Bankruptcy Code”). This section provides additional
details regarding the Purchase Agreements and TW NY’s and
Comcast’s underlying acquisition of Adelphia’s assets
(the “TW NY Adelphia Acquisition” and the
“Comcast Adelphia Acquisition,” respectively), along
with certain other agreements TWC entered into with Comcast.
The TW NY Purchase Agreement. On
April 20, 2005, TW NY, one of TWC’s subsidiaries,
entered into the TW NY Purchase Agreement with ACC. The TW NY
Purchase Agreement provided that TW NY would purchase certain
assets and assume certain liabilities from Adelphia. On
June 21, 2006, ACC and TW NY entered into Amendment
No. 2 to the TW NY Purchase Agreement (the “TW NY
Amendment”). Under the terms of the TW NY Amendment, the
assets TW NY acquired from Adelphia and the consideration to be
paid to Adelphia remained unchanged. However, the TW NY
Amendment provided that the TW NY Adelphia Acquisition would be
effected in accordance with the provisions of sections 105,
363 and 365 of the Bankruptcy Code and, as a result,
Adelphia’s creditors were not required to approve a plan of
reorganization under chapter 11 of the Bankruptcy Code
prior to the consummation of the TW NY Adelphia Acquisition. The
TW NY Adelphia Acquisition closed on July 31, 2006,
immediately after the Redemptions. The TW NY Adelphia
Acquisition included cable systems located in the following
areas: West Palm Beach, Florida; Cleveland and Akron, Ohio; Los
Angeles, California; and suburbs of the District of Columbia. As
consideration for the assets purchased from Adelphia, TW NY
assumed certain liabilities as specified in the TW NY Purchase
Agreement and paid to ACC approximately $8.9 billion in
cash (including approximately $360 million paid into
escrow), after giving effect to certain purchase price
adjustments discussed below, and delivered
149,765,147 shares of TWC Class A common stock to ACC
and 6,148,283 shares of TWC Class A common stock into
escrow. This represents approximately 17.3% of the TWC
Class A common stock outstanding (including shares issued
into escrow), and approximately 16% of TWC’s total
outstanding common stock as of the closing of the TW NY Adelphia
Acquisition.
The purchase price is subject to customary adjustments to
reflect changes in Adelphia’s net liabilities and
subscribers as well as any shortfall in Adelphia’s capital
expenditure spending relative to its budget during the interim
period (the “Interim Period”) between the execution of
the TW NY Purchase Agreement and the closing of the transactions
contemplated by the TW NY Purchase Agreement (the “Adelphia
Closing”). The approximately $360 million in cash and
6 million shares of TWC Class A common stock that were
deposited into escrow are securing Adelphia’s obligations
in respect of any post-closing adjustments to the purchase price
and its indemnification obligations for, among other things,
breaches of its representations, warranties and covenants
contained in the TW NY Purchase Agreement. One-third of the
escrow, beginning with the cash amounts, was to be released on
January 31, 2007 (six months after the Adelphia Closing)
with the remaining amounts to be released on July 31, 2007
(12 months after the Adelphia Closing), in each case except
to the extent of amounts paid prior to such date or that would
be expected to be necessary to satisfy claims asserted on or
prior to such date. On January 31, 2007, the escrow agent
released to Adelphia approximately $172 million in cash,
representing one-third of the aggregate value of the escrow.
The parties to the TW NY Purchase Agreement made customary
representations and warranties. ACC’s representations and
warranties survive for twelve months after the Adelphia Closing
and, to the extent any claims are made prior to such date, until
such claims are resolved. The debtors in Adelphia’s
bankruptcy proceedings (excluding, except to the extent provided
in the TW NY Purchase Agreement, the joint ventures described in
“— The Comcast Purchase Agreement” below),
are jointly and severally liable for breaches or violations by
ACC of its representations, warranties and covenants. The
representations and warranties of TW NY contained in the TW NY
Purchase Agreement expired at the Adelphia Closing.
The TW NY Purchase Agreement included customary and certain
other covenants made by Adelphia and TW NY, including covenants
that require Adelphia to deliver financial statements for the
systems purchased sufficient to fulfill TWC’s obligations
to provide such financial statements in connection with the
distribution of TWC Class A common stock by ACC to certain
of Adelphia’s creditors.
The TW NY Purchase Agreement requires ACC to indemnify TW NY and
each of its affiliates (including TWC), their respective
directors, officers, shareholders, agents and other individuals
(the “TW Indemnified Parties”) for losses and expenses
stemming from the breach of any representation or warranty,
covenant and certain other items. Subject to very limited
exceptions, the TW Indemnified Parties are only able to seek
reimbursement for
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losses from the escrowed cash and shares. In addition, subject
to specified exceptions, losses associated with breaches of
representations and warranties generally must exceed certain
dollar amounts before a TW Indemnified Party may make a claim
for indemnification. Even after the applicable threshold has
been reached, a claim for indemnification for losses associated
with breaches of representations and warranties is subject to
specified aggregate deductibles and cap amounts. With respect to
assets acquired from Adelphia by TW NY that were subsequently
transferred to Comcast in the Exchange, ACC’s
indemnification obligation is subject to a threshold of
$74 million, a deductible of $42 million and is capped
at $296.7 million, subject to certain adjustments, and with
respect to assets acquired by TW NY that were not transferred to
Comcast pursuant to the Exchange, ACC’s indemnification
obligation is subject to a threshold of $67 million, a
deductible of $38 million and is capped at
$267.9 million, subject to certain adjustments.
The TW NY Purchase Agreement required TWC, at the Adelphia
Closing, to amend and restate its by-laws to restrict TWC and
its subsidiaries from entering into transactions with or for the
benefit of Time Warner and its affiliates other than TWC and its
subsidiaries (the “Time Warner Group”), subject to
specified exceptions. Additionally, prior to August 1, 2011
(five years following the Adelphia Closing), TWC’s restated
certificate of incorporation and by-laws (as required to be
amended by the TW NY Purchase Agreement) do not allow for an
amendment to the provisions of TWC’s by-laws restricting
these transactions without the consent of a majority of the
holders of TWC Class A common stock, other than any member
of the Time Warner Group. Additionally, under the TW NY Purchase
Agreement, TWC agreed that it will not enter into any short-form
merger prior to August 1, 2008 (two years after the
Adelphia Closing) and that it will not issue equity securities
to any person (other than, subject to satisfying certain
requirements, TWC and its affiliates) that have a higher vote
per share than TWC Class A common stock prior to
February 1, 2008 (18 months after the Adelphia
Closing).
At the closing of the Adelphia Acquisition, TWC and Adelphia
entered into a registration rights and sale agreement (the
“Adelphia Registration Rights and Sale Agreement”),
which governed the disposition of the shares of TWC Class A
common stock received by Adelphia in the TW NY Adelphia
Acquisition. Upon the effectiveness of Adelphia’s plan of
reorganization, the parties’ obligations under the Adelphia
Registration Rights and Sale Agreement terminated.
Parent Agreement. Pursuant to the Parent
Agreement among ACC, TW NY and TWC, dated as of April 20,
2005, TWC, among other things, guaranteed the obligations of TW
NY to Adelphia under the TW NY Purchase Agreement.
The Comcast Purchase Agreement. The Comcast
Purchase Agreement has similar terms to the TW NY Purchase
Agreement and the transactions contemplated by the Comcast
Purchase Agreement also closed on July 31, 2006. The
Comcast Adelphia Acquisition was effected in accordance with the
provisions of sections 105, 363 and 365 of the Bankruptcy
Code and a plan of reorganization for the joint ventures
referred to in the following sentence. The Comcast Adelphia
Acquisition included cable systems and Adelphia’s interest
in two joint ventures in which Comcast also held interests:
Century-TCI California Communications, L.P. (the
“Century-TCI joint venture”), which owned cable
systems in the Los Angeles, California area, and Parnassos
Communications, L.P. (the “Parnassos joint venture”),
which owned cable systems in Ohio and Western New York. The
purchase price under the Comcast Purchase Agreement was
approximately $3.6 billion in cash.
As described in more detail below, on the same day as the
parties consummated the transactions governed by the Purchase
Agreements, TWC and some of its affiliates (collectively, the
“TWC Group”) and Comcast consummated the TWC
Redemption, the TWE Redemption and the Exchange (collectively,
the “TWC/Comcast Transactions”). Under the terms of
the agreement which governed the TWC Redemption (the “TWC
Redemption Agreement”), TWC redeemed Comcast’s
investment in TWC in exchange for one of TWC’s subsidiaries
that held both cable systems and cash. In accordance with the
terms of the agreement which governed the TWE Redemption (the
“TWE Redemption Agreement”), TWE redeemed
Comcast’s interest in TWE in exchange for one of TWE’s
subsidiaries that held both cable systems and cash. In
accordance with the terms of the agreement which governed the
Exchange (as amended, the “Exchange Agreement”), TW NY
and Comcast transferred to one another subsidiaries that held
certain cable systems, including cable systems acquired by each
from Adelphia. The TWC
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Redemption Agreement, the TWE Redemption Agreement and
the Exchange Agreement, are collectively referred to as the
“TWC/Comcast Agreements.”
The TWC Redemption Agreement. Pursuant to
the TWC Redemption Agreement, dated as of April 20,
2005, as amended, among TWC and certain other members of the TWC
Group and Comcast, the TWC Redemption was effected and
Comcast’s interest in TWC was redeemed on July 31,
2006, immediately prior to the Adelphia Acquisition. The TWC
Redemption Agreement required that TWC redeem all of the
TWC Class A common stock held by TWE Holdings II Trust
(“Comcast Trust II”), a trust that was
established for the benefit of Comcast, in exchange for 100% of
the common stock of Cable Holdco II Inc. (“Cable
Holdco II”), then a subsidiary of TWC. At the time of
the TWC Redemption, Cable Holdco II held both certain cable
systems previously owned directly or indirectly by TWC
(“TWC Redemption Systems”) serving approximately
589,000 basic subscribers and approximately $1.9 billion in
cash, subject generally to the liabilities associated with the
TWC Redemption Systems. Certain specified assets and
liabilities of the TWC Redemption Systems were retained by
TWC.
The TWC Redemption Agreement contains closing adjustments
to be paid in cash based on (1) the relative growth or
decline in the number of basic video subscribers served by the
TWC Redemption Systems as compared to the relative growth
or decline in the number of basic video subscribers served by
the other cable systems operated by TWC and (2) the excess,
if any, of the net liabilities of the TWC
Redemption Systems over an agreed upon threshold amount.
The TWC Redemption Agreement contains various customary
representations and warranties of the parties thereto including
representations by TWC as to the absence of certain changes or
events concerning the TWC Redemption Systems, compliance
with law, litigation, employee benefit plans, property,
intellectual property, environmental matters, financial
statements, regulatory matters, taxes, material contracts,
insurance and brokers. The representations and warranties of the
parties to the TWC Redemption Agreement generally survive
the closing of the TWC Redemption for a period of one year and
certain representations and warranties either did not survive
the closing of the TWC Redemption, survive indefinitely or
survive until the expiration of the applicable statute of
limitations (giving effect to any waiver, mitigation or
extension thereof).
The TWC Redemption Agreement contains customary
indemnification obligations on the part of the parties thereto
with respect to breaches of representations, warranties and
covenants and certain other matters, generally subject to a
$20 million threshold and $200 million cap, with
respect to certain of TWC’s representations and warranties
regarding the TWC Redemption Systems and related matters,
and with respect to certain representations and warranties of
the Comcast parties relating to litigation, financial
statements, finder’s fees and certain regulatory matters.
TWC/Comcast Tax Matters Agreement. In
connection with the closing of the TWC Redemption, TWC, Cable
Holdco II and Comcast entered into the Holdco Tax Matters
Agreement (the “TWC/Comcast Tax Matters Agreement”).
The TWC/Comcast Tax Matters Agreement allocates responsibility
for income taxes of Cable Holdco II and deals with matters
relating to the income tax consequences of the TWC Redemption.
This agreement contains representations, warranties and
covenants relevant to such income tax treatment. The TWC/Comcast
Tax Matters Agreement also contains indemnification obligations
relating to the foregoing.
The TWE Redemption Agreement. Pursuant to
the TWE Redemption Agreement, dated as of April 20,
2005, as amended, among TWC and Comcast, Comcast’s interest
in TWE was redeemed on July 31, 2006, immediately prior to
the Adelphia Acquisition. Prior to the TWE Redemption, TWE
Holdings I Trust (“Comcast Trust I”), a trust
established for the benefit of Comcast, owned a 4.7% residual
equity interest in TWE. Pursuant to the TWE
Redemption Agreement, TWE redeemed all of the TWE residual
equity interest held by Comcast Trust I in exchange for
100% of the limited liability company interests of Cable
Holdco III LLC (“Cable Holdco III”), then a
subsidiary of TWE. At the time of the TWE Redemption, Cable
Holdco III held both certain cable systems previously owned
or operated directly or indirectly by TWE (the “TWE
Redemption Systems”) serving approximately 162,000
subscribers and approximately $147 million in cash, subject
generally to the liabilities associated with the TWE
Redemption Systems. Certain specified assets and
liabilities of the TWE Redemption Systems were retained by
TWE.
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The TWE Redemption Agreement contains closing adjustments
to be paid in cash based on (1) the relative growth or
decline in the number of basic video subscribers served by the
TWE Redemption Systems as compared to the relative growth
or decline in the number of basic video subscribers served by
the other cable systems owned by TWE and (2) the excess, if
any, of the net liabilities of the TWE Redemption Systems
over an agreed upon threshold amount.
The TWE Redemption Agreement contained various customary
representations and warranties of the parties thereto including
representations by TWE as to the absence of certain changes or
events concerning the TWE Redemption Systems, compliance
with law, litigation, employee benefit plans, property,
intellectual property, environmental matters, financial
statements, regulatory matters, taxes, material contracts,
insurance and brokers. The representations and warranties of the
parties to the TWE Redemption Agreement generally survive
the closing of the TWE Redemption Agreement for a period of
one year and certain representations and warranties either
survive indefinitely or survive until the expiration of the
applicable statute of limitations (giving effect to any waiver,
mitigation or extension thereof).
The TWE Redemption Agreement contained customary
indemnification obligations on the part of the parties thereto
with respect to breaches of representations and warranties and
covenants and certain other matters, generally subject to a
$6 million threshold and $60 million cap, with respect
to certain representations and warranties of TWE regarding the
TWE Redemption Systems and related matters, and with
respect to certain representations and warranties of the Comcast
parties relating to litigation, financial statements,
finder’s fees and certain regulatory matters.
The Exchange Agreement. Pursuant to the
Exchange Agreement, dated as of April 20, 2005, as amended,
among TWC, TW NY and Comcast, the Exchange closed on
July 31, 2006, immediately after the Adelphia Acquisition.
Pursuant to the Exchange Agreement, TW NY transferred all
outstanding limited liability company interests of certain newly
formed limited liability companies (collectively, the “TW
Newcos”) to Comcast in exchange for all limited liability
company interests of certain newly formed limited liability
companies or limited partnerships, respectively, owned by
Comcast (collectively, the “Comcast Newcos”). In
addition, TWC paid Comcast approximately $67 million in
cash for certain adjustments related to the Exchange. Included
in the systems TWC acquired in the Exchange were cable systems
(i) that were owned by the Century-TCI joint venture in the
Los Angeles, California area and the Parnassos joint venture in
Ohio and Western New York and (ii) then owned by Comcast
located in the Dallas, Texas, Los Angeles, California, and
Cleveland, Ohio areas.
The Exchange Agreement contains various customary
representations and warranties of the parties thereto (which
generally survive for a period of 12 months after the
closing of the Exchange), including representations concerning
the cable systems subject to the Exchange Agreement originally
owned by TWC or Comcast as to the absence of certain changes or
events, compliance with law, litigation, employee benefit plans,
property, intellectual property, environmental matters,
financial statements, regulatory matters, taxes, material
contracts, insurance and brokers. The Exchange Agreement also
contained representations regarding the accuracy of certain of
the representations of Adelphia set forth in the Purchase
Agreements for events, circumstances and conditions occurring
after the closing of the TW NY Adelphia Acquisition.
The Exchange Agreement contains customary indemnification
obligations on the part of the parties thereto with respect to
breaches of representations, warranties, covenants and certain
other matters. Each party’s indemnification obligations
with respect to breaches of representations and warranties
(other than certain specified representations and warranties)
are subject to (1) with respect to cable systems originally
owned by TWC that were acquired by Comcast, a $5.7 million
threshold and $19.1 million cap, (2) with respect to
cable systems originally owned by Adelphia that were initially
acquired by TWC pursuant to the TW NY Purchase Agreement and
then transferred to Comcast pursuant to the Exchange Agreement,
a $74.6 million threshold and $746 million cap,
(3) with respect to cable systems originally owned by
Comcast that were acquired by TWC, a $41.5 million
threshold and $415 million cap, and (4) with respect
to cable systems originally owned by Adelphia that were
initially acquired by Comcast pursuant to the Comcast Purchase
Agreement and then transferred to TWC pursuant to the Exchange
Agreement, a $34.9 million threshold and $349 million
cap. In addition, no party is required to indemnify the other
for breaches of representations, warranties or covenants
relating to assets or liabilities initially acquired from
Adelphia and then transferred to the other party, unless the
breach is of a representation, warranty or
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covenant actually made by the party under the Exchange Agreement
in relation to those Adelphia assets or liabilities.
TWE is a Delaware limited partnership that was formed in 1992.
At the time of the restructuring of TWE, which was completed on
March 31, 2003, (the “TWE Restructuring”),
subsidiaries of Time Warner owned general and limited
partnership interests in TWE consisting of 72.36% of the
pro-rata priority capital and residual equity capital and 100%
of the junior priority capital, and Comcast Trust I owned
limited partnership interests in TWE consisting of 27.64% of the
pro rata priority capital and residual equity capital. Prior to
the TWE Restructuring, TWE’s business consisted of
interests in cable systems, cable networks and filmed
entertainment.
Through a series of steps executed in connection with the TWE
Restructuring, TWE transferred its non-cable businesses,
including its filmed entertainment and cable network businesses,
along with associated liabilities, to Warner Communications Inc.
(“WCI”), a wholly owned subsidiary of Time Warner, and
the ownership structure of TWE was reorganized so that
(i) TWC owned 94.3% of the residual equity interests in
TWE, (ii) Comcast Trust I owned 4.7% of the residual
equity interests in TWE and (iii) American Television and
Communications Corporation (“ATC”), a wholly owned
subsidiary of Time Warner, owned 1.0% of the residual equity
interests in TWE and $2.4 billion in mandatorily redeemable
preferred equity issued by TWE. In addition, following the TWE
Restructuring, Time Warner indirectly held shares of TWC
Class A common stock and Class B common stock
representing, in the aggregate, 89.3% of TWC’s voting power
and 82.1% of TWC’s outstanding equity.
On July 28, 2006, the partnership interests and preferred
equity originally held by ATC, were contributed to TW NY Cable
Holding Inc. (“TW NY Holding”), a wholly owned
subsidiary of TWC, in exchange for a 12.4% non-voting common
stock interest in TW NY Holding (the “ATC
Contribution”) and upon the closing of the TWE Redemption,
Comcast Trust I’s ownership interest in TWE was
redeemed. As a result, Time Warner has no direct interest in TWE
and Comcast no longer has any interest in TWE. As of
December 31, 2006, TWE had $3.2 billion in principal
amount of outstanding debt securities with maturities ranging
from 2008 to 2033 and fixed interest rates ranging from 7.25% to
10.15%. See “Management’s Discussion and Analysis of
Results of Operations and Financial Condition —
Financial Condition and Liquidity — TWE Notes.”
The TWE partnership agreement requires that transactions between
TWC and its subsidiaries, on the one hand, and TWE and its
subsidiaries on the other hand, be conducted on an
arm’s-length basis, with management, corporate or similar
services being provided by TWC on a “no
mark-up”
basis with fair allocations of administrative costs and general
overhead.
The following description summarizes certain provisions of the
partnership agreement relating to the Time Warner
Entertainment-Advance/Newhouse Partnership
(“TWE-A/N”). Such description does not purport to be
complete and is subject to, and is qualified in its entirety by
reference to, the provisions of the TWE-A/N partnership
agreement.
Partners of TWE-A/N. The general partnership
interests in TWE-A/N are held by TW NY and an indirect
subsidiary of TWE (such TWE subsidiary and TW NY are together,
the “TW Partners”) and the Advance/Newhouse
Partnership (“A/N”), a partnership owned by wholly
owned subsidiaries of Advance Publications Inc. and Newhouse
Broadcasting Corporation. The TW Partners also hold preferred
partnership interests.
2002 Restructuring of TWE-A/N. The TWE-A/N
cable television joint venture was formed by TWE and A/N in
December 1995. A restructuring of the partnership was completed
during 2002. As a result of this restructuring, cable systems
and their related assets and liabilities serving approximately
2.1 million subscribers as of December 31, 2002 (which
amount is not included in TWE-A/N’s 4.0 million
consolidated subscribers, as of December 31,
2006) located primarily in Florida (the “A/N
Systems”), were transferred to a subsidiary of TWE-A/N (the
“A/N Subsidiary”). As part of the restructuring,
effective August 1, 2002, A/N’s interest in TWE-A/N
was converted into an interest that tracks the economic
performance of the A/N Systems, while the TW Partners retain the
economic
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interests and associated liabilities in the remaining TWE-A/N
cable systems. Also, in connection with the restructuring, TWC
effectively acquired A/N’s interest in Road Runner.
TWE-A/N’s financial results, other than the results of the
A/N Systems, are consolidated with TWC. Road Runner continues to
provide high-speed data services to the A/N Subsidiary.
Management and Operations of TWE-A/N. Subject
to certain limited exceptions, a subsidiary of TWE is the
managing partner, with exclusive management rights of TWE-A/N,
other than with respect to the A/N Systems. Also, subject to
certain limited exceptions, A/N has authority for the
supervision of the
day-to-day
operations of the A/N Subsidiary and the A/N Systems. In
connection with the 2002 restructuring, TWE entered into a
services agreement with A/N and the A/N Subsidiary under which
TWE agreed to exercise various management functions, including
oversight of programming and various engineering-related
matters. TWE and A/N also agreed to periodically discuss
cooperation with respect to new product development.
Restrictions on Transfer — TW
Partners. Each TW Partner is generally permitted
to directly or indirectly dispose of its entire partnership
interest at any time to a wholly owned affiliate of TWE (in the
case of transfers by TWE-A/N Holdco, L.P. (“TWE-A/N
Holdco”)) or to TWE, Time Warner or a wholly owned
affiliate of TWE or Time Warner (in the case of transfers by
TWC). In addition, the TW Partners are also permitted to
transfer their partnership interests through a pledge to secure
a loan, or a liquidation of TWE in which Time Warner, or its
affiliates, receives a majority of the interests of TWE-A/N held
by the TW Partners. TWE-A/N Holdco is allowed to issue
additional partnership interests in TWE-A/N Holdco so long as
Time Warner continues to own, directly or indirectly, either 35%
or 43.75% of the residual equity capital of TWE-A/N Holdco,
depending on when the issuance occurs.
Restrictions on Transfer — A/N
Partner. A/N is generally permitted to directly
or indirectly transfer its entire partnership interest at any
time to certain members of the Newhouse family or specified
affiliates of A/N. A/N is also permitted to dispose of its
partnership interest through a pledge to secure a loan and in
connection with specified restructurings of A/N.
Restructuring Rights of the Partners. TWE-A/N
Holdco and A/N each has the right to cause TWE-A/N to be
restructured at any time. Upon a restructuring, TWE-A/N is
required to distribute the A/N Subsidiary with all of the A/N
Systems to A/N in complete redemption of A/N’s interests in
TWE-A/N, and A/N is required to assume all liabilities of the
A/N Subsidiary and the A/N Systems. To date, neither TWE-A/N
Holdco nor A/N has delivered notice of the intent to cause a
restructuring of TWE-A/N.
TWE’s Regular Right of First
Offer. Subject to exceptions, A/N and its
affiliates are obligated to grant TWE-A/N Holdco a right of
first offer prior to any sale of assets of the A/N Systems to a
third party.
TWE’s Special Right of First
Offer. Within a specified time period following
the first, seventh, thirteenth and nineteenth anniversaries of
the deaths of two specified members of the Newhouse family
(those deaths have not yet occurred), A/N has the right to
deliver notice to TWE-A/N Holdco stating that it wishes to
transfer some or all of the assets of the A/N Systems, thereby
granting TWE-A/N Holdco the right of first offer to purchase the
specified assets. Following delivery of this notice, an
appraiser will determine the value of the assets proposed to be
transferred. Once the value of the assets has been determined,
A/N has the right to terminate its offer to sell the specified
assets. If A/N does not terminate its offer, TWE-A/N Holdco will
have the right to purchase the specified assets at a price equal
to the value of the specified assets determined by the
appraiser. If TWE-A/N Holdco does not exercise its right to
purchase the specified assets, A/N has the right to sell the
specified assets to an unrelated third party within
180 days on substantially the same terms as were available
to TWE.
The following description summarizes certain provisions of
agreements related to, and constituent documents of, TWC that
affect and govern the ongoing operations of TWC. Such
description does not purport to be complete and is qualified in
its entirety by reference to the provisions of such agreements
and constituent documents.
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Stockholders of TWC. A subsidiary of Time
Warner owns 746,000,000 shares of TWC Class A common
stock, which generally has one vote per share, and
75,000,000 shares of TWC Class B common stock, which
generally has ten votes per share, which together represent
90.6% of the voting power of TWC stock and approximately 84% of
the equity of TWC. The TWC Class B common stock is not
convertible into TWC Class A common stock. The TWC
Class A common stock and the TWC Class B common stock
vote together as a single class on all matters, except with
respect to the election of directors and certain matters
described below.
Board of Directors of TWC. The TWC
Class A common stock votes as a separate class with respect
to the election of the Class A directors of TWC (the
“Class A Directors”), and the TWC Class B
common stock votes as a separate class with respect to the
election of the Class B directors of TWC (the
“Class B Directors”). Pursuant to the amended and
restated certificate of incorporation of TWC (the “TWC
Certificate of Incorporation”), which was adopted upon the
closing of the Adelphia Acquisition, the Class A Directors
must represent not less than one-sixth and not more than
one-fifth of the directors of TWC, and the Class B
Directors must represent not less than four-fifths of the
directors of TWC. As a result of its holdings, Time Warner has
the ability to cause the election of all Class A Directors
and Class B Directors, subject to certain restrictions on
the identity of these directors discussed below.
The TWC Certificate of Incorporation requires that there be at
least two independent directors on the board of directors of
TWC. Pursuant to a shareholder agreement between TWC and Time
Warner (the “Shareholder Agreement”), so long as Time
Warner has the power to elect a majority of TWC’s board of
directors, TWC must obtain Time Warner’s consent before
entering into any agreement that binds or purports to bind Time
Warner or its affiliates or that would subject TWC or its
subsidiaries to significant penalties or restrictions as a
result of any action or omission of Time Warner or its
affiliates; or adopting a stockholder rights plan, becoming
subject to section 203 of the Delaware General Corporation
Law, adopting a “fair price” provision in its
certificate of incorporation or taking any similar action.
Furthermore, pursuant to the Shareholder Agreement, Time Warner
may purchase debt securities issued by TWE under the TWE
Indenture only after giving notice to TWC of the approximate
amount of debt securities it intends to purchase and the general
time period for the purchase, which period may not be greater
than 90 days, subject to TWC’s right to give notice to
Time Warner that it intends to purchase such amount of TWE debt
securities itself.
Under the terms of the TWC Certificate of Incorporation, for
three years following July 31, 2006, the date upon which
shares of TWC common stock were issued in connection with the
Adelphia Acquisition, at least 50% of the board of directors of
TWC must be independent directors.
Protections of Minority Class A Common
Stockholders. The approval of the holders of a
majority of the voting power of the outstanding shares of TWC
Class A common stock held by persons other than Time Warner
is necessary in connection with:
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Indebtedness Approval Right. Under the
Shareholder Agreement, until such time as the indebtedness of
TWC is no longer attributable to Time Warner, in Time
Warner’s reasonable judgment, TWC, its subsidiaries and
entities that it manages may not, without the consent of Time
Warner, create, incur or guarantee any indebtedness (except for
the issuance of commercial paper or borrowings under TWC’s
current revolving credit facility up to the limit of that credit
facility, to which Time Warner has consented), including
preferred equity, or rental obligations if its ratio of
indebtedness plus six times its annual rental expense to EBITDA
(as EBITDA is defined in the Shareholder Agreement) plus rental
expense, or “EBITDAR,” then exceeds or would exceed
3:1.
Time Warner Standstill. Under the Shareholder
Agreement, Time Warner has agreed that prior to August 1,
2009 (three years following the closing of the Adelphia
Acquisition), Time Warner will not make or announce a tender
offer or exchange offer for TWC Class A common stock
without the approval of a majority of the independent directors
of TWC; and prior to August 1, 2016 (10 years
following the closing of the Adelphia Acquisition), Time Warner
will not enter into any business combination with TWC, including
a short-form merger, without the approval of a majority of the
independent directors of TWC. Under the Adelphia Acquisition
agreement, TWC has agreed that for a period of two years
following the closing of the Adelphia Acquisition it will not
enter into any short-form merger and that for a period of
18 months following the closing of the Adelphia Acquisition
it will not issue equity securities to any person (other than,
subject to satisfying certain requirements, Time Warner and its
affiliates) that have a higher vote per share than the TWC
Class A common stock.
Transactions between Time Warner and TWC. The
TWC By-Laws provide that Time Warner may only enter into
transactions with TWC and its subsidiaries, including TWE, that
are on terms that, at the time of entering into such
transaction, are substantially as favorable to TWC or its
subsidiaries as they would be able to receive in a comparable
arm’s-length transaction with a third party. Any such
transaction involving reasonably anticipated payments or other
consideration of $50 million or greater also requires the
prior approval of a majority of the independent directors of
TWC. The TWC By-Laws also prohibit TWC from entering into any
transaction having the intended effect of benefiting Time Warner
and any of its affiliates (other than TWC and its subsidiaries)
at the expense of TWC or any of its subsidiaries in a manner
that would deprive TWC or any of its subsidiaries of the benefit
it would have otherwise obtained if the transaction were to have
been effected on arm’s-length terms.
Time Warner Registration Rights Agreement between TWC and
Time Warner. At the closing of the TWE
Restructuring, Time Warner and TWC entered into a registration
rights agreement (the “Registration Rights Agreement”)
relating to Time Warner’s shares of TWC common stock.
Subject to several exceptions, including TWC’s right to
defer a demand registration under some circumstances, Time
Warner may, under that agreement, require that TWC take
commercially reasonable steps to register for public resale
under the Securities Act all shares of common stock that Time
Warner requests to be registered. Time Warner may demand an
unlimited number of registrations. In addition, Time Warner has
been granted “piggyback” registration rights subject
to customary restrictions and TWC is permitted to piggyback on
Time Warner’s registrations. TWC has also agreed that, in
connection with a registration and sale by Time Warner under the
Registration Rights Agreement, it will indemnify Time Warner and
bear all fees, costs and expenses, except underwriting discounts
and selling commissions.
TWC’s industry is and will continue to be highly
competitive. Some of TWC’s principal
competitors — in particular, direct broadcast
satellite operators and incumbent local telephone
companies — either offer or are making significant
capital investments that will allow them to offer services that
provide directly comparable features and functions to those TWC
offers, and they are aggressively seeking to offer them in
bundles similar to TWC’s.
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Incumbent local telephone companies have recently increased
their efforts to provide video services. The two major incumbent
local telephone companies — AT&T and
Verizon — have both announced that they intend to make
fiber upgrades of their networks, although each is using a
different architecture. AT&T is expected to utilize one of a
number of fiber architectures, including FTTN, and Verizon
utilizes a fiber architecture known as FTTH. Some upgraded
portions of these networks are or will be capable of carrying
two-way video services that are technically comparable to
TWC’s, high-speed data services that operate at speeds as
high or higher than those TWC makes available to customers in
these areas and digital voice services that are similar to
TWC’s. In addition, these companies continue to offer their
traditional phone services as well as bundles that include
wireless voice services provided by affiliated companies. In
areas where they have launched video services, these parties are
aggressively marketing video, voice and data bundles at entry
level prices similar to those TWC uses to market its bundles.
TWC’s video business faces intense competition from direct
broadcast satellite providers. These providers compete with TWC
based on aggressive promotional pricing and exclusive
programming (e.g., “NFL Sunday Ticket,” which is not
available to cable operators). Direct broadcast satellite
programming is comparable in many respects to TWC’s analog
and digital video services, including TWC’s DVR service. In
addition, the two largest direct broadcast satellite providers
offer some interactive programming features. These providers are
working to increase the number of HDTV channels they offer in
order to differentiate their service from services offered by
cable operators.
In some areas, incumbent local telephone companies and direct
broadcast satellite operators have entered into co-marketing
arrangements that allow both parties to offer synthetic bundles
(i.e., video services provided principally by the direct
broadcast satellite operator, and DSL and traditional phone
service offered by the telephone companies). From a consumer
standpoint, the synthetic bundles appear similar to TWC’s
bundles and result in a single bill. AT&T is offering a
service in some areas that utilizes direct broadcast satellite
video but in an integrated package with AT&T’s DSL
product, which enables an Internet-based return path that allows
the user to order a VOD-like product and other services that TWC
provides using its two-way network.
TWC operates its cable systems under non-exclusive franchises
granted by state or local authorities. The existence of more
than one cable system operating in the same territory is
referred to as an “overbuild.” In some of TWC’s
operating areas, other operators have overbuilt TWC’s
systems and offer video, data
and/or voice
services in competition with TWC.
In addition to these competitors, TWC faces competition on
individual services from a range of competitors. For instance,
TWC’s video service faces competition from providers of
paid television services (such as satellite master antenna
services) and from video delivered over the Internet. TWC’s
high-speed data service faces competition from, among others,
incumbent local telephone companies utilizing their
newly-upgraded
fiber networks
and/or DSL
lines, Wi-Fi, Wi-Max and 3G wireless broadband services provided
by mobile carriers such as Verizon Wireless, broadband over
power line providers, and from providers of traditional
dial-up
Internet access. TWC’s voice service faces competition for
voice customers from incumbent local telephone companies,
cellular telephone service providers, Internet phone providers,
such as Vonage, and others.
Any inability to compete effectively or an increase in
competition with respect to video, voice or high-speed data
services could have an adverse effect on TWC’s financial
results and return on capital expenditures due to possible
increases in the cost of gaining and retaining subscribers and
lower per subscriber revenue, could slow or cause a decline in
TWC’s growth rates, reduce its revenues, reduce the number
of its subscribers or reduce its ability to increase penetration
rates for services. As TWC expands and introduces new and
enhanced products and services, TWC may be subject to
competition from other providers of those products and services,
such as telecommunications providers, ISPs and consumer
electronics companies, among others. TWC cannot predict the
extent to which this competition will affect its future
financial results or return on capital expenditures.
Future advances in technology, as well as changes in the
marketplace and in the regulatory and legislative environments,
may result in changes to the competitive landscape. For
additional information regarding the regulatory and legal
environment, see “— Risks Related to Government
Regulation” and Item 1, “Business —
Regulatory Matters.”
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TWC operates its cable systems under franchises that are
non-exclusive. State and local franchising authorities can grant
additional franchises and foster additional competition.
TWC’s cable systems are constructed and operated under
non-exclusive franchises granted by state or local governmental
authorities. Federal law prohibits franchising authorities from
unreasonably denying requests for additional franchises.
Consequently, competing operators may build systems in areas in
which TWC holds franchises. In the past, competing
operators — most of them relatively small —
have obtained such franchises and offered competing services in
some areas in which TWC holds franchises. More recently,
incumbent local telephone companies with significant resources,
particularly Verizon and AT&T, have obtained or have sought
to obtain such franchises in connection with or in preparation
for offering of video, high speed data and digital voice
services in some of TWC’s service areas. See
“— TWC faces a wide range of competition, which
could affect its future results of operations” above. The
existence of more than one cable system operating in the same
territory is referred to as an “overbuild.”
TWC faces competition from incumbent local telephone companies
and other overbuilders in many of the areas it serves, including
within each of its five major geographic operating areas. In New
York City, TWC faces competition from Verizon and another
overbuilder, RCN Corporation (“RCN”). In upstate New
York, overbuild activity is focused primarily in the Binghamton
and Rochester areas, where competitors include Delhi Telephone
and Empire Video Corporation, respectively. In the Carolinas, a
number of local telephone companies, including Horry Telephone
Cooperative, Southern Coastal Cable and Knology, are offering
competing services, principally in South Carolina. TWC’s
Ohio operations face competition from local telephone companies
such as New Knoxville Telephone Company, Wide Open West,
Telephone Service Company and Columbus Grove Telephone Company.
Recently, AT&T was granted franchises in the Columbus area.
There is also local telephone company and other overbuild
competition in TWC’s Texas region in the areas of Dallas,
San Antonio, Waco, Austin and other areas in south and west
Texas that TWC serves. Competing providers include FISION,
Grande Communications, Wide Open West, and Western Integrated
Networks. AT&T and Verizon have also been granted
state-issued franchises in Texas. In southern California, TWC
faces competition from RCN, AT&T and Verizon.
Additional overbuild situations may occur in these and
TWC’s other operating areas. In particular, Verizon and
AT&T have both indicated that they will continue to upgrade
their networks to enable the delivery of video and high-speed
data services, in addition to their existing telephone services.
In addition, companies that traditionally have not provided
cable services and that have substantial financial resources may
also decide to obtain franchises and seek to provide competing
services.
Increased competition from any source, including overbuilders,
could require TWC to charge lower prices for existing or future
services than it otherwise might or require TWC to invest in or
otherwise obtain additional services more quickly or at higher
costs than it otherwise might. These actions, or the failure to
take steps to allow TWC to compete effectively, could adversely
affect TWC’s growth, financial condition and results of
operations.
TWC faces risks relating to competition for the leisure
and entertainment time of audiences, which has intensified in
part due to advances in technology.
In addition to the various competitive factors discussed above,
TWC’s business is subject to risks relating to increasing
competition for the leisure and entertainment time of consumers.
TWC’s business competes with all other sources of
entertainment and information delivery, including broadcast
television, movies, live events, radio broadcasts, home video
products, console games, print media and the Internet.
Technological advancements, such as VOD, new video formats, and
Internet streaming and downloading, have increased the number of
entertainment and information delivery choices available to
consumers and intensified the challenges posed by audience
fragmentation. The increasing number of choices available to
audiences could negatively impact not only consumer demand for
TWC’s products and services, but also advertisers’
willingness to purchase advertising from TWC. If TWC does not
respond appropriately to further increases in the leisure and
entertainment choices available to consumers, its competitive
position could deteriorate, and its financial results could
suffer.
Significant increases in the use of bandwidth-intensive
Internet-based services could increase TWC’s costs.
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The rising popularity of bandwidth-intensive Internet-based
services poses special risks for TWC’s high-speed data
business. Examples of such services include
peer-to-peer
file sharing services, gaming services, the delivery of video
via streaming technology and by download, as well as Internet
phone services. If heavy usage of bandwidth-intensive services
grows beyond TWC’s current expectations, it may need to
invest more capital than currently anticipated to expand the
bandwidth capacity of its systems or its customers may have a
suboptimal experience when using its high-speed data service.
TWC’s ability to manage its network efficiently could be
restricted by legislative efforts to impose so-called “net
neutrality” requirements on cable operators. See
“— Risks Related to Government
Regulation — TWC’s business is subject to
extensive governmental regulation, which could adversely affect
its business.”
TWC offers high-quality information, entertainment and
communication services over sophisticated broadband cable
networks. TWC believes these networks currently provide the most
efficient means to provide such services to consumers’
homes. However, consumers are increasingly interested in
accessing information, entertainment and communication services
outside the home as well.
TWC is exploring various means by which it can offer its
customers mobile services but there can be no assurance that TWC
will be successful in doing so or that any such services it
offers will appeal to consumers. In November 2005, TWC and
several other cable operators, together with Sprint, announced
the formation of a joint venture that would develop integrated
cable and wireless products that the venture’s owners could
offer to customers bundled with cable services. There can be no
assurance that the joint venture will successfully develop any
such products, that any products developed will be accepted by
consumers or, even if accepted, that the offering will be
profitable. A separate joint venture formed by the same parties
participated in the recently completed FCC Auction 66 for
Advanced Wireless Spectrum and was the winning bidder of 137
licenses. The FCC awarded these licenses to the venture on
November 29, 2006. There can be no assurance that the
venture will successfully develop mobile voice and related
wireless services or otherwise benefit from the acquired
spectrum.
Until recently, TWC’s telephone competitors have only been
able to include mobile services in their offerings through
co-marketing relationships with affiliated wireless providers,
which TWC does not believe have proven particularly compelling
to consumers. However, TWC anticipates that, in the future, its
competitors will either gain greater ownership of, or enter into
more effective marketing arrangements with, these wireless
providers. For instance, as a result of AT&T’s recent
acquisition of BellSouth Corp., it has acquired 100% ownership
of Cingular Wireless, LLC, a wireless provider of which AT&T
previously owned 60%. If TWC’s competitors begin to expand
their service bundles to include compelling mobile features
before TWC has developed an equivalent or more compelling
offering, TWC may not be in a position to provide a competitive
product offering and its business and financial results could
suffer.
If TWC pursues wireless strategies intended to provide it with a
competitive response to offerings such as those described above,
there can be no assurance that such strategies will succeed. For
instance, TWC could, in pursuing such a strategy, select
technologies, products and services that fail to appeal to
consumers. In addition, TWC could incur significant costs in
gaining access to, developing and marketing, such services. If
TWC incurred such costs, and the resulting products and services
were not competitive with other parties’ products or
appealing to TWC’s customers, its business and financial
results could suffer.
Additional
Risks of TWC’s Operations
TWC operates in a highly competitive, consumer-driven and
rapidly changing environment and is, to a large extent,
dependent on its ability to acquire, develop, adopt and exploit
new and existing technologies to distinguish its services from
those of its competitors. This may take long periods of time and
require significant capital investments. In addition, TWC may be
required to anticipate far in advance which technologies and
equipment it should adopt for new products and services or for
future enhancements of or upgrades to its existing products and
services. If TWC chooses technologies or equipment that are less
effective, cost-efficient or attractive to its
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customers than those chosen by its competitors, or if TWC offers
products or services that fail to appeal to consumers, are not
available at competitive prices or that do not function as
expected, its competitive position could deteriorate, and its
business and financial results could suffer.
TWC’s competitive position also may be adversely affected
by various timing factors, such as the ability of its
competitors to acquire or develop and introduce new
technologies, products and services more quickly than it does.
Furthermore, advances in technology, decreases in the cost of
existing technologies or changes in competitors’ product
and service offerings also may require TWC in the future to make
additional research and development expenditures or to offer at
no additional charge or at a lower price certain products and
services it currently offers to customers separately or at a
premium. In addition, the uncertainty of the costs for obtaining
intellectual property rights from third parties could impact
TWC’s ability to respond to technological advances in a
timely manner.
The combination of increased competition, more technologically
advanced platforms, products and services, the increasing number
of choices available to consumers and the overall rate of change
in media and entertainment industries requires companies such as
TWC to become more responsive to consumer needs and to adapt
more quickly to market conditions than has been necessary in the
past. TWC could have difficulty managing these changes while at
the same time maintaining its rates of growth and profitability.
The Transactions have combined cable systems that were
previously owned and operated by three different companies. TWC
expects that it will realize cost savings and other financial
and operating benefits as a result of the Transactions. However,
due to the complexity of and risks relating to the integration
of these systems, among other factors, TWC cannot predict with
certainty when these cost savings and benefits will occur or the
extent to which they actually will be achieved, if at all.
The successful integration of the Acquired Systems will depend
primarily on TWC’s ability to manage the combined
operations and integrate into its operations the Acquired
Systems (including management information, marketing,
purchasing, accounting and finance, sales, billing, customer
support and product distribution infrastructure, personnel,
payroll and benefits, regulatory compliance and technology
systems). The integration of these systems, including the
upgrade of certain portions of the Acquired Systems, requires
significant capital expenditures and may require TWC to use
financial resources it would otherwise devote to other business
initiatives, including marketing, customer care, the development
of new products and services and the expansion of its existing
cable systems. While TWC has planned for certain capital
expenditures for, among other things, improvements to plant and
technical performance and upgrading system capacity of the
Acquired Systems, TWC may be required to spend more than
anticipated for those purposes. Furthermore, these integration
efforts may require more attention from TWC’s management
and impose greater strains on its technical resources than
anticipated. If TWC fails to successfully integrate the Acquired
Systems, it could have a material adverse effect on TWC’s
business and financial results.
Additionally, to the extent TWC encounters significant
difficulties in integrating systems or other operations,
TWC’s customer care efforts may be hampered. For instance,
TWC may experience
higher-than-normal
call volumes under such circumstances, which might interfere
with its ability to take orders, assist customers not impacted
by the integration difficulties, and conduct other ordinary
course activities. In addition, depending on the scope of the
difficulties, TWC may be the subject of negative press reports
or customer perception.
TWC has transitional services arrangements with Comcast under
which Comcast has agreed to assist TWC by providing certain
services to applicable Acquired Systems as TWC integrates those
systems into its existing systems. Any failure by Comcast to
perform under its agreements may cause the integration of the
applicable Acquired Systems to be delayed and may increase the
amount of time and money TWC needs to devote to the integration
of the applicable Acquired Systems.
TWC may encounter unforeseen difficulties as it introduces its
voice services in new operating areas, including the Acquired
Systems,
and/or
increases the scale of its voice service offerings in areas in
which they have already
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been launched. First, TWC faces heightened customer expectations
for the reliability of voice services as compared with its video
and high-speed data services. TWC has undertaken significant
training of customer service representatives and technicians,
and it will continue to need a highly trained workforce. To
ensure reliable service, TWC may need to increase its
expenditures, including spending on technology, equipment and
personnel. If the service is not sufficiently reliable or TWC
otherwise fails to meet customer expectations, its voice
services business could be adversely affected. Second, the
competitive landscape for voice services is intense; TWC faces
competition from providers of Internet phone services, as well
as incumbent local telephone companies, cellular telephone
service providers and others. See “— Risks
Related to Competition — TWC faces a wide range of
competition, which could affect its future results of
operations.” Third, TWC’s voice services depend on
interconnection and related services provided by certain third
parties. As a result, TWC’s ability to implement changes as
the service grows may be limited. Finally, TWC expects advances
in communications technology, as well as changes in the
marketplace and the regulatory and legislative environment.
Consequently, TWC is unable to predict the effect that ongoing
or future developments in these areas might have on its voice
services business and operations.
In addition, TWC’s launch of voice services in the Acquired
Systems may pose certain risks. TWC will be unable to provide
its voice services in some of the Acquired Systems without first
upgrading the facilities. Additionally, TWC may need to obtain
certain services from third parties prior to deploying voice
services in the Acquired Systems. If TWC encounters difficulties
or significant delays in launching voice services in the
Acquired Systems, its business and financial results may be
adversely affected.
Providing basic video services is an established and highly
penetrated business. Approximately 85% of U.S. households
are now receiving multi-channel video service. As a result,
TWC’s ability to achieve incremental growth in basic video
subscribers is dependent in part on growth in new housing in its
service areas, which is influenced by various factors outside of
TWC’s control, including both national and local economic
conditions. If growth in new housing falls or if there are
population declines in TWC’s operating areas, opportunities
to gain new basic subscribers will decrease, which may have a
material adverse effect on TWC’s growth, business and
financial results or financial condition.
TWC
relies on network and information systems and other technology,
and a disruption or failure of such networks, systems or
technology as a result of computer viruses, misappropriation of
data or other malfeasance, as well as outages, natural
disasters, accidental releases of information or similar events,
may disrupt TWC’s business.
Because network and information systems and other technologies
are critical to TWC’s operating activities, network or
information system shutdowns caused by events such as computer
hacking, dissemination of computer viruses, worms and other
destructive or disruptive software, denial of service attacks
and other malicious activity, as well as power outages, natural
disasters, terrorist attacks and similar events, pose increasing
risks. Such an event could have an adverse impact on TWC and its
customers, including degradation of service, service disruption,
excessive call volume to call centers and damage to equipment
and data. Such an event also could result in large expenditures
necessary to repair or replace such networks or information
systems or to protect them from similar events in the future.
Significant incidents could result in a disruption of TWC’s
operations, customer dissatisfaction, or a loss of customers and
revenues.
Furthermore, TWC’s operating activities could be subject to
risks caused by misappropriation, misuse, leakage, falsification
and accidental release or loss of information maintained in
TWC’s information technology systems and networks,
including customer, personnel and vendor data. TWC could be
exposed to significant costs if such risks were to materialize,
and such events could damage its reputation and credibility. TWC
also could be required to expend significant capital and other
resources to remedy any such security breach. As a result of the
increasing awareness concerning the importance of safeguarding
personal information, the potential misuse of such information
and legislation that has been adopted or is being considered
regarding the protection and security of
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personal information, information-related risks are increasing,
particularly for businesses like TWC’s that handle a large
amount of personal customer data.
TWC’s success depends in part on its ability to attract,
hire, train and retain qualified managerial, sales, customer
service and marketing personnel. TWC faces significant
competition for these types of personnel. TWC may be
unsuccessful in attracting and retaining the required personnel
to conduct and expand its operations successfully and, in such
an event, its revenues and profitability could decline.
TWC’s success also depends to a significant extent on the
continued service of its senior management team, including
Messrs. Britt and Hobbs, with whom TWC has employment
agreements. The loss of any member of TWC’s senior
management team or other qualified employees could impair
TWC’s ability to execute its business plan and growth
strategy, cause TWC to lose subscribers and reduce its net
sales, or lead to employee morale problems
and/or the
loss of key employees. In addition, key personnel may leave TWC
and compete against it.
TWC relies on patent, copyright, trademark and trade secret laws
and licenses and other agreements with its employees, customers,
suppliers, and other parties, to establish and maintain its
intellectual property rights in technology and the products and
services used in TWC’s operations. However, any of
TWC’s intellectual property rights could be challenged or
invalidated, or such intellectual property rights may not be
sufficient to permit TWC to take advantage of current industry
trends or otherwise to provide competitive advantages, which
could result in costly redesign efforts, discontinuance of
certain product or service offerings or other competitive harm.
Additionally, from time to time TWC receives notices from others
claiming that it infringes their intellectual property rights,
and the number of these claims could increase in the future.
Claims of intellectual property infringement could require TWC
to enter into royalty or licensing agreements on unfavorable
terms, incur substantial monetary liability or be enjoined
preliminarily or permanently from further use of the
intellectual property in question, which could require TWC to
change its business practices and limit its ability to compete
effectively. Even if TWC believes that the claims are without
merit, the claims can be time-consuming and costly to defend and
divert management’s attention and resources away from
TWC’s businesses. Also, because of the rapid pace of
technological change, TWC relies on technologies developed or
licensed by third parties, and TWC may not be able to obtain or
continue to obtain licenses from these third parties on
reasonable terms, if at all. See also “— Risks
Related to TWC’s Relationship with Time Warner —
TWC is party to agreements with Time Warner governing the use of
TWC’s brand names, including the “Time Warner
Cable” brand name, that may be terminated by Time Warner if
TWC fails to perform its obligations under those agreements or
if it undergoes a change of control.”
As of December 31, 2006, TWC had approximately
$41.0 billion of unamortized intangible assets, including
goodwill of $2.1 billion and cable franchises of
$38.1 billion on its balance sheet. At December 31,
2006, these intangible assets represented approximately 74% of
TWC’s total assets.
Financial Accounting Standards Board (“FASB”)
Statement No. 142, Goodwill and Other Intangible Assets
(“FAS 142”) requires that goodwill, including
the goodwill included in the carrying value of investments
accounted for using the equity method of accounting, and other
intangible assets deemed to have indefinite useful lives, such
as franchise agreements, cease to be amortized. FAS 142
requires that goodwill and certain intangible assets be tested
at least annually for impairment. If TWC finds that the carrying
value of goodwill or a certain intangible asset exceeds its fair
value, it will reduce the carrying value of the goodwill or
intangible asset to the fair value, and will recognize an
impairment loss. Any such impairment losses are required to be
recorded as noncash operating losses.
TWC’s 2006 annual impairment analysis, which was performed
during the fourth quarter, did not result in an impairment
charge. For one reporting unit, the 2006 estimated fair value
was within 10% of the respective book
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value. Applying a hypothetical 10% decrease to the fair value of
this reporting unit would result in a greater book value than
fair value for cable franchises in the amount of approximately
$20 million. Other intangible assets not subject to
amortization are tested for impairment annually, or more
frequently if events or circumstances indicate that the asset
might be impaired. See “Management’s Discussion and
Analysis of Results of Operations and Financial
Condition — Critical Accounting Policies —
Asset Impairments — Goodwill and Indefinite-lived
Intangible Assets” and “— Finite-lived
Intangible Assets.”
The impairment tests require TWC to make an estimate of the fair
value of intangible assets, which is primarily determined using
discounted cash flow methodologies, research analyst estimates,
market comparisons and a review of recent transactions. Since a
number of factors may influence determinations of fair value of
intangible assets, including those set forth in this discussion
of “Risk Factors,” TWC is unable to predict whether
impairments of goodwill or other indefinite-lived intangibles
will occur in the future. Any such impairment would result in
TWC recognizing a corresponding operating loss, which could have
a material adverse effect on the market price of its
Class A common stock.
The
IRS and state and local tax authorities may challenge the tax
characterizations of the Adelphia Acquisition, the Redemptions
and the Exchange, or TWC’s related valuations, and any
successful challenge by the IRS or state or local tax
authorities could materially adversely affect TWC’s tax
profile, significantly increase TWC’s future cash tax
payments and significantly reduce its future earnings and cash
flow.
The Adelphia Acquisition was designed to be a fully taxable
asset sale, the TWC Redemption was designed to qualify as a
tax-free split-off under section 355 of the Internal
Revenue Code of 1986, as amended (the “Tax Code”), the
TWE Redemption was designed as a redemption of Comcast’s
partnership interest in TWE, and the Exchange was designed as an
exchange of designated cable systems. There can be no assurance,
however, that the Internal Revenue Service (the “IRS”)
or state or local tax authorities (collectively with the IRS,
the “Tax Authorities”) will not challenge one or more
of such characterizations or TWC’s related valuations. Such
a successful challenge by the Tax Authorities could materially
adversely affect TWC’s tax profile (including its ability
to recognize the intended tax benefits from the Transactions),
significantly increase TWC’s future cash tax payments and
significantly reduce its future earnings and cash flow. The tax
consequences of the Adelphia Acquisition, the Redemptions and
the Exchange are complex and, in many cases, subject to
significant uncertainties, including, but not limited to,
uncertainties regarding the application of federal, state and
local income tax laws to various transactions and events
contemplated therein and regarding matters relating to valuation.
A significant portion of TWC’s indebtedness will
mature over the next three to five years. If TWC is unable to
refinance this indebtedness on favorable terms its financial
condition and results of operations may suffer.
As of December 31, 2006, TWC had $14.4 billion in
long-term debt. In particular, TWC is the borrower under two
$4.0 billion term loan facilities and a $6.0 billion
revolving credit facility, which become due in February 2009,
February 2011 and February 2011, respectively, as well as an
issuer of commercial paper. In addition, TWE’s
7.25% senior debentures with a principal amount of
$600 million will mature in 2008. No assurance can be given
that TWC will be able to refinance its or its subsidiaries’
existing indebtedness on favorable terms, if at all. TWC’s
ability to refinance its indebtedness could be affected by many
factors, including adverse developments in the lending markets
and other external factors which are beyond TWC’s control.
If TWC is unable to refinance its indebtedness on favorable
terms, its cost of financing could increase significantly and
have a material adverse effect on its business, financial
results and financial condition. See “Management’s
Discussion and Analysis of Results of Operations and Financial
Condition — Financial Condition and Liquidity.”
As a result of the indebtedness incurred in connection
with the Transactions, TWC will be required to use an increased
amount of the cash provided by its operating activities to
service its debt obligations, which could limit its flexibility
to grow its business and take advantage of new business
opportunities.
Borrowings under TWC’s bank credit agreements and
commercial paper program increased from $1.1 billion at
December 31, 2005 to $11.1 billion at
December 31, 2006, primarily in order to fund a large
portion of the cash payments made in connection with the
Transactions. As a result, TWC’s obligations to make
principal and interest payments related to TWC’s
indebtedness have increased. TWC’s increased amount of
indebtedness and debt servicing obligations will require TWC to
dedicate a larger amount of its cash flow from operations to
making
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payments on its indebtedness than it has in the past. This
reduces the availability of TWC’s cash flow to fund working
capital and capital expenditures and for other general corporate
purposes, may increase TWC’s vulnerability to general
adverse economic and industry conditions, may limit TWC’s
flexibility in planning for, or reacting to, changes in its
business and the industry in which it operates, may limit
TWC’s ability to make strategic acquisitions or pursue
other business opportunities and may limit its ability to borrow
additional funds and may increase the cost of any such
borrowings.
Programming has been, and is expected to continue to be, one of
TWC’s largest operating expense items for the foreseeable
future. In recent years, TWC has experienced significant
increases in the cost of programming, particularly sports
programming. The increases are expected to continue due to a
variety of factors, including inflationary and negotiated annual
increases, additional programming being provided to subscribers,
and increased costs to purchase new programming.
Programming cost increases that are not passed on fully to
TWC’s subscribers have had, and will continue to have, an
adverse impact on cash flow and operating margins. In addition,
such increases could have an adverse impact on cash flow and
operating margins from new video products and services. Current
and future programming providers that provide content that is
desirable to TWC’s subscribers may enter into exclusive
affiliation agreements with TWC’s cable and non-cable
competitors and may be unwilling to enter into affiliation
agreements with TWC on acceptable terms, if at all.
In addition, increased demands by owners of some broadcast
stations for carriage of other services or payments to those
broadcasters for retransmission consent could further increase
TWC’s programming costs. Federal law allows commercial
television broadcast stations to make an election between
“must-carry” rights and an alternative
“retransmission-consent” regime. When a station opts
for the latter, cable operators are not allowed to carry the
station’s signal without the station’s permission. TWC
currently has multi-year agreements with most of the
retransmission consent stations that it carries. In some cases,
TWC carries stations under short-term arrangements while it
attempts to negotiate new long-term retransmission agreements.
If negotiations with these programmers prove unsuccessful, they
could require TWC to cease carrying their signals, possibly for
an indefinite period. Any loss of stations could make TWC’s
video service less attractive to subscribers, which could result
in less subscription and advertising revenue. In
retransmission-consent negotiations, broadcasters often
condition consent with respect to one station on carriage of one
or more other stations or programming services in which they or
their affiliates have an interest. Carriage of these other
services may increase TWC’s programming expenses and
diminish the amount of capacity it has available to introduce
new services, which could have an adverse effect on TWC’s
business and financial results.
TWC may not be able to obtain necessary hardware, software
and operational support.
TWC depends on third party suppliers and licensors to supply
some of the hardware, software and operational support necessary
to provide some of its services. TWC obtains these items from a
limited number of vendors, some of which do not have a long
operating history. Some of TWC’s hardware, software and
operational support vendors represent TWC’s sole source of
supply or have, either through contract or as a result of
intellectual property rights, a position of some exclusivity. If
demand exceeds these vendors’ capacity or if these vendors
experience operating or financial difficulties, TWC’s
ability to provide some services might be materially adversely
affected, or the need to procure or develop alternative sources
of the affected materials might delay the provision of services.
These events could materially and adversely affect TWC’s
ability to retain and attract subscribers, and have a material
negative impact on TWC’s operations, business, financial
results and financial condition. Since late 2006, TWC has noted
increased demand for HDTV-capable set-top boxes. This increased
demand comes at a time when TWC’s set-top box suppliers
need to begin making changes in their production processes to
enable them to supply cable operators with set-top boxes that
use separate security. See “— Risks Related to
Government Regulation — The FCC’s set-top box
rules could impose significant additional costs on TWC”
below. As of February 20, 2007, TWC was experiencing, and
may continue to experience during the near term, difficulty in
obtaining sufficient quantities of HDTV-capable set-top boxes to
satisfy all consumer requests for such boxes.
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A limited number of vendors of key technologies can lead to less
product innovation and higher costs. For these reasons, TWC
generally endeavors to establish alternative vendors for
materials it consider critical, but may not be able to establish
these relationships or be able to obtain required materials on
favorable terms. For example, each of TWC’s systems
currently purchases set-top boxes from a limited number of
vendors. This is due to the fact that each of TWC’s cable
systems uses one of two proprietary conditional access security
schemes, which allow TWC to regulate subscriber access to some
services, such as premium channels. TWC believes that the
proprietary nature of these conditional access schemes makes
other manufacturers reluctant to produce set-top boxes. Future
innovation in set-top boxes may be restricted until these issues
are resolved. In addition, TWC believes that the general lack
of compatibility among set-top box operating systems has slowed
the industry’s development and deployment of digital
set-top box applications. TWC has developed a proprietary user
interface and interactive programming guide that it expects to
introduce in most of its operating areas during 2007. No
assurance can be given that TWC’s proprietary interface and
guide will operate correctly, will be popular with consumers or
will be compatible with other products and services that
TWC’s customers value.
In addition, TWC has agreements with Verizon and Sprint under
which these companies assist TWC in providing Digital Phone
service to customers by routing voice traffic to the public
switched network, delivering enhanced 911 service and assisting
in local number portability and long distance traffic carriage.
In July 2006, TWC agreed to expand its multi-year relationship
with Sprint, selecting Sprint as its primary provider of these
services, including in the Acquired Systems. TWC’s
transition to and reliance on a single provider for the bulk of
these services may render it vulnerable to service disruptions.
In addition, in some limited areas, as a result of rulings of
the applicable state public utility commissions, Verizon and
Sprint cannot provide TWC with certain of their services,
including those that use interconnection obtained from certain
local telephone companies. While TWC has filed a petition with
the FCC requesting clarification that Verizon and Sprint are
entitled to provide these services to TWC and, in the interim,
plans to provide its Digital Phone service in these limited
areas, where possible, by obtaining interconnection directly
from the local telephone companies and providing TWC’s own
911 connectivity and number portability, TWC’s inability to
use Sprint and Verizon for these services could negatively
impact its ability to offer Digital Phone in certain areas as
well as the cost of providing its service.
Under federal law, TWC has the right to attach cables carrying
video services to the telephone and similar poles of
investor-owned utilities at regulated rates. However, because
these cables carry services other than video services, such as
high-speed data services or new forms of voice services, some
utility pole owners have sought to impose additional fees for
pole attachment. The U.S. Supreme Court has rejected the
efforts of some utility pole owners to make cable attachments
carrying Internet traffic ineligible for regulatory protection.
Pole owners have, however, made arguments in other areas of pole
regulation that, if successful, could significantly increase
TWC’s costs. In addition, TWC’s pole attachment rates
may increase insofar as TWC’s systems are providing voice
services.
Some of the poles TWC uses are exempt from federal regulation
because they are owned by utility cooperatives and municipal
entities. These entities may not renew TWC’s existing
agreements when they expire, and they may require TWC to pay
substantially increased fees. A number of these entities are
currently seeking to impose substantial rate increases. Any
inability to secure continued pole attachment agreements with
these cooperatives or municipal utilities on commercially
reasonable terms could cause TWC’s business, financial
results or financial condition to suffer.
Customer acceptance and use of new and enhanced services depend,
to some extent, on customers having ready access and exposure to
these services. One of the ways this access is facilitated is
through the user interface included in TWC’s digital
set-top boxes. As of December 31, 2006, approximately 54%
of TWC’s basic video subscribers leased one or more digital
set-top boxes from it. The consumer electronics industry’s
provision of “cable
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ready” and “digital cable ready” televisions and
other devices, as well as the IT industry’s provision of
computing devices capable of tuning, storing and displaying
cable video signals, means customers owning these devices may
use a different user interface from the one TWC provides
and/or may
not be able to access services requiring two-way transmission
capabilities unless they also have a set-top box. Accordingly,
customers using these devices without set-top boxes may have
limited exposure and access to TWC’s advanced video
services, including its interactive program guide and VOD and
SVOD. If such devices attain wide consumer acceptance,
TWC’s revenue from equipment rental and two-way
transmission-based services could decrease, and there could be a
negative impact on TWC’s ability to sell advanced services
to customers. TWC cannot predict the extent to which different
interfaces will affect TWC’s future business and
operations. See Item 1, “Business —
Regulatory Matters — Communications Act and FCC
Regulation.”
TWC and other cable operators are involved in various efforts to
ensure that consumer electronics and IT industry devices are
capable of utilizing TWC’s two-way services, including:
direct arrangements with a handful of consumer electronics
companies that have led to the imminent deployment of a limited
number of two-way capable televisions and other devices;
continuing efforts (unsuccessful to date) to negotiate two-way
interoperability standards with the broad consumer electronics
industry; the development of an open software architecture layer
that such devices could use to accept two-way applications; and
an effort to develop a downloadable security system for consumer
electronics devices. No assurances can be given that these or
other efforts will be successful or that, if successful,
consumers will widely adopt devices utilizing these technologies.
TWC’s video and voice services are subject to extensive
regulation at the federal, state, and local levels. In addition,
the federal government also has been exploring possible
regulation of high-speed data services. Additional regulation,
including regulation relating to rates, equipment, programming,
levels and types of services, taxes and other charges, could
have an adverse impact on TWC’s services. TWC expects that
legislative enactments, court actions, and regulatory
proceedings will continue to clarify and in some cases change
the rights of cable companies and other entities providing
video, data and voice services under the Communications Act and
other laws, possibly in ways that TWC has not foreseen. The
results of these legislative, judicial, and administrative
actions may materially affect TWC’s business operations in
areas such as:
At the state level, several states, including California, New
Jersey, North Carolina, South Carolina and Texas have enacted
statutes intended to streamline entry by additional video
competitors. Some of these statutes provide more favorable
treatment to new entrants than to existing providers. Similar
bills are pending or may be enacted in additional states. To the
extent federal or state laws or regulations facilitate
additional competitive entry or create more favorable regulatory
treatment for new entrants, TWC’s operations could be
materially and adversely affected.
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“Net
neutrality” legislation or regulation could limit
TWC’s ability to operate its high-speed data business
profitably, to manage its broadband facilities efficiently and
to make upgrades to those facilities sufficient to respond to
growing bandwidth usage by its high-speed data
customers.
Several disparate groups have adopted the term “net
neutrality” in connection with their efforts to persuade
Congress and regulators to adopt rules that could limit the
ability of broadband providers to manage their networks
efficiently and profitably. Although the positions taken by
these groups are not well defined and are sometimes inconsistent
with one another, most would directly or indirectly limit the
ability of broadband providers to apply differential pricing or
network management policies to different uses of the Internet.
Proponents of such regulation also seek to prohibit broadband
providers from recovering the costs of rising bandwidth usage
from any parties other than retail customers. The average
bandwidth usage of TWC’s high-speed data customers has been
increasing significantly in recent years as the amount of
high-bandwidth content and the number of applications available
on the Internet continues to grow. In order to continue to
provide quality service at attractive prices, TWC needs the
continued flexibility to develop and refine business models that
respond to changing consumer uses and demands, to manage
bandwidth usage efficiently and to make upgrades to its
broadband facilities. As a result, depending on the form it
might take, “net neutrality” legislation or regulation
could impact TWC’s ability to operate its high-speed data
network profitably and to undertake the upgrades that may be
needed to continue to provide high quality high-speed data
services. TWC is unable to predict the likelihood that such
regulatory proposals will be adopted. For a
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description of current regulatory proposals, see Item 1,
“Business — Regulatory Matters —
Communications Act and FCC Regulation.”
Under current FCC regulations, rates for “basic” video
service and associated equipment are permitted to be regulated.
In many localities, TWC is not subject to basic video rate
regulation, either because the local franchising authority has
not asked the FCC for permission to regulate rates or because
the FCC has found that there is “effective
competition.” Also, there is currently no rate regulation
for TWC’s other services, including high-speed data
services. It is possible, however, that the FCC or Congress will
adopt more extensive rate regulation for TWC’s video
services or regulate other services, such as high-speed data and
voice services, which could impede TWC’s ability to raise
rates, or require rate reductions, and therefore could cause
TWC’s business, financial results or financial condition to
suffer.
Although TWC would likely choose to carry almost all local full
power analog broadcast signals voluntarily, so called “must
carry” rules require TWC to carry video programming that it
might not otherwise carry, including some local broadcast
television signals on some of its cable systems. In addition,
TWC is required to carry local public, educational and
government access video programming and unaffiliated commercial
leased access video programming. These regulations require TWC
to use a substantial part of its capacity for this video
programming and, for the most part, TWC must carry this
programming without payment or compensation from the programmer.
TWC’s carriage burden might increase due to changes in
regulation in connection with the transition to digital
broadcasting. FCC regulations require most television broadcast
stations to broadcast in digital format as well as in analog
format until digital broadcasting becomes widely accepted by
television viewers. After this transition period, digital
broadcasters must cease broadcasting in analog format. The FCC
has concluded that, during the transition period, cable
operators will not be required to carry the digital signals of
broadcasters that are broadcasting in both analog and digital
format. Only the few stations that broadcast solely in digital
format will be entitled to carriage of their digital signals
during the transition period. Some broadcast parties have asked
that the FCC reconsider that determination. If the FCC does so
and changes the decision, TWC’s carriage burden could
increase significantly.
TWC expects that, once the digital transition is complete, cable
operators will be required to carry most local
broadcasters’ digital signals. TWC is uncertain whether
that requirement will be more onerous than the carriage
requirement concerning analog signals. Under the current
regulations, each broadcaster is allowed to use the digital
spectrum allocated to it to transmit either one “high
definition” program stream or multiple separate
“standard definition” program streams. The FCC has
determined that cable operators will have to carry only one
program stream per broadcaster. Some broadcast parties have
asked the FCC to reconsider that determination. If the FCC does
so and changes the decision, TWC could be compelled to carry
more programming over which it is not able to assert editorial
control. Consequently, TWC’s mix of programming could
become less attractive to subscribers. Moreover, if the FCC
adopts rules that are not competitively neutral, cable operators
could be placed at a disadvantage versus other multi-channel
video providers.
It is not clear whether cable operators may “down
convert” must-carry digital signals after the transition to
digital broadcasts is complete to ensure they can be viewed by
households that do not have digital equipment. If the FCC
interprets the relevant statute, or if Congress clarifies the
statute, with the result that such down conversion is not
permitted, TWC could be required to incur additional costs to
deliver the signals to non-digital homes.
Local franchising authorities generally require cable operators
to pay a franchise fee of five percent of revenue, which cable
operators collect in turn from their subscribers. TWC has taken
the position that under the Communications Act, local
franchising authorities are allowed to impose a franchise fee
only on revenue from “cable services.” Following the
FCC’s March 2002 determination that cable modem service
does not constitute a “cable
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service,” TWC and most other multiple system operators
stopped collecting and paying franchise fees on cable modem
revenue.
The FCC has initiated a rulemaking proceeding to explore the
consequences of its March 2002 order. If either the FCC or a
court were to determine that, despite the March 2002 order, TWC
is required to pay franchise fees on cable modem revenue,
TWC’s franchise fee burden could increase going forward.
TWC would be permitted to collect those increased fees from its
subscribers, but doing so could impair its competitive position
as compared to high-speed data service providers who are not
required to collect and pay franchise fees. TWC could also
become liable for franchise fees back to the time it stopped
paying them. TWC may not be able to recover those fees from
subscribers.
Currently, many cable subscribers rent set-top boxes from TWC
that perform both signal-reception functions and
conditional-access security functions, as well as enable
delivery of advanced services. In 1996, Congress enacted a
statute seeking to allow cable subscribers to use set-top boxes
obtained from certain third parties, including third-party
retailers. The most important of the FCC’s implementing
regulations requires cable operators to offer separate equipment
that provides only the security functions and not the
signal-reception functions (so that cable subscribers can
purchase set-top boxes or other navigational devices from third
parties) and to cease placing into service new set-top boxes
that have integrated security and signal-reception functions.
The regulations requiring cable operators to cease distributing
new set-top boxes with integrated security and signal-reception
functions are currently scheduled to go into effect on
July 1, 2007. On August 16, 2006, the NCTA filed with
the FCC a request that these rules be waived for all cable
operators, including TWC, until a downloadable security solution
is available or December 31, 2009, whichever is earlier. No
assurance can be given that the FCC will grant this or any other
waiver request.
TWC’s vendors have not yet manufactured, on a commercial
scale, set-top boxes that can support all the services that TWC
offers while relying on separate security devices. It is
possible that TWC’s vendors will be unable to deliver the
necessary set-top boxes in time for TWC to comply with the FCC
regulations. It is also possible that the FCC will determine
that the set-top boxes that TWC eventually obtains are not
compliant with applicable rules. In either case, the FCC may
penalize TWC. In addition, design and manufacture of the new
set-top boxes will come at a significant expense, which
TWC’s vendors will seek to pass on to TWC, but which TWC in
turn may not be able to pass on to its customers, thereby
increasing its costs. TWC expects to incur approximately
$50 million in incremental set-top box costs during 2007 as
a result of these regulations. The FCC has indicated that direct
broadcast satellite operators are not required to comply with
the FCC’s set-top box rules, and one telephone company has
asked for a waiver of the rules. If TWC has to comply with the
rule prohibiting set-top boxes with integrated security while
its competitors are not required to comply with that rule, TWC
may be at a competitive disadvantage.
The exact requirements of applicable law are not always clear,
and the rules affecting TWC’s businesses are always subject
to change. For example, the FCC may interpret its rules and
regulations in enforcement proceedings in a manner that is
inconsistent with the judgments TWC has made. Likewise,
regulators and legislators at all levels of government may
sometimes change existing rules or establish new rules.
Congress, for example, considers new legislative requirements
for cable operators virtually every year, and there is always a
risk that such proposals will ultimately be enacted. See
Item 1, “Business — Regulatory Matters.”
Risks
Related to TWC’s Relationship with Time Warner
Some of TWC’s officers and directors may experience
conflicts of interest with respect to decisions involving
business opportunities and similar matters that may arise in the
ordinary course of TWC’s business or the business of Time
Warner and its affiliates. One of TWC’s directors is also
an executive officer of Time Warner, another is an
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executive officer of a subsidiary of Time Warner that is a
sister company of TWC and four of TWC’s directors
(including Glenn A. Britt, TWC’s President and Chief
Executive Officer) served as executive officers of Time Warner
or its predecessors in the past. A number of TWC’s
directors and all of its executive officers also have restricted
shares, restricted stock units
and/or
options to purchase shares of Time Warner common stock. In
addition, many of TWC’s directors and executive officers
have invested in Time Warner common stock through their
participation in Time Warner’s and TWC’s savings
plans. These past and ongoing relationships with Time Warner and
any significant financial interest in Time Warner by these
persons may present conflicts of interest that could materially
adversely affect TWC’s business, financial results or
financial condition. For example, these decisions could be
materially related to:
The TWC Certificate of Incorporation requires that TWC’s
board of directors include independent members, subject to
certain limitations, and the TWC By-Laws require that certain
related party transactions be approved by a majority of these
independent directors.
Time Warner and its affiliates are engaged in a diverse range of
entertainment and media-related businesses, including filmed
entertainment, home video and Internet-related businesses, and
these businesses may have interests that conflict with or
compete in some manner with TWC’s business. Time Warner and
its affiliates are generally under no obligation to share any
future business opportunities available to it with TWC and the
TWC Certificate of Incorporation contains provisions that
release Time Warner and its affiliates, including TWC’s
directors who are also Time Warner’s employees or executive
officers, from this obligation and any liability that would
result from breach of this obligation. Time Warner may deliver
video, high-speed data, voice and wireless services over DSL,
satellite or other means using the “Time Warner” brand
name or similar brand names, potentially causing confusion among
customers and complicating TWC’s marketing efforts. For
instance, Time Warner has licensed the use of “Time Warner
Telecom,” until July 2007, and “TW Telecom” and
“TWTC” to Time Warner Telecom Inc., a former affiliate
of Time Warner and a provider of managed voice and data
networking solutions to enterprise organizations, which may
compete with TWC’s commercial offerings. Any competition
directly with Time Warner or its affiliates could materially
adversely impact TWC’s business, financial results or
financial condition.
Some of the agreements governing the use of TWC’s brand
names may be terminated by Time Warner if TWC:
TWC licenses its brand name, “Time Warner Cable,” and
the trademark “Road Runner” from affiliates of Time
Warner. TWC believes the “Time Warner Cable” and
“Road Runner” brand names are valuable, and their loss
could materially adversely affect TWC’s business, financial
results or financial condition.
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If Time Warner terminates these brand name license agreements,
TWC would lose the goodwill associated with its brand names and
be forced to develop new brand names, which would likely require
substantial expenditures, and its business, financial results or
financial condition would likely be materially adversely
affected.
Time Warner indirectly holds all of TWC’s outstanding
Class B common stock and approximately 82.7% of its
outstanding Class A common stock. The common stock held by
Time Warner represents approximately 90.6% of TWC’s
combined voting power and 84.0% of the total number of shares of
capital stock outstanding of all classes of TWC’s voting
stock. Accordingly, Time Warner can control the outcome of most
matters submitted to a vote of TWC’s stockholders. In
addition, Time Warner, because it is the indirect holder of all
of TWC’s outstanding Class B common stock, and because
it also indirectly holds more than a majority of TWC’s
outstanding Class A common stock, is able to elect all of
TWC’s directors and will continue to be able to do so as
long as it owns a majority of TWC Class A common stock and
Class B common stock. As a result of Time Warner’s
share ownership and representation on TWC’s board of
directors, Time Warner is able to influence all of TWC’s
affairs and actions, including matters requiring stockholder
approval such as the election of directors and approval of
significant corporate transactions. The interests of Time Warner
may differ from the interests of TWC’s other stockholders.
The TWC Certificate of Incorporation requires that TWC’s
board of directors include independent members, subject to
certain limitations, and the TWC By-Laws require that certain
related party transactions be approved by a majority of these
independent directors.
Under a shareholder agreement entered into between TWC and Time
Warner on April 20, 2005 (the “Shareholder
Agreement”), which became effective upon the closing of the
TWC Redemption, until Time Warner no longer considers TWC to
have an impact on its credit profile, TWC must obtain the
approval of Time Warner prior to incurring additional debt or
rental expense (other than with respect to certain approved
leases) or issuing preferred equity, if TWC’s consolidated
ratio of debt, including preferred equity, plus six times its
annual rental expense to consolidated earnings before interest,
taxes, depreciation and amortization (each as defined in the
Shareholder Agreement) (“EBITDA”) plus rental expense,
or “EBITDAR,” then exceeds, or would as a result of
that incurrence exceed, 3:1, calculated without including any of
TWC’s indebtedness or preferred equity held by Time Warner
and its wholly owned subsidiaries. On December 31, 2006,
this ratio did not exceed 3:1. Although Time Warner has
consented to the issuance of commercial paper or borrowings
under TWC’s current revolving credit facility up to the
limit of that credit facility, if the ratio were exceeded, any
other incurrence of debt or rental expense (other than with
respect to certain approved leases) or the issuance of preferred
stock would require Time Warner’s approval. As a result,
TWC may in the future have a limited ability to incur future
debt and rental expense (other than with respect to certain
approved leases) and issue preferred equity without the consent
of Time Warner, which if needed to raise additional capital,
could limit TWC’s flexibility in exploring and pursuing
financing alternatives and could have a material adverse effect
on the market price of TWC Class A common stock and its
liquidity and operations and restrict its growth.
TWC’s ability to obtain financing in the capital markets
and from other private sources may be adversely affected by
future capital markets activity undertaken by Time Warner and
its other subsidiaries. Capital raised by or committed to Time
Warner for matters unrelated to TWC may reduce the supply of
capital available for TWC as a result of increased leverage of
Time Warner on a consolidated basis or reluctance in the market
to incur additional credit exposure to Time Warner on a
consolidated basis. In addition, TWC’s ability to undertake
significant capital raising activities may be constrained by
competing capital needs of other Time Warner businesses
unrelated to TWC. For instance, on November 13, 2006, Time
Warner issued $5 billion in principal amount of notes and
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debentures with maturity dates ranging from November 2009 to
November 2036. As of December 31, 2006, Time Warner had
unused committed capacity of $7.1 billion, including
approximately $1.5 billion of cash and equivalents, under
its $7.0 billion committed credit facility, and TWC had
approximately $2.8 billion of available borrowing capacity,
including approximately $51 million of cash and
equivalents, under its $14.0 billion committed credit
facilities.
TWC
is exempt from certain corporate governance requirements since
TWC is a “controlled company” within the meaning of
the New York Stock Exchange (the “NYSE”) rules and, as
a result, its stockholders do not have the protections afforded
by these corporate governance requirements.
Time Warner controls more than 50% of the voting power of the
outstanding TWC common stock. As a result, TWC is considered to
be a “controlled company” for the purposes of the NYSE
listing requirements and therefore is permitted to, and has,
opted out of the NYSE listing requirements that would otherwise
require its board of directors to have a majority of independent
directors and its compensation and nominating and governance
committees to be comprised entirely of independent directors.
Accordingly, TWC’s stockholders do not have the same
protections afforded to stockholders of companies that are
subject to all of the NYSE corporate governance requirements.
However, the TWC Certificate of Incorporation contains
provisions requiring that independent directors constitute at
least 50% of its board of directors and the TWC By-Laws require
that certain related party transactions be approved by a
majority of these independent directors.
As a condition to the consummation of the Adelphia Acquisition,
the TWC Certificate of Incorporation provides that this
provision may not be amended, altered or repealed, and no
provision inconsistent with this requirement may be adopted, for
a period of three years following the closing of the Adelphia
Acquisition without, among other things, the consent of a
majority of the holders of the Class A common stock other
than Time Warner and its affiliates.
Not applicable.
TWC’s principal physical assets consist of operating plant
and equipment, including signal receiving, encoding and decoding
devices, headends and distribution systems and equipment at or
near subscribers’ homes for each of TWC’s cable
systems. The signal receiving apparatus typically includes a
tower, antenna, ancillary electronic equipment and earth
stations for reception of satellite signals. Headends,
consisting of electronic equipment necessary for the reception,
amplification and modulation of signals, are located near the
receiving devices. TWC’s distribution system consists
primarily of coaxial and fiber optic cables, lasers, routers,
switches and related electronic equipment. TWC’s cable
plant and related equipment generally are 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. Customer premise equipment
consists principally of set-top boxes and cable modems. The
physical components of cable systems require periodic
maintenance.
TWC’s high-speed data backbone consists of fiber owned by
TWC or circuits leased from affiliated and
third-party
vendors, and related equipment. TWC also operates regional and
national data centers with equipment that is used to provide
services, such as
e-mail, news
and web services to TWC’s high-speed data subscribers and
to provide services to its Digital Phone customers. In addition,
TWC maintains a network operations center with equipment
necessary to monitor and manage the status of TWC’s
high-speed data network.
As of December 31, 2006, the largest property TWC owned was
an approximately 318,500 square foot building housing one
of TWC’s divisional headquarters, a call center and a
warehouse in Columbia, SC, of which approximately 50% is leased
to a
third-party
tenant, and TWC leased and owned other real property housing
national operations centers and regional data centers used in
TWC’s high-speed data services business in Herndon, VA;
Raleigh, NC; Tampa, FL; Syracuse, NY; Austin, TX; Kansas City,
MO; Orange County, CA; New York, NY; and Columbus, OH. As of
December 31, 2006, TWC also leased and owned locations for
its corporate offices in Stamford, CT and Charlotte, NC as well
as numerous business offices, warehouses and properties housing
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divisional operations throughout the country. TWC’s signal
reception sites, primarily antenna towers and headends, and
microwave facilities are located on owned and leased parcels of
land, and TWC owns or leases space on the towers on which
certain of TWC’s equipment is located. TWC owns most of its
service vehicles.
TWC believes that its properties, both owned and leased, taken
as a whole, are in good operating condition and are suitable and
adequate for its business operations. The nature of the
facilities and properties that TWC acquired as a result of the
Transactions is substantially similar to those used in its
existing business.
On May 20, 2006, the America Channel LLC filed a lawsuit in
U.S. District Court for the District of Minnesota against
both TWC and Comcast alleging that the purchase of Adelphia by
Comcast and TWC will injure competition in the cable system and
cable network markets and violate the federal antitrust laws.
The lawsuit seeks monetary damages as well as an injunction
blocking the Adelphia Acquisition. The United States Bankruptcy
Court for the Southern District of New York issued an order
enjoining the America Channel from pursuing injunctive relief in
the District of Minnesota and ordering that the America
Channel’s efforts to enjoin the transaction can only be
heard in the Southern District of New York, where the Adelphia
bankruptcy is pending. America Channel’s appeal of this
order was dismissed on October 10, 2006 and its claim for
injunctive relief should now be moot. However, America Channel
has announced its intention to proceed with its damages case in
the District of Minnesota. On September 19, 2006, TWC filed
a motion to dismiss this action, which was granted on
January 17, 2007 with leave to replead. On February 5,
2007, the America Channel filed an amended complaint. TWC
intends to defend against this lawsuit vigorously. TWC is unable
to predict the outcome of this suit or reasonably estimate a
range of possible loss.
On June 22, 2005, Mecklenburg County filed suit against
TWE-A/N in the General Court of Justice District Court Division,
Mecklenburg County, North Carolina. Mecklenburg County, the
franchisor in TWE-A/N’s Mecklenburg County cable system,
alleges that TWE-A/N’s predecessor failed to construct an
institutional network in 1981 and that TWE-A/N assumed that
obligation upon the transfer of the franchise in 1995.
Mecklenburg County is seeking compensatory damages and
TWE-A/N’s release of certain video channels it is currently
using on the cable system. On April 14, 2006, TWE-A/N filed
a motion for summary judgment, which is pending. TWE-A/N intends
to defend against this lawsuit vigorously. TWC is unable to
predict the outcome of this suit or reasonably estimate a range
of possible loss.
On June 16, 1998, plaintiffs in Andrew Parker and Eric
DeBrauwere, et al. v. Time Warner Entertainment
Company, L.P. and Time Warner Cable filed a purported
nationwide class action in U.S. District Court for the
Eastern District of New York claiming that TWE sold its
subscribers’ personally identifiable information and failed
to inform subscribers of their privacy rights in violation of
the Cable Communications Policy Act of 1984 (the “Cable
Act”) and common law. The plaintiffs seek damages and
declaratory and injunctive relief. On August 6, 1998, TWE
filed a motion to dismiss, which was denied on September 7,
1999. On December 8, 1999, TWE filed a motion to deny class
certification, which was granted on January 9, 2001 with
respect to monetary damages, but denied with respect to
injunctive relief. On June 2, 2003, the U.S. Court of
Appeals for the Second Circuit vacated the District Court’s
decision denying class certification as a matter of law and
remanded the case for further proceedings on class certification
and other matters. On May 4, 2004, plaintiffs filed a
motion for class certification, which TWC has opposed. On
October 25, 2005, the court granted preliminary approval of
a class settlement arrangement on terms that were not material
to the Company. A final settlement approval hearing was held on
May 19, 2006, and on January 26, 2007, the court
denied approval of the settlement. TWC intends to defend against
this lawsuit vigorously, but is unable to predict the outcome of
the suit or reasonably estimate a range of possible loss.
On September 1, 2006, Ronald A. Katz Technology Licensing,
L.P. filed a complaint in the U.S. District Court for the
District of Delaware alleging that TWC and several other cable
operators infringe a number of patents purportedly relating to
TWC’s customer call center operations, voicemail
and/or VOD
services. The plaintiff is seeking unspecified monetary damages
as well as injunctive relief. TWC intends to defend against the
claim vigorously. TWC is unable to predict the outcome of the
suit or reasonably estimate a range of possible loss.
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On July 14, 2006, Hybrid Patents Inc. filed a complaint in
the U.S. District Court for the Eastern District of Texas
alleging that TWC and a number of other cable operators infringe
several patents purportedly relating to high-speed data and
Internet-based phone services. The plaintiff is seeking
unspecified monetary damages as well as injunctive relief. TWC
intends to defend against the claim vigorously but is unable to
predict the outcome of the suit or reasonably estimate a range
of possible loss.
On June 1, 2006, Rembrandt Technologies, LP filed a
complaint in the U.S. District Court for the Eastern
District of Texas alleging that TWC and a number of other cable
operators infringe several patents purportedly related to a
variety of technologies, including high-speed data and
Internet-based phone services. In addition, on
September 13, 2006, Rembrandt Technologies, LP filed a
complaint in the U.S. District Court for the Eastern
District of Texas alleging that TWC infringes several patents
purportedly related to “high-speed cable modem internet
products and services.” In each of these cases, the
plaintiff is seeking unspecified monetary damages as well as
injunctive relief. TWC intends to defend against this lawsuits
vigorously. TWC is unable to predict the outcome of these suits
or reasonably estimate a range of possible loss.
On July 14, 2005, Forgent Networks, Inc.
(“Forgent”) filed suit in the U.S. District Court
for the Eastern District of Texas alleging that TWC and a number
of other cable operators and direct broadcast satellite
operators infringed a patent related to digital video recorder
technology. TWC is working closely with its digital video
recorder equipment vendors in defense of this matter, certain of
whom have filed a declaratory judgment lawsuit against Forgent
alleging the patent cited by Forgent to be non-infringed,
invalid and unenforceable. Forgent is seeking monetary damages,
ongoing royalties and injunctive relief in its suit against the
Company. The Company intends to defend against this lawsuit
vigorously, but is unable to predict the outcome of this suit or
reasonably estimate a range of possible loss.
On April 26, 2005, Acacia Media Technologies
(“AMT”) filed suit against TWC in U.S. District
Court for the Southern District of New York alleging that TWC
infringes several patents held by AMT. AMT has publicly taken
the position that delivery of broadcast video (except live
programming such as sporting events),
Pay-Per-View,
VOD and ad insertion services over cable systems infringe its
patents. AMT has brought similar actions regarding the same
patents against numerous other entities, and all of the
previously pending litigations have been made the subject of a
multidistrict litigation (“MDL”) order consolidating
the actions for pretrial activity in the U.S. District
Court for the Northern District of California. On
October 25, 2005, TWC’s action was consolidated into
the MDL proceedings. The plaintiff is seeking unspecified
monetary damages as well as injunctive relief. TWC intends to
defend against this lawsuit vigorously. TWC is unable to predict
the outcome of this suit or reasonably estimate a range of
possible loss.
From time to time, TWC receives notices from third parties
claiming that TWC infringes their intellectual property rights.
Claims of intellectual property infringement could require TWC
to enter into royalty or licensing agreements on unfavorable
terms, incur substantial monetary liability or be enjoined
preliminarily or permanently from further use of the
intellectual property in question. In addition, certain
agreements that TWC enters may require TWC to indemnify the
other party for certain
third-party
intellectual property infringement claims, which could increase
TWC’s damages and its costs of defending against such
claims. Even if the claims are without merit, defending against
the claims can be time consuming and costly.
As part of the TWE Restructuring, Time Warner agreed to
indemnify the cable businesses of TWE from and against any and
all liabilities relating to, arising out of or resulting from
specified litigation matters brought against TWE’s former
Non-cable Businesses. Although Time Warner has agreed to
indemnify the cable businesses of TWE against such liabilities,
TWE remains a named party in certain litigation matters.
In the normal course of business, TWC’s tax returns are
subject to examination by various domestic taxing authorities.
Such examinations may result in future tax and interest
assessments on TWC. In instances where TWC believes that a loss
is probable, it has accrued a liability.
The costs and other effects of pending or future litigation,
governmental investigations, legal and administrative cases and
proceedings (whether civil or criminal), settlements, judgments
and investigations, claims and changes in those matters
(including those matters described above), and developments or
assertions by or against
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TWC relating to intellectual property rights and intellectual
property licenses, could have a material adverse effect on
TWC’s business, financial condition and operating results.
Pursuant to Section 228 of the General Corporation Law of
the State of Delaware, the following actions were taken by
written consent of Warner Communications Inc., the holder of
746,000,000 shares of TWC Class A common stock and
75,000,000 shares of TWC Class B common stock,
representing a majority of the voting power of each of the TWC
Class A and Class B common stock, voting together and
as separate classes:
1. By written consent dated December 15, 2006, the
following individuals were elected directors of the Company for
terms expiring in 2007, or until their successors are duly
elected and qualified:
Class A Directors:
David C. Chang
James E. Copeland, Jr.
Class B Directors:
Carole Black
Glenn A. Britt Thomas Castro Peter R. Haje Don Logan Michael Lynne N.J. Nicholas, Jr. Wayne H. Pace
2. By written consent dated December 19, 2006, the
Time Warner Cable Inc. 2006 Stock Incentive Plan was approved.
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Pursuant to General Instruction G(3) to
Form 10-K,
the information regarding the Company’s executive officers
required by Item 401(b) of
Regulation S-K
is hereby included in Part I of this report.
The following table sets forth the name of each executive
officer of the Company, the office held by such officer and the
age of such officer as of February 8, 2007.
Set forth below are the principal positions held during at least
the last five years by each of the executive officers named
above:
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The principal market for TWC Class A common stock is
expected to be the NYSE. It is expected that TWC Class A
common stock will begin to trade on the NYSE on or about
March 1, 2007. The TWC Class A common stock has
recently been trading in the over-the-counter market and is
expected to continue to trade in such market until it is listed
on the NYSE. There were approximately 5,400 holders of record of
TWC Class A common stock as of February 20, 2007.
There is no established public trading market for the
Company’s Class B common stock, which was held of
record by one holder as of February 20, 2007.
TWC has not paid any cash dividends on its common stock over the
last two years and currently does not expect to pay cash
dividends on its common stock in the future. TWC expects to
retain its future earnings, if any, for use in the operation and
expansion of its business. TWC’s board of directors will
determine whether to pay dividends in the future based on
conditions then existing, including TWC’s earnings,
financial condition and capital requirements, as well as
economic and other conditions TWC’s board may deem
relevant. In addition, TWC’s ability to declare and pay
dividends on its common stock is subject to requirements under
Delaware law and covenants in TWC’s senior unsecured
revolving credit facility.
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On July 31, 2006, immediately after the consummation of the
Redemptions but prior to the consummation of the Adelphia
Acquisition, TWC paid a stock dividend to WCI, a wholly owned
subsidiary of Time Warner and the only holder of record of
TWC’s outstanding Class A and Class B common
stock at that time, of 999,999 shares of Class A or
Class B common stock, as applicable, per share of
Class A or Class B common stock. An aggregate of
745,999,254 shares of Class A common stock and
74,999,925 shares of Class B common stock were issued
to WCI in connection with the stock dividend. The stock dividend
was declared and paid in anticipation of TWC becoming a public
company.
The selected financial information of the Company for the five
years ended December 31, 2006 is set forth at
pages 149 through 150 herein and is incorporated herein by
reference.
The information set forth under the caption
“Management’s Discussion and Analysis” at
pages 59 through 99 herein is incorporated herein by
reference.
The information set forth under the caption “Market Risk
Management” at page 92 herein is incorporated herein
by reference.
The consolidated financial statements of the Company and the
report of independent auditors thereon set forth at
pages 100 through 145 and 147 herein are incorporated
herein by reference.
Not Applicable.
TWC, under the supervision and with the participation of its
management, including the Chief Executive Officer and Chief
Financial Officer, evaluated the effectiveness of the design and
operation of TWC’s “disclosure controls and
procedures” (as such term is defined in
Rule 13a-15(e)
under the Exchange Act) as of the end of the period covered by
this report. Based on that evaluation, the Chief Executive
Officer and the Chief Financial Officer concluded that
TWC’s disclosure controls and procedures are effective in
timely making known to them material information relating to TWC
and its consolidated subsidiaries required to be disclosed in
TWC’s reports filed or submitted under the Exchange Act.
Management’s report on internal control over financial
reporting and the report of the independent auditors thereon set
forth at pages 146 and 148 incorporated herein by reference.
On July 31, 2006, TWC acquired certain cable systems from
Adelphia and Comcast and, as a result, is integrating the
processes, systems and controls relating to the acquired cable
systems into TWC’s existing system of internal control over
financial reporting. TWC has continued to integrate into its
control structure many of the processes, systems and controls
relating to the acquired cable systems in accordance with its
integration plans. In addition, various transitional controls
designed to supplement existing internal controls have been
implemented with respect to the acquired systems. Except for the
processes, systems and controls relating to the integration of
the
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acquired cable systems, there have not been any changes in
TWC’s internal control over financial reporting during the
quarter ended December 31, 2006 that have materially
affected, or are reasonably likely to materially affect, its
internal control over financial reporting.
Not applicable.
Information called for by Items 10, 11, 12, 13 and 14
of Part III is incorporated by reference from the
Company’s definitive Proxy Statement to be filed in
connection with its 2007 Annual Meeting of Stockholders pursuant
to Regulation 14A, except that the information regarding
the Company’s executive officers called for by
Item 401(b) of
Regulation S-K
has been included in Part I of this Annual Report.
The Company has adopted a Code of Ethics for its Senior
Executive and Senior Financial Officers. A copy of the Code is
publicly available on the Company’s website at
www.timewarnercable.com/investors. Amendments to the Code
or any grant of a waiver from a provision of the Code requiring
disclosure under applicable SEC rules will also be disclosed on
the Company’s website.
(a)(1)-(2) Financial Statements and Schedules:
(i) The list of consolidated financial statements and
schedules set forth in the accompanying Index to Consolidated
Financial Statements and Other Financial Information at
page 58 herein is incorporated herein by reference. Such
consolidated financial statements and schedules are filed as
part of this Annual Report.
(ii) All other financial statement schedules are omitted
because the required information is not applicable, or because
the information required is included in the consolidated
financial statements and notes thereto.
(3) Exhibits:
The exhibits listed on the accompanying Exhibit Index are
filed or incorporated by reference as part of this Annual Report
and such Exhibit Index is incorporated herein by reference.
Exhibits 10.35 through 10.41 and 10.44 through 10.47 listed
on the accompanying Exhibit Index identify management
contracts or compensatory plans or arrangements required to be
filed as exhibits to this Annual Report, and such listing is
incorporated herein by reference.
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Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
TIME WARNER CABLE INC.
Name: Glenn A. Britt
Title: President and Chief Executive Officer
Dated: February 23, 2007
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, this report has been signed
below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
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TIME
WARNER CABLE INC.
INDEX TO
CONSOLIDATED FINANCIAL STATEMENTS
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TIME
WARNER CABLE INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Management’s discussion and analysis of results of
operations and financial condition (“MD&A”) is
provided as a supplement to the accompanying consolidated
financial statements and notes to help provide an understanding
of Time Warner Cable Inc.’s (together with its
subsidiaries, “TWC” or the “Company”)
financial condition, changes in financial condition and results
of operations. MD&A is organized as follows:
As discussed more fully in Note 1 to the accompanying
consolidated financial statements, the 2005 and 2004 financial
information was recast so that the basis of presentation would
be consistent with that of 2006. Specifically, the amounts were
recast to reflect (i) the retrospective application of
Financial Accounting Standards Board (“FASB”)
Statement No. 123 (revised 2004), Share-Based Payment
(“FAS 123R”), which was adopted by the
Company in 2006, (ii) the retrospective presentation of
certain cable systems transferred in 2006 as discontinued
operations and (iii) the effect of a stock dividend that
occurred immediately prior to the consummation of the
acquisition of assets of Adelphia Communications Corporation
(“Adelphia”).
TWC is the second-largest cable operator in the U.S. and is an
industry leader in developing and launching innovative video,
data and voice services. As part of the strategy to expand
TWC’s cable footprint and improve the clustering of its
cable systems, on July 31, 2006, a subsidiary of TWC, Time
Warner NY Cable LLC (“TW NY”), and Comcast Corporation
(together with its subsidiaries, “Comcast”) completed
their respective acquisitions of assets comprising in the
aggregate substantially all of the cable systems of Adelphia.
Immediately prior to the Adelphia acquisition, TWC and Time
Warner Entertainment Company, L.P. (“TWE”) redeemed
Comcast’s interests in TWC and TWE, respectively. In
addition, TW NY exchanged certain cable systems with Comcast. In
connection with these transactions, TWC acquired approximately
3.2 million net basic video subscribers,
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TIME
WARNER CABLE INC.
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF RESULTS
OF
OPERATIONS AND FINANCIAL
CONDITION — (Continued)
consisting of approximately 4.0 million acquired
subscribers and approximately 0.8 million subscribers
transferred to Comcast. The systems transferred to Comcast that
TWC owned prior to the Adelphia acquisition have been reflected
as discontinued operations for all periods presented. Refer to
“Recent Developments” for further details.
At December 31, 2006, TWC had approximately
13.4 million basic video subscribers in technologically
advanced, well-clustered systems located mainly in five
geographic areas — New York state, the Carolinas,
Ohio, southern California and Texas. This subscriber number
includes approximately 788,000 managed subscribers located in
the Kansas City, south and west Texas and New Mexico cable
systems (the “Kansas City Pool”) that were
consolidated on January 1, 2007, upon the distribution of
the assets of Texas and Kansas City Cable Partners, L.P.
(“TKCCP”), an equity method investee at
December 31, 2006, to its partners, TWC and Comcast. Refer
to “Recent Developments” for further details. As of
December 31, 2006, TWC was the largest cable operator in a
number of large cities, including New York City and Los Angeles.
Time Warner Inc. (“Time Warner”) currently holds an
84.0% economic interest in TWC (representing a 90.6% voting
interest). The financial results of TWC’s operations are
consolidated by Time Warner.
TWC principally offers three products — video,
high-speed data and voice, which have been primarily targeted to
residential customers. Video is TWC’s largest product in
terms of revenues generated. TWC expects to continue to increase
video revenues through the offering of advanced digital video
services such as
video-on-demand
(“VOD”),
subscription-video-on-demand
(“SVOD”), high definition television
(“HDTV”) and set-top boxes equipped with digital video
recorders (“DVRs”), as well as through price increases
and subscriber growth. TWC’s digital video subscribers
provide a broad base of potential customers for additional
advanced services. Providing basic video services is a
competitive and highly penetrated business, and, as a result,
TWC continues to expect slower incremental growth in the number
of basic video subscribers compared to the growth in TWC’s
advanced service offerings. Video programming costs represent a
major component of TWC’s expenses and are expected to
continue to increase, reflecting contractual rate increases,
subscriber growth and the expansion of service offerings, and it
is expected that the Company’s video product margins will
decline over the next few years as programming cost increases
outpace growth in video revenues.
High-speed data has been one of TWC’s fastest-growing
products over the past several years and is a key driver of its
results. At December 31, 2006, TWC had approximately
6.6 million residential high-speed data subscribers
(including approximately 374,000 managed subscribers in the
Kansas City Pool). TWC expects continued strong growth in
residential high-speed data subscribers and revenues for the
foreseeable future; however, the rate of growth of both
subscribers and revenues is expected to slow over time as
high-speed data services become increasingly well-penetrated. In
addition, as narrowband Internet users continue to migrate to
broadband connections, TWC anticipates that an increasing
percentage of its new high-speed data customers will elect to
purchase its entry-level high-speed data service, which is
generally less expensive than TWC’s flagship service level.
As a result, over time, TWC’s average high-speed data
revenue per subscriber may decline reflecting this shift in mix.
TWC also offers commercial high-speed data services and had
approximately 245,000 commercial high-speed data subscribers
(including approximately 15,000 managed subscribers in the
Kansas City Pool) at December 31, 2006.
TWC’s voice service, Digital Phone, is TWC’s newest
product, and approximately 1.9 million subscribers
(including approximately 141,000 managed subscribers in the
Kansas City Pool) received the service as of December 31,
2006. For a monthly fixed fee, Digital Phone customers typically
receive the following services: unlimited local, in-state and
U.S., Canada and Puerto Rico long-distance calling, as well as
call waiting, caller ID and E911 services. TWC also is currently
deploying a lower-priced unlimited in-state-only calling plan to
serve those customers that do not use long-distance services
extensively and, in the future, intends to offer additional
plans with a variety of local and long-distance options. Digital
Phone enables TWC to offer its customers a convenient package,
or “bundle,” of video, high-speed data and voice
services, and to compete effectively against similar bundled
products available from its competitors. TWC expects strong
increases in Digital Phone subscribers and revenues and during
2007 intends to introduce a commercial voice service to small-
to medium-sized businesses
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TIME
WARNER CABLE INC.
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF RESULTS
OF
OPERATIONS AND FINANCIAL
CONDITION — (Continued)
in most of the systems TWC owned before and retained after the
transactions with Adelphia and Comcast (the “Legacy
Systems”).
In November 2005, TWC and several other cable companies,
together with Sprint Nextel Corporation (“Sprint”),
announced the formation of a joint venture to develop integrated
video entertainment, wireline and wireless data and
communications products and services. In 2006, TWC began
offering a bundle that includes Sprint wireless voice service in
limited operating areas and will continue to roll out this
product during 2007.
Some of TWC’s principal competitors, in particular, direct
broadcast satellite operators and incumbent local telephone
companies, either offer or are making significant capital
investments that will allow them to offer services that provide
features and functions comparable to the video, data
and/or voice
services that TWC offers and they are aggressively seeking to
offer them in bundles similar to TWC’s. TWC expects that
the availability of these service offerings will intensify
competition.
In addition to the subscription services described above, TWC
also earns revenues by selling advertising time to national,
regional and local businesses. In 2006, nearly one-half of
TWC’s Advertising revenues were derived from sales to the
automotive and media and entertainment industries, with no other
individual industry providing a significant portion of
Advertising revenues.
As of July 31, 2006, the date the transactions with
Adelphia and Comcast closed, the penetration rates for basic
video, digital video and high-speed data services were generally
lower in the systems acquired from Adelphia and Comcast (the
“Acquired Systems”) than in the Legacy Systems.
Furthermore, certain advanced services were not available in
some of the Acquired Systems, and
IP-based
telephony service was not available in any of the Acquired
Systems. To increase the penetration of these services in the
Acquired Systems, TWC is in the midst of a significant
integration effort that includes upgrading the capacity and
technical performance of these systems to levels that will allow
the delivery of these advanced services and features. Such
integration-related efforts are expected to be largely complete
by year-end 2007. As of December 31, 2006, Digital Phone
was available in some of the Acquired Systems on a limited
basis. TWC expects to roll out Digital Phone across the Acquired
Systems during 2007.
Improvement in the financial and operating performance of the
Acquired Systems depends in part on the completion of these
initiatives and the subsequent availability of the
Company’s bundled advanced services in the Acquired
Systems. In addition, due to various operational and competitive
challenges, the Company expects that the acquired systems
located in the Los Angeles, CA and Dallas, TX areas will likely
require more time and resources than the other acquired systems
to stabilize and then meaningfully improve their financial and
operating performance. As of December 31, 2006, the
acquired Los Angeles and Dallas area systems together served
approximately 2.0 million subscribers (about 50% of the
subscribers served by the Acquired Systems). TWC believes that
by upgrading the plant and integrating the Acquired Systems into
its operations, there is a significant opportunity over time to
stem subscriber losses, increase penetration rates of its
service offerings, and improve Subscription revenues and
Operating Income before Depreciation and Amortization in the
Acquired Systems.
On July 31, 2006, TW NY and Comcast completed their
respective acquisitions of assets comprising in the aggregate
substantially all of the cable assets of Adelphia (the
“Adelphia Acquisition”). At the closing of the
Adelphia Acquisition, TW NY paid approximately $8.9 billion
in cash, after giving effect to certain purchase price
adjustments, and shares representing 17.3% of TWC’s
Class A common stock (16% of TWC’s outstanding common
stock) for the portion of the Adelphia assets it acquired. In
addition, on July 28, 2006, American Television and
Communications Corporation (“ATC”), a subsidiary of
Time Warner, contributed its 1% common equity interest and
$2.4 billion preferred equity interest in TWE to TW NY
Cable Holding Inc. (“TW NY Holding”), a newly created
subsidiary of TWC and the parent of TW NY, in exchange for an
approximately 12.4% non-voting common stock interest in TW NY
Holding (the “ATC Contribution”).
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TIME
WARNER CABLE INC.
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF RESULTS
OF
OPERATIONS AND FINANCIAL
CONDITION — (Continued)
On February 13, 2007, Adelphia’s plan of
reorganization under Chapter 11 of title 11 of the
United States Code became effective and, under applicable
securities law regulations and provisions of the
U.S. bankruptcy code, TWC became a public company subject
to the requirements of the Securities Exchange Act of 1934 on
the same day. Under the terms of the plan, as of
February 20, 2007, approximately 75% of the shares of TWC
Class A common stock that Adelphia received as part of the
payment for its assets in July 2006 have been distributed to
Adelphia’s creditors. The remaining shares are expected to
be distributed during the coming months as remaining disputes
are resolved by the bankruptcy court, including 4% of such
shares that are being held in escrow in connection with the
Adelphia Acquisition. It is expected that the TWC Class A
common stock will begin to trade on the New York Stock Exchange
on or about March 1, 2007.
At the closing of the Adelphia Acquisition, TWC and Adelphia
entered into a registration rights and sale agreement (the
“Adelphia Registration Rights and Sale Agreement”),
which governed the disposition of the shares of TWC’s
Class A common stock received by Adelphia in the Adelphia
Acquisition. Upon the effectiveness of Adelphia’s plan of
reorganization, the parties’ obligations under the Adelphia
Registration Rights and Sale Agreement terminated.
On July 31, 2006, immediately before the closing of the
Adelphia Acquisition, Comcast’s interests in TWC and TWE
were redeemed. Specifically, Comcast’s 17.9% interest in
TWC was redeemed in exchange for 100% of the capital stock of a
subsidiary of TWC holding both cable systems serving
approximately 589,000 subscribers and approximately
$1.857 billion in cash (the “TWC Redemption”). In
addition, Comcast’s 4.7% interest in TWE was redeemed in
exchange for 100% of the equity interests of a subsidiary of TWE
holding both cable systems serving approximately 162,000
subscribers and approximately $147 million in cash (the
“TWE Redemption” and, together with the TWC
Redemption, the “Redemptions”). The TWC Redemption was
designed to qualify as a tax-free split-off under
section 355 of the Internal Revenue Code of 1986, as
amended (the “Tax Code”). For accounting purposes, the
Redemptions were treated as an acquisition of Comcast’s
minority interests in TWC and TWE and a disposition of the cable
systems that were transferred to Comcast. The purchase of the
minority interests resulted in a reduction of goodwill of
$738 million related to the excess of the carrying value of
the Comcast minority interests over the total fair value of the
Redemptions. In addition, the disposition of the cable systems
resulted in an after-tax gain of $945 million, included in
discontinued operations, which is comprised of a
$131 million pretax gain (calculated as the difference
between the carrying value of the systems acquired by Comcast in
the Redemptions totaling $2.969 billion and the estimated
fair value of $3.100 billion) and a net tax benefit of
$814 million, including the reversal of historical deferred
tax liabilities of approximately $838 million that had
existed on systems transferred to Comcast in the TWC Redemption.
Following the Redemptions and the Adelphia Acquisition, on
July 31, 2006, TW NY and Comcast swapped certain cable
systems, most of which were acquired from Adelphia, in order to
enhance TWC’s and Comcast’s respective geographic
clusters of subscribers (the “Exchange” and, together
with the Adelphia Acquisition and the Redemptions, the
“Transactions”), and TW NY paid Comcast approximately
$67 million for certain adjustments related to the
Exchange. The Company did not record a gain or loss on systems
TW NY acquired from Adelphia and transferred to Comcast in the
Exchange because such systems were recorded at fair value in the
Adelphia Acquisition. The Company did, however, record a pretax
gain of $34 million ($20 million net of tax) on the
Exchange related to the disposition of Urban Cable Works of
Philadelphia, L.P. (“Urban Cable”). This gain is
included as a component of discontinued operations in the
accompanying consolidated statement of operations in 2006.
The results of the systems acquired in connection with the
Transactions have been included in the accompanying consolidated
statement of operations since the closing of the Transactions on
July 31, 2006. The systems transferred to Comcast in
connection with the Redemptions and the Exchange (the
“Transferred Systems”),
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WARNER CABLE INC.
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF RESULTS
OF
OPERATIONS AND FINANCIAL
CONDITION — (Continued)
including the gains discussed above, have been reflected as
discontinued operations in the consolidated statement of
operations for all periods presented. See Note 5 to the
accompanying consolidated financial statements for additional
information regarding the discontinued operations.
As a result of the closing of the Transactions, TWC gained
systems with approximately 3.2 million net basic video
subscribers. As of February 23, 2007, Time Warner owns 84.0% of
TWC’s outstanding common stock (including 82.7% of
TWC’s outstanding Class A common stock and all
outstanding shares of TWC’s Class B common stock), as
well as an approximately 12.4% non-voting common stock interest
in TW NY Holding. Comcast no longer has an interest in TWC or
TWE. As a result of the TWE Redemption and the ATC Contribution,
two of TWC’s subsidiaries are the sole general and limited
partners of TWE.
The Adelphia Acquisition was designed to be a taxable
acquisition of assets that would result in a tax basis in the
acquired assets equal to the purchase price paid. The
depreciation and amortization deductions resulting from this
step-up in
the tax basis of the assets would reduce future net cash tax
payments and thereby increase the Company’s future cash
flows. The Company believes that most cable operators have a tax
basis that is below the fair market value of their cable systems
and, accordingly, the Company has viewed a portion of its tax
basis in the acquired assets as incremental value above the
amount of basis more generally associated with cable systems.
The tax benefit of such incremental
step-up
would reduce net cash tax payments by more than
$300 million per year, assuming the following:
(i) incremental
step-up
relating to 85% of a $14.4 billion purchase price (which
assumes that 15% of the fair market value of cable systems
represents a typical amount of basis), (ii) straight-line
amortization deductions over 15 years,
(iii) sufficient taxable income to utilize the amortization
deductions, and (iv) a 40% effective tax rate. The Internal
Revenue Service (the “IRS”) or state or local tax
authorities might challenge the anticipated tax
characterizations or related valuations, and any successful
challenge could materially adversely affect the Company’s
tax profile (including its ability to recognize the intended tax
benefits from the Transactions), significantly increase the
Company’s future cash tax payments and significantly reduce
the Company’s future earnings and cash flow.
Also, the TWC Redemption was designed to qualify as a tax-free
split-off under section 355 of the Tax Code. If the IRS
were successful in challenging the tax-free characterization of
the TWC Redemption, an additional cash liability on account of
taxes of up to an estimated $900 million could become
payable by the Company.
In its order approving the Adelphia Acquisition, the Federal
Communications Commission (the “FCC”) imposed
conditions on TWC related to regional sports networks
(“RSNs”), as defined in the order, and the resolution
of disputes pursuant to the FCC’s leased access
regulations. In particular, the order provides that:
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WARNER CABLE INC.
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF RESULTS
OF
OPERATIONS AND FINANCIAL
CONDITION — (Continued)
The application and scope of these conditions, which will expire
in July 2012, have not yet been tested. TWC retains the right to
obtain FCC and judicial review of any arbitration awards made
pursuant to these conditions.
TKCCP is a
50-50 joint
venture between Time Warner Entertainment-Advance/Newhouse
Partnership (“TWE-A/N”) (a partnership of TWE and the
Advance/Newhouse Partnership) and Comcast. In accordance with
the terms of the TKCCP partnership agreement, on July 3,
2006, Comcast notified TWC of its election to trigger the
dissolution of the partnership and its decision to allocate all
of TKCCP’s debt, which totaled approximately
$2 billion, to the pool of assets consisting of the Houston
cable systems (the “Houston Pool”). On August 1,
2006, TWC notified Comcast of its election to receive the Kansas
City Pool. On October 2, 2006, TWC received approximately
$630 million from Comcast due to the repayment of debt owed
by TKCCP to TWE-A/N that had been allocated to the Houston Pool.
Since July 1, 2006, TWC has been entitled to 100% of the
economic interest in the Kansas City Pool (and has recognized
such interest pursuant to the equity method of accounting), and
it has not been entitled to any economic benefits of ownership
from the Houston Pool.
On January 1, 2007, TKCCP distributed its assets to its
partners. TWC received the Kansas City Pool, which served
approximately 788,000 basic video subscribers as of
December 31, 2006, and Comcast received the Houston Pool,
which served approximately 795,000 basic video subscribers as of
December 31, 2006. TWC began consolidating the results of
the Kansas City Pool on January 1, 2007. As a result of the
asset distribution, TKCCP no longer has any assets, and TWC
expects that TKCCP will be formally dissolved in 2007. For
accounting purposes, the distribution of TKCCP’s assets has
been treated as a sale of the Company’s 50% interest in the
Houston Pool, and, as a result, the Company expects to record a
pretax gain of approximately $150 million in the first
quarter of 2007.
The following schedule presents selected operating statement
information of the Kansas City Pool for the years ended
December 31, 2006 and 2005 (in millions):
If the consolidation of the Kansas City Pool had occurred on
January 1, 2006, for the year ended December 31, 2006,
(i) TWC’s revenues would have increased by
$711 million, reflecting $795 million in revenues from
the Kansas City Pool, as noted above, offset by the
$84 million in revenues that TWC recognized in 2006 in
connection with the provision of Road Runner services to TKCCP
and (ii) TWC’s Operating Income would have increased
by $107 million, reflecting the $155 million of
Operating Income generated by the Kansas City Pool, as noted
above, and $51 million of lower costs at TWC that would
have resulted from TWC not serving the Houston Pool, offset by
the absence of $15 million of management fee income that
was recognized by TWC in 2006 for the provision of services to
the Houston Pool and the absence of $84 million in revenues
that TWC recognized in 2006 for the provision of Road Runner
services to TKCCP.
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MANAGEMENT’S
DISCUSSION AND ANALYSIS OF RESULTS
OF
OPERATIONS AND FINANCIAL
CONDITION — (Continued)
As a result of the pending TKCCP dissolution, TWC presents its
managed subscriber numbers including only the managed
subscribers in the Kansas City Pool. Accordingly, the
subscribers from the Houston Pool are not included in the
managed subscriber numbers for any period presented.
On October 18, 2006, TWC, together with TWE, TW NY Holding,
certain other subsidiaries of Time Warner and The Bank of New
York, as Trustee, entered into the Tenth Supplemental Indenture
to the indenture (the “TWE Indenture”) governing
$3.2 billion of notes and debentures issued by TWE (the
“TWE Notes”). Pursuant to the Tenth Supplemental
Indenture to the TWE Indenture, TW NY Holding fully,
unconditionally and irrevocably guaranteed the payment of
principal and interest on the TWE Notes. Also on
October 18, 2006, TW NY contributed all of its general
partnership interests in TWE to TWE GP Holdings LLC, its wholly
owned subsidiary. In addition, on November 2, 2006, a
consent solicitation to amend the TWE Indenture was successfully
completed. See “Financial Condition and
Liquidity — TWE Notes” for further details.
As previously disclosed, the Securities and Exchange Commission
(the “SEC”) had been conducting an investigation into
certain accounting and disclosure practices of TWC’s parent
company, Time Warner. On March 21, 2005, Time Warner
announced that the SEC had approved Time Warner’s proposed
settlement, which resolved the SEC’s investigation of Time
Warner. Under the terms of the settlement with the SEC, Time
Warner agreed, without admitting or denying the SEC’s
allegations, to be enjoined from future violations of certain
provisions of the securities laws and to comply with the
cease-and-desist
order issued by the SEC to AOL LLC (formerly America Online,
Inc. (“AOL”)), a subsidiary of Time Warner, in May
2000. Time Warner also agreed to appoint an independent
examiner, who was to either be or hire a certified public
accountant. The independent examiner was to review whether Time
Warner’s historical accounting for certain transactions (as
well as any subsequent amendments) with 17 counterparties
identified by the SEC staff, principally involving online
advertising revenues and including three cable programming
affiliation agreements with related online advertising elements,
was appropriate, and provide a report to Time Warner’s
Audit and Finance Committee of its conclusions. The transactions
that were to be reviewed were entered into (or amended) between
June 1, 2000 and December 31, 2001, including
subsequent amendments thereto, and involved online advertising
and related transactions for which the majority of the revenue
was recognized by Time Warner before January 1, 2002.
During the third quarter of 2006, the independent examiner
completed his review, in which he concluded that certain of the
transactions under review with 15 counterparties, including
the three cable programming affiliation agreements with
advertising elements, had been accounted for improperly because
the historical accounting did not reflect the substance of the
arrangements. Under the terms of its SEC settlement, Time Warner
was required to restate any transactions that the independent
examiner determined were accounted for improperly. Accordingly,
Time Warner restated its consolidated financial results for each
of the years ended December 31, 2000 through
December 31, 2005 and for the six months ended
June 30, 2006. The impact of the adjustments is reflected
in amendments filed by Time Warner with the SEC on
September 13, 2006. In addition, TWC restated its
consolidated financial results for the years ended
December 31, 2001 through December 31, 2005 and for
the six months ended June 30, 2006. The restated
consolidated financial results are reflected in TWC’s
Current Report on
Form 8-K
filed with the SEC on February 13, 2007, as well as in the
financial statements presented herein.
The three transactions impacting TWC are ones in which TWC
entered into cable programming affiliation agreements at the
same time it committed to deliver (and did subsequently deliver)
network and online advertising services to those same
counterparties. Total Advertising revenues recognized by TWC
under these transactions were approximately $274 million
(approximately $134 million in 2001 and approximately
$140 million in 2002). Included in the $274 million
was $56 million related to operations that have been
subsequently classified as
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OPERATIONS AND FINANCIAL
CONDITION — (Continued)
discontinued operations. In addition to reversing the
recognition of revenue, based on the independent examiner’s
conclusions, the Company has recorded corresponding reductions
in the cable programming costs over the life of the related
cable programming affiliation agreements (which range from 10 to
12 years) that were acquired contemporaneously with the
execution of the advertising agreements. This has the effect of
increasing earnings beginning in 2003 and continuing through
future periods.
The net effect of restating these transactions is that
TWC’s net income was reduced by approximately
$60 million in 2001 and $61 million in 2002 and was
increased by approximately $12 million in each of 2003,
2004 and 2005, and by approximately $6 million for the
first six months of 2006 (the impact for the year ended
December 31, 2006 was an increase to the Company’s net
income of approximately $12 million). While the restatement
resulted in changes in the classification of cash flows within
cash provided by operating activities, it has not impacted total
cash flows during the periods.
The Company’s revenues consist of Subscription and
Advertising revenues. Subscription revenues consist of revenues
from video, high-speed data and Digital Phone services.
Video revenues include monthly fees for basic, standard and
digital services, together with related equipment rental
charges, charges for set-top boxes and charges for premium
channels and SVOD services. Video revenues also include
installation,
Pay-Per-View
and VOD charges and franchise fees relating to video charges
collected on behalf of local franchising authorities. Several
ancillary items are also included within video revenues, such as
commissions related to the sale of merchandise by home shopping
services and rental income earned on the leasing of antenna
attachments on the Company’s transmission towers. In each
period presented, these ancillary items constitute less than 2%
of video revenues.
High-speed data revenues include monthly subscriber fees from
both residential and commercial subscribers, along with related
equipment rental charges, home networking fees and installation
charges. High-speed data revenues also include fees received
from TKCCP (an unconsolidated joint venture at December 31,
2006, which is in the process of being dissolved), third parties
and certain cable systems owned by a subsidiary of TWE-A/N and
managed by the Advance/Newhouse Partnership (“A/N”).
Digital Phone revenues include monthly subscriber fees from
voice subscribers, including Digital Phone subscribers and
circuit-switched subscribers acquired from Comcast in the
Exchange, along with related installation charges. TWC continues
to provide traditional, circuit-switched services to those
subscribers and will continue to do so for some period of time,
while simultaneously marketing Digital Phone to those customers.
After some period of time, TWC intends to discontinue the
circuit-switched offering in accordance with regulatory
requirements, at which time the only voice services provided by
TWC in those systems will be Digital Phone service.
Advertising revenues include the fees charged to local, regional
and national advertising customers for advertising placed on the
Company’s video and high-speed data services. Nearly all
Advertising revenues are attributable to the Company’s
video service.
Costs of revenues include: video programming costs (including
fees paid to the programming vendors net of certain amounts
received from the vendors); high-speed data connectivity costs;
Digital Phone network costs; other service-related expenses,
including non-administrative labor costs directly associated
with the delivery of products and services to subscribers;
maintenance of the Company’s delivery systems; franchise
fees; and other related
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OPERATIONS AND FINANCIAL
CONDITION — (Continued)
expenses. The Company’s programming agreements are
generally multi-year agreements that provide for the Company to
make payments to the programming vendors at agreed upon rates
based on the number of subscribers to which the Company provides
the service.
Selling, general and administrative expenses include amounts not
directly associated with the delivery of products and services
to subscribers or the maintenance of the Company’s delivery
systems, such as administrative labor costs, marketing expenses,
billing charges, repair and maintenance costs, management fees
paid to Time Warner and other administrative overhead costs, net
of management fees received from TKCCP. Effective August 1,
2006, as a result of the pending dissolution of TKCCP, TWC no
longer receives management fees from TKCCP.
OIBDA is a non-GAAP financial measure. The Company defines OIBDA
as Operating Income before depreciation of tangible assets and
amortization of intangible assets. Management utilizes OIBDA,
among other measures, in evaluating the performance of the
Company’s business and as a significant component of its
annual incentive compensation programs because OIBDA eliminates
the uneven effect across its business of considerable amounts of
depreciation of tangible assets and amortization of intangible
assets recognized in business combinations. OIBDA is also a
measure used by the Company’s parent, Time Warner, to
evaluate the Company’s performance and is an important
metric in the Time Warner reportable segment disclosures.
Management also uses OIBDA because it provides an indication of
the Company’s ability to service debt and fund capital
expenditures, as OIBDA removes the impact of depreciation and
amortization. A limitation of this measure, however, is that it
does not reflect the periodic costs of certain capitalized
tangible and intangible assets used in generating revenues in
the Company’s business. To compensate for this limitation,
management evaluates the investments in such tangible and
intangible assets through other financial measures, such as
capital expenditure budget variances, investment spending levels
and return on capital analysis. Additionally, OIBDA should be
considered in addition to, and not as a substitute for,
Operating Income, net income and other measures of financial
performance reported in accordance with GAAP and may not be
comparable to similarly titled measures used by other companies.
Free Cash Flow is a non-GAAP financial measure. The Company
defines Free Cash Flow as cash provided by operating activities
(as defined under GAAP) plus excess tax benefits from the
exercise of stock options, less cash provided by (used by)
discontinued operations, capital expenditures, partnership
distributions and principal payments on capital leases.
Management uses Free Cash Flow to evaluate the Company’s
business and as a component of its annual incentive compensation
programs. The Company believes this measure is an important
indicator of its liquidity, including its ability to reduce net
debt and make strategic investments, because it reflects the
Company’s operating cash flow after considering the
significant capital expenditures required to operate its
business. A limitation of this measure, however, is that it does
not reflect payments made in connection with investments and
acquisitions, which reduce liquidity. To compensate for this
limitation, management evaluates such expenditures through other
financial measures, such as capital expenditure budget variances
and return on investment analyses. Free Cash Flow should not be
considered as an alternative to net cash provided by operating
activities as a measure of liquidity, and may not be comparable
to similarly titled measures used by other companies.
Both OIBDA and Free Cash Flow should be considered in addition
to, not as a substitute for, the Company’s Operating
Income, net income and various cash flow measures (e.g., cash
provided by operating activities), as well as other measures of
financial performance and liquidity reported in accordance with
GAAP. A reconciliation of OIBDA to Operating Income is presented
under “Results of Operations.” A reconciliation of
Free Cash Flow to cash provided by operating activities is
presented under “Financial Condition and Liquidity.”
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OF
OPERATIONS AND FINANCIAL
CONDITION — (Continued)
RESULTS
OF OPERATIONS
Historically, TWC employees have participated in various Time
Warner equity plans. TWC has established the Time Warner Cable
Inc. 2006 Stock Incentive Plan (the “2006 Plan”). The
Company expects that its employees will participate in the 2006
Plan starting in 2007 and thereafter will not continue to
participate in Time Warner’s equity plan. TWC employees who
have outstanding equity awards under the Time Warner equity
plans will retain any rights under those Time Warner equity
awards pursuant to their terms regardless of their participation
in the 2006 Plan. The Company has adopted the provisions of
FAS 123R as of January 1, 2006. The provisions of
FAS 123R require a company to measure the cost of employee
services received in exchange for an award of equity instruments
based on the grant-date fair value of the award. That cost is
recognized in the statement of operations over the period during
which an employee is required to provide service in exchange for
the award. FAS 123R also amends FASB Statement No. 95,
Statement of Cash Flows, to require that excess tax
benefits, as defined, realized from the exercise of stock
options be reported as a financing cash inflow rather than as a
reduction of taxes paid in cash flow from operations.
Prior to the adoption of FAS 123R, the Company had followed
the provisions of FASB Statement No. 123, Accounting for
Stock-Based Compensation (“FAS 123”), which
allowed the Company to follow the intrinsic value method set
forth in Accounting Principles Board (“APB”) Opinion
No. 25, Accounting for Stock Issued to Employees,
and disclose the pro forma effects on net income (loss) had the
fair value of the equity awards been expensed. In connection
with adopting FAS 123R, the Company elected to adopt the
modified retrospective application method provided by
FAS 123R and, accordingly, financial statement amounts for
all prior periods presented herein reflect results as if the
fair value method of expensing had been applied from the
original effective date of FAS 123 (see Note 1 to the
accompanying consolidated financial statements for a discussion
on the impact of the adoption of FAS 123R).
Prior to the adoption of FAS 123R, for disclosure purposes,
the Company recognized stock-based compensation expense for
awards with graded vesting by treating each vesting
tranche as a separate award and recognizing compensation
expense ratably for each tranche. For equity awards granted
subsequent to the adoption of FAS 123R, the Company treats
such awards as a single award and recognizes stock-based
compensation expense on a straight-line basis (net of estimated
forfeitures) over the employee service period. Stock-based
compensation expense is recorded in costs of revenues or
selling, general and administrative expense depending on the
employee’s job function.
Additionally, when recording compensation cost for equity
awards, FAS 123R requires companies to estimate the number
of equity awards granted that are expected to be forfeited.
Prior to the adoption of FAS 123R, for disclosure purposes,
the Company recognized forfeitures when they occurred, rather
than using an estimate at the grant date and subsequently
adjusting the estimated forfeitures to reflect actual
forfeitures. Accordingly, the Company recorded a benefit of
$2 million, net of tax, as the cumulative effect of a
change in accounting principle upon the adoption of
FAS 123R in 2006, to recognize the effect of estimating the
number of Time Warner equity-based awards granted to TWC
employees prior to January 1, 2006 that are not ultimately
expected to vest. Total equity-based compensation expense (which
includes expense recognized related to Time Warner stock
options, restricted stock and restricted stock units) recognized
in 2006, 2005 and 2004 was $33 million, $53 million
and $70 million, respectively.
On December 31, 2006, the Company adopted the provisions of
FASB Statement No. 158, Employers’ Accounting for
Defined Benefit Pension and Other Postretirement Benefits
(“FAS 158”). FAS 158 addresses the
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DISCUSSION AND ANALYSIS OF RESULTS
OF
OPERATIONS AND FINANCIAL
CONDITION — (Continued)
accounting for defined benefit pension plans and other
postretirement benefit plans (“plans”). Specifically,
FAS 158 requires companies to recognize an asset for a
plan’s overfunded status or a liability for a plan’s
underfunded status as of the end of the company’s fiscal
year, the offset of which is recorded, net of tax, as a
component of accumulated other comprehensive income (loss) in
shareholders’ equity. As a result of adopting FAS 158,
on December 31, 2006, the Company reflected the funded
status of its plans by reducing its net pension asset by
approximately $208 million to reflect actuarial and
investment losses that had been deferred pursuant to prior
pension accounting rules and recording a corresponding deferred
tax asset of approximately $84 million and a net after-tax
charge of approximately $124 million in accumulated other
comprehensive loss, net, in shareholders’ equity.
Discontinued
Operations
As previously noted under “Recent Developments,” the
Company has reflected the operations of the Transferred Systems
as discontinued operations for all periods presented.
Certain reclassifications have been made to the prior
year’s financial information to conform to the
December 31, 2006 presentation.
In June 2006, the Emerging Issues Task Force (“EITF”)
reached a consensus on EITF Issue
No. 06-02,
Accounting for Sabbatical Leave and Other Similar Benefits
(“EITF
06-02”).
EITF 06-02
provides that an employee’s right to a compensated absence
under a sabbatical leave or similar benefit arrangement in which
the employee is not required to perform any duties during the
absence is an accumulating benefit. Therefore, such arrangements
should be accounted for as a liability with the cost recognized
over the service period during which the employee earns the
benefit. The provisions of EITF
06-02 became
effective for TWC as of January 1, 2007 with respect to
certain employment arrangements that are similar to a sabbatical
leave and are expected to result in a reduction to retained
earnings of approximately $62 million ($37 million,
net of tax).
In June 2006, the EITF reached a consensus on EITF Issue
No. 06-03,
How Taxes Collected from Customers and Remitted to
Governmental Authorities Should Be Presented in the Income
Statement (That Is, Gross versus Net Presentation)
(“EITF
06-03”).
EITF 06-03
provides that the presentation of taxes assessed by a
governmental authority that is directly imposed on a
revenue-producing transaction between a seller and a customer on
either a gross basis (included in revenues and costs) or on a
net basis (excluded from revenues) is an accounting policy
decision that should be disclosed. The provisions of EITF
06-03 became
effective for TWC as of January 1, 2007. EITF
06-03 is not
expected to have a material impact on the Company’s
consolidated financial statements.
In June 2006, the FASB issued FASB Interpretation No. 48,
Accounting for Uncertainty in Income Taxes — an
interpretation of FASB Statement No. 109
(“FIN 48”), which clarifies the accounting
for uncertainty in income tax positions. This Interpretation
requires that the Company recognize in the consolidated
financial statements the tax benefits related to tax positions
that are more likely than not to be sustained upon examination
based on the technical merits of the position. The provisions of
FIN 48 became effective for TWC as of the beginning of the
Company’s 2007 fiscal year. The cumulative impact of this
guidance is not expected to have a material impact on the
Company’s consolidated financial statements.
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MANAGEMENT’S
DISCUSSION AND ANALYSIS OF RESULTS
OF
OPERATIONS AND FINANCIAL
CONDITION — (Continued)
In September 2006, the EITF reached a consensus on EITF Issue
No. 06-01,
Accounting for Consideration Given by a Service Provider to
Manufacturers or Resellers of Equipment Necessary for an
End-Customer to Receive Service from the Service Provider
(“EITF
06-01”).
EITF 06-01
provides that consideration provided to the manufacturers or
resellers of specialized equipment should be accounted for as a
reduction of revenue if the consideration provided is in the
form of cash and the service provider directs that such cash be
provided directly to the customer. Otherwise, the consideration
should be recorded as an expense. EITF
06-01 will
be effective for TWC as of January 1, 2008 and is not
expected to have a material impact on the Company’s
consolidated financial statements.
In September 2006, the SEC issued Staff Accounting Bulletin
(“SAB”) No. 108, Considering the Effects of
Prior Year Misstatements when Quantifying Misstatements in
Current Year Financial Statements
(“SAB 108”). SAB 108 requires that
registrants quantify errors using both a balance sheet and
statement of operations approach and evaluate whether either
approach results in a misstated amount that, when all relevant
quantitative and qualitative factors are considered, is
material. SAB 108 became effective for TWC in the fourth
quarter of 2006 and did not have a material impact on the
Company’s consolidated financial statements.
In September 2006, the FASB issued FASB Statement No. 157,
Fair Value Measurements (“FAS 157”).
FAS 157 establishes a single authoritative definition of
fair value, sets out a framework for measuring fair value, and
expands on required disclosures about fair value measurement.
FAS 157 is effective for TWC on January 1, 2008 and
will be applied prospectively. The provisions of FAS 157
are not expected to have a material impact on the Company’s
consolidated financial statements.
2006 vs.
2005
Consolidated
Results
Revenues. Revenues by major category were as
follows (in millions):
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OPERATIONS AND FINANCIAL
CONDITION — (Continued)
As previously reported, Adelphia and Comcast employed
methodologies that differed slightly from those used by TWC to
determine subscriber numbers. As of September 30, 2006, TWC
had converted subscriber numbers for most of the Acquired
Systems to TWC’s methodology. During the fourth quarter of
2006, TWC completed the conversion of such data, which resulted
in a reduction of approximately 46,000 basic video subscribers
in the Acquired Systems. Subscriber numbers are as follows (in
thousands):
Subscription revenues increased in 2006 as a result of increases
in video, high-speed data and Digital Phone revenues. The
increase in video revenues in 2006 was primarily due to the
impact of the Acquired Systems, the continued penetration of
digital video services and video price increases and growth in
basic video subscriber levels in the Legacy Systems. Video
revenues in the Acquired Systems totaled $1.165 billion in
2006. Aggregate revenues associated with the Company’s
digital video services, including digital tiers,
Pay-Per-View,
VOD, SVOD and DVRs, increased 41% to $1.027 billion in 2006
from $727 million in 2005.
High-speed data revenues in 2006 increased primarily due to the
Acquired Systems and growth in high-speed data subscribers.
High-speed data revenues in the Acquired Systems totaled
$321 million in 2006. Consolidated commercial high-speed
data revenues increased to $318 million in 2006 from
$241 million in 2005. Consolidated residential high-speed
data penetration, expressed as a percentage of service-ready
homes, was 26.1% at both December 31, 2006 and
December 31, 2005 as a result of strong growth in the
Legacy Systems offset by lower penetration rates in the Acquired
Systems. Strong growth rates for high-speed data service
revenues are expected to continue into 2007.
The increase in Digital Phone revenues in 2006 was primarily due
to growth in Digital Phone subscribers. Digital Phone revenues
in 2006 also included approximately $27 million of revenues
associated with subscribers acquired from Comcast who received
traditional, circuit-switched telephone service. As of
December 31, 2006, Digital Phone service was only available
in some of the Acquired Systems on a limited basis. Consolidated
Digital Phone penetration, expressed as a percentage of
service-ready homes, increased to 11.3% at December 31,
2006 from 7.0% at December 31, 2005. Strong growth rates
for Digital Phone revenues are expected to continue into 2007.
Average monthly subscription revenue (which includes video,
high-speed data and Digital Phone revenues) per basic video
subscriber (“subscription ARPU”) increased
approximately 11% to $90 in 2006 from approximately $81 in 2005
as a result of the increased penetration in advanced services
and higher video rates, as discussed above.
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OPERATIONS AND FINANCIAL
CONDITION — (Continued)
Advertising revenues increased primarily due to a
$136 million increase in local advertising and a
$29 million increase in national advertising in 2006,
primarily attributable to the Acquired Systems. Advertising
revenues in the Acquired Systems totaled $137 million in
2006. Excluding the results of the Acquired Systems, Advertising
revenues increased slightly as a result of an increase in
political advertising revenues in 2006.
Costs of revenues. The major components of
costs of revenues were as follows (in millions):
Costs of revenues increased 37%, and, as a percentage of
revenues, were 46% in 2006 compared to 44% in 2005. The increase
in costs of revenues is primarily related to the impact of the
Acquired Systems, as well as increases in video programming
costs, employee costs and Digital Phone costs. The increase in
costs of revenues as a percentage of revenues reflects the items
noted above and lower margins for the Acquired Systems.
The increase in video programming costs was due primarily to the
impact of the Acquired Systems, higher sports network
programming costs, the increase in video subscribers and
non-sports-related contractual rate increases. Video programming
costs in the Acquired Systems were $409 million in 2006.
Per subscriber programming costs increased 11%, to
$20.33 per month in 2006 from $18.35 per month in
2005. The increase in per subscriber programming costs was
primarily due to higher sports network programming costs and
non-sports-related contractual rate increases. Video programming
costs in both 2006 and 2005 also benefited from comparable
amounts of adjustments related to changes in programming
estimates and the settlement of terms with program vendors.
Employee costs increased primarily due to the impact of the
Acquired Systems, salary increases and higher headcount
resulting from the roll-out of advanced services. These
increases were partially offset by a benefit of approximately
$32 million related to both changes in estimates and a
correction of prior period medical benefit accruals.
High-speed data service costs consist of the direct costs
associated with the delivery of high-speed data services,
including network connectivity and certain other costs.
High-speed data service costs increased due to the Acquired
Systems, subscriber growth and an increase in per subscriber
connectivity costs.
Digital Phone costs consist of the direct costs associated with
the delivery of Digital Phone services, including network
connectivity and certain other costs. Digital Phone costs
increased primarily due to the growth in Digital Phone
subscribers.
Other costs increased due to revenue-driven increases in fees
paid to local franchise authorities, as well as increases in
other costs associated with the continued roll-out of advanced
services, including Digital Phone.
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OF
OPERATIONS AND FINANCIAL
CONDITION — (Continued)
Selling, general and administrative
expenses. The major components of selling,
general and administrative expenses were as follows (in
millions):
Selling, general and administrative expenses increased as a
result of higher employee, marketing and other costs. Employee
costs increased primarily due to the impact of the Acquired
Systems, increased headcount resulting from the continued
roll-out of advanced services and salary increases, partially
offset by a benefit of approximately $8 million related to
both changes in estimates and a correction of prior period
medical benefit accruals. Marketing costs increased as a result
of the Acquired Systems and higher costs associated with the
roll-out of advanced services. Other costs increased primarily
due to the impact of the Acquired Systems and increases in
administrative costs associated with the increase in headcount
discussed above.
Merger-related and restructuring costs. In
2006 and 2005, the Company expensed $38 million and
$8 million, respectively, of non-capitalizable
merger-related costs associated with the Transactions. These
merger-related costs are related primarily to consulting fees
concerning integration planning for the Transactions and other
costs incurred in connection with notifying new customers of the
change in cable providers. Such costs are expected to continue
into 2007. In addition, the results for 2006 include
$18 million of restructuring costs. The results for 2005
included $35 million of restructuring costs, primarily
associated with the early retirement of certain senior
executives and the closing of several local news channels,
partially offset by a $1 million reduction in restructuring
charges, reflecting changes to previously established
restructuring accruals. The Company’s restructuring
activities are part of the Company’s broader plans to
simplify its organizational structure and enhance its customer
focus. TWC is in the process of executing these initiatives and
expects to incur additional costs as these plans continue to be
implemented throughout 2007.
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OPERATIONS AND FINANCIAL
CONDITION — (Continued)
Reconciliation of Operating Income to
OIBDA. The following table reconciles Operating
Income to OIBDA. In addition, the table provides the components
from Operating Income to Net income for purposes of the
discussions that follow (in millions):
NM — Not meaningful.
OIBDA. OIBDA increased to $4.229 billion
in 2006 from $3.323 billion in 2005. This increase was
attributable to the impact of the Acquired Systems and revenue
growth (particularly growth in high margin high-speed data
revenues), partially offset by higher costs of revenues and
selling, general and administrative expenses, as discussed above.
Depreciation expense. Depreciation expense
increased to $1.883 billion in 2006 from
$1.465 billion in 2005 primarily due to the impact of the
Acquired Systems and demand-driven increases in recent years of
purchases of customer premise equipment, which generally has a
significantly shorter useful life compared to the mix of assets
previously purchased.
Amortization expense. Amortization expense
increased to $167 million in 2006 from $72 million in
2005 as a result of the amortization of intangible assets
associated with customer relationships acquired as part of the
Transactions.
Operating Income. Operating Income increased
to $2.179 billion in 2006 from $1.786 billion in 2005
primarily due to the increase in OIBDA, partially offset by the
increase in depreciation and amortization expense, as discussed
above.
As a result of the impact of the Adelphia Acquisition and the
consolidation of TKCCP, beginning January 1, 2007, the
Company anticipates that OIBDA and Operating Income will
increase during 2007. Refer to Note 5 of the accompanying
consolidated financial statements for certain pro forma
information presenting the Company’s financial results as
if the Transactions had occurred on January 1, 2005 and
refer to “Overview — Recent
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OPERATIONS AND FINANCIAL
CONDITION — (Continued)
Developments — Dissolution of TKCCP” for selected
operating statement information for the Kansas City Pool for the
years ended December 31, 2006 and 2005.
Interest expense, net. Interest expense, net,
increased to $646 million in 2006 from $464 million in
2005 primarily due to an increase in debt levels attributable to
the Transactions.
Income from equity investments, net. Income
from equity investments, net, increased to $129 million in
2006 from $43 million in 2005. This increase was primarily
due to an increase in the profitability of TKCCP, as well as
changes in the economic benefit of TWE’s partnership
interest in TKCCP due to the pending dissolution of the
partnership triggered by Comcast on July 3, 2006. Beginning
in the third quarter of 2006, the income from TKCCP reflects
100% of the operations of the Kansas City Pool and does not
reflect any of the economic benefits of the Houston Pool. In
addition, income from equity investments, net reflects the
benefit from the allocation of all the TKCCP debt to the Houston
Pool, which reduced interest expense for the Kansas City Pool.
TWC received the Kansas City Pool on January 1, 2007 in the
TKCCP asset distribution and began consolidating its results on
that date.
Minority interest expense, net. Minority
interest expense, net, increased to $108 million in 2006
from $64 million in 2005. This increase primarily reflects
a change in the ownership structure of the Company and TWE. At
December 31, 2005, ATC, a subsidiary of Time Warner, and
Comcast had residual equity ownership interests in TWE of 1% and
4.7%, respectively. On July 28, 2006, ATC contributed its
1% common equity interest (as well as its $2.4 billion
preferred equity interest) in TWE to TW NY Holding in exchange
for an approximately 12.4% non-voting common stock interest in
TW NY Holding. On July 31, 2006, the Company and TWE
redeemed Comcast’s ownership interests in the Company and
TWE, respectively.
Income tax provision. TWC’s income tax
provision has been prepared as if the Company operated as a
stand-alone taxpayer for all periods presented. In 2006 and
2005, the Company recorded income tax provisions of
$620 million and $153 million, respectively. The
effective tax rate was approximately 40% in 2006 compared to
approximately 12% in 2005. The increase in the effective tax
rate was primarily due to the favorable impact in 2005 of state
tax law changes in Ohio, an ownership restructuring in Texas and
certain other methodology changes. The income tax provision for
2005, absent the noted deferred tax impacts, would have been
$532 million, with a related effective tax rate of
approximately 41%.
Income before discontinued operations and cumulative effect
of accounting change. Income before discontinued
operations and cumulative effect of accounting change was
$936 million in 2006 compared to $1.149 billion in
2005. Basic and diluted income per common share before
discontinued operations and cumulative effect of accounting
change were $0.95 in 2006 compared to $1.15 in 2005. These
decreases were primarily due to the increase in the income tax
provision, discussed above, and higher interest expense,
partially offset by increased Operating Income and income from
equity investments, net.
Discontinued operations, net of
tax. Discontinued operations, net of tax, reflect
the impact of treating the Transferred Systems as discontinued
operations. For the years ended December 31, 2006 and 2005,
the Company recognized pretax income applicable to these systems
of $285 million and $163 million, respectively,
($1.038 billion and $104 million, respectively, net of
tax). Included in the 2006 results are a pretax gain of
approximately $165 million on the Transferred Systems and a
tax benefit of approximately $800 million comprised of a
tax benefit of $814 million on the Redemptions, partially
offset by a provision of $14 million on the Exchange. The
tax benefit of $814 million resulted primarily from the
reversal of historical deferred tax liabilities that had existed
on systems transferred to Comcast in the TWC Redemption. The TWC
Redemption was designed to qualify as a tax-free split-off under
section 355 of the Tax Code, and as a result, such
liabilities were no longer required. However, if the IRS were
successful in challenging the tax-free characterization of the
TWC Redemption, an additional cash liability on account of taxes
of up to an estimated $900 million could become payable by
the Company. See “Recent Developments — Tax
Benefits from the Transactions.”
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WARNER CABLE INC.
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF RESULTS
OF
OPERATIONS AND FINANCIAL
CONDITION — (Continued)
Cumulative effect of accounting change, net of
tax. In 2006, the Company recorded a benefit of
$2 million, net of tax, as the cumulative effect of a
change in accounting principle upon the adoption of
FAS 123R in 2006, to recognize the effect of estimating the
number of Time Warner equity-based awards granted to TWC
employees prior to January 1, 2006 that are not ultimately
expected to vest.
Net income and Net income per common
share. Net income was $1.976 billion in 2006
compared to $1.253 billion in 2005. Basic and diluted net
income per common share were $2.00 in 2006 compared to $1.25 in
2005.
2005 vs.
2004
Consolidated
Results
Revenues. Revenues by major category were as
follows (in millions):
NM — Not meaningful.
Subscriber results were as follows (in thousands):
NM — Not meaningful
Subscription revenues increased in 2005 as a result of increases
in video, high-speed data and Digital Phone revenues. Total
video revenues increased by $338 million, or 6%, over 2004,
primarily due to continued penetration of digital video services
and video price increases, as well as an increase in basic video
subscribers between
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WARNER CABLE INC.
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF RESULTS
OF
OPERATIONS AND FINANCIAL
CONDITION — (Continued)
December 31, 2004 and December 31, 2005. Aggregate
revenues associated with digital video services, including
digital tiers,
Pay-Per-View,
VOD, SVOD and digital video recorders, increased 19% from
$612 million in 2004 to $727 million in 2005.
High-speed data revenues increased in 2005 primarily due to
growth in high-speed data subscribers. Consolidated residential
high-speed data penetration, expressed as a percentage of
service-ready homes, increased from 21.8% at December 31,
2004 to 26.1% at December 31, 2005. Commercial high-speed
data revenues increased from $181 million in 2004 to
$241 million in 2005.
The increase in Digital Phone revenues in 2005 was primarily due
to the full-scale launch of Digital Phone across the
Company’s footprint. Digital Phone was available to nearly
88% of TWC’s consolidated homes passed as of
December 31, 2005.
Subscription ARPU increased approximately 13% to $81 in 2005
from approximately $72 in 2004 as a result of the increased
penetration in advanced services and higher video prices, as
discussed above.
Advertising revenues in 2005 increased as a result of an
approximate $19 million increase in national advertising,
partially offset by a $4 million decline in local
advertising. The increase in national advertising was driven by
growth in both the rate and volume of advertising spots sold.
Local advertising declined as a result of a decrease in
political advertising.
Costs of revenues. The primary components of
costs of revenues were as follows (in millions):
NM — Not meaningful.
Total video programming costs increased by 11% in 2005. On a per
subscriber basis, programming costs increased by 11%, from
$16.60 per month in 2004 to $18.35 per month in 2005.
These increases were primarily attributable to contractual rate
increases and the ongoing deployment of new service offerings,
including VOD and SVOD.
Employee costs increased in 2005, in part, as a result of
increased headcount driven by new product deployment
initiatives, including Digital Phone. Salary increases also
contributed to the increase in employee costs.
High-speed data costs have benefited as connectivity costs have
continued to decrease on a per subscriber basis due to
industry-wide cost reductions.
Digital Phone costs increased due to the ongoing deployment of
Digital Phone.
Other costs increased due largely to the revenue-driven increase
in fees paid to local franchise authorities.
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WARNER CABLE INC.
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF RESULTS
OF
OPERATIONS AND FINANCIAL
CONDITION — (Continued)
Selling, general and administrative
expenses. The primary components of selling,
general and administrative expenses were as follows (in
millions):
Employee costs increased primarily due to an increase in
headcount associated with the continued roll-out of advanced
services, as well as salary increases, partially offset by a
decrease in equity-based compensation expense. Marketing costs
increased due to a continued focus on aggressive marketing of
the Company’s broad range of products and services. Other
costs decreased slightly primarily due to $34 million of
costs incurred in 2004 in connection with a settlement related
to Urban Cable, partially offset by an increase in legal fees.
Merger-related and restructuring costs. In
2005, the Company expensed approximately $8 million of
non-capitalizable merger-related costs associated with the
Adelphia Acquisition and the Exchange. In addition, the 2005
results include approximately $35 million of restructuring
costs, primarily associated with the early retirement of certain
senior executives and the closing of several local news
channels, partially offset by a $1 million reduction in
restructuring charges, reflecting changes to previously
established restructuring accruals. These charges are part of
the Company’s broader plans to simplify its organizational
structure and enhance its customer focus.
Reconciliation of Operating Income to
OIBDA. The following table reconciles Operating
Income to OIBDA. In addition, the table provides the components
from Operating Income to Net income for purposes of the
discussions that follow (in millions):
OIBDA. OIBDA increased $368 million, or
12%, from $2.955 billion in 2004 to $3.323 billion in
2005. This increase was driven by revenue growth (particularly
high margin high-speed data revenues), partially offset by
increases in costs of revenues, selling, general and
administrative expenses and the $42 million of
merger-related and restructuring charges in 2005, discussed
above.
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WARNER CABLE INC.
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF RESULTS
OF
OPERATIONS AND FINANCIAL
CONDITION — (Continued)
Depreciation expense. Depreciation expense
increased 10% to $1.465 billion in 2005 from
$1.329 billion in 2004. This increase was primarily due to
the increased spending on customer premise equipment in recent
years. Such equipment generally has a shorter useful life
compared to the mix of assets previously purchased.
Operating Income. Operating Income increased
to $1.786 billion in 2005 from $1.554 billion in 2004,
due to the increase in OIBDA, partially offset by the increase
in depreciation expense.
Interest expense, net. Interest expense, net,
decreased slightly from $465 million in 2004 to
$464 million in 2005, primarily due to an increase in
interest income associated with loans to TKCCP, which was
largely offset by an increase in interest expense related to
long-term debt.
Income from equity investments, net. Income
from equity investments, net, increased slightly from
$41 million in 2004 to $43 million in 2005. This
increase was primarily due to an increase in the profitability
of iN DEMAND and a decrease in losses incurred by local news
joint ventures, partially offset by a decline in profitability
of TKCCP, as a result of higher interest expense associated with
an increase in debt at the joint venture.
Minority interest expense, net. The results of
TWE are consolidated by TWC for financial reporting purposes.
Minority interest expense, net, increased from $56 million
in 2004 to $64 million in 2005. This increase primarily
reflects an increase in the profitability of TWE, in which Time
Warner and Comcast had residual equity ownership interests of 1%
and 4.7%, respectively, at December 31, 2005.
Other income. Other income decreased from
$11 million in 2004 to $1 million in 2005 due to a
reversal of previously established reserves associated with the
dissolution of a joint venture in 2004.
Income tax provision. TWC’s income tax
provision has been prepared as if the Company operated as a
stand-alone taxpayer for all periods presented. The income tax
provision decreased from $454 million in 2004 to
$153 million in 2005. The effective tax rate was
approximately 42% in 2004 compared to 12% in 2005. The decrease
in the tax provision and the effective tax rate was primarily a
result of the favorable impact of state tax law changes in Ohio,
an ownership restructuring in Texas and certain other
methodology changes, partially offset by an increase in earnings
during 2005 as compared to 2004. The income tax provision for
2005, absent the noted deferred tax impacts, would have been
$532 million, with a related effective tax rate of
approximately 41%.
Income before discontinued operations. Income
before discontinued operations was $1.149 billion in 2005
compared to $631 million in 2004. Basic and diluted income
per common share before discontinued operations and cumulative
effect of accounting change were $1.15 in 2005 compared to $0.63
in 2004. These increases were due to higher Operating Income and
a lower income tax provision, partially offset by higher
minority interest expense.
Discontinued operations, net of
tax. Discontinued operations, net of tax, reflect
the impact of treating the Transferred Systems as discontinued
operations. The increase to $104 million in 2005 from
$95 million in 2004 was as a result of higher earnings at
the Transferred Systems.
Net income and Net income per common
share. Net income was $1.253 billion in 2005
compared to $726 million in 2004. Basic and diluted net
income per common share were $1.25 in 2005 compared to $0.73 in
2004.
FINANCIAL
CONDITION AND LIQUIDITY
Management believes that cash generated by or available to TWC
should be sufficient to fund its capital and liquidity needs for
the foreseeable future. TWC’s sources of cash include cash
provided by operating activities, cash and equivalents on hand,
$2.747 billion of available borrowing capacity under its
committed credit facilities and commercial paper program as of
December 31, 2006 and access to the capital markets. TWC
increased the size of its unsecured commercial paper program
from $2.0 billion to $6.0 billion in the fourth
quarter of 2006.
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WARNER CABLE INC.
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF RESULTS
OF
OPERATIONS AND FINANCIAL
CONDITION — (Continued)
At December 31, 2006, the Company had $14.732 billion
of debt and mandatorily redeemable non-voting Series A
Preferred Membership Units issued by TW NY in connection with
the Adelphia Acquisition (the “TW NY Series A
Preferred Membership Units”), $51 million of cash and
equivalents and $23.564 billion of shareholders’
equity. At December 31, 2005, the Company had
$6.863 billion of debt and mandatorily redeemable preferred
equity, $12 million of cash and equivalents and
$20.347 billion of shareholders’ equity.
With the closing of the Adelphia Acquisition and the
Redemptions, TWC’s outstanding debt increased substantially
during 2006. Accordingly, cash paid for interest is expected to
continue to negatively impact cash provided by operating
activities. Management does not believe that the interest
incurred with respect to funding the Transactions will result in
a significant negative impact to net income because such
incremental interest is expected to be substantially offset by
the positive earnings before interest of the Acquired Systems.
The following table shows the significant items contributing to
the increase in net debt (defined as total debt, mandatorily
redeemable preferred equity issued by a subsidiary and TW NY
Series A Preferred Membership Units less cash and
equivalents) from December 31, 2005 to December 31,
2006 (in millions):
On July 31, 2006, TW NY, a subsidiary of TWC, acquired
assets of Adelphia for a combination of cash and stock of TWC,
Comcast’s interests in TWC and TWE were redeemed and TW NY
exchanged certain cable systems with Comcast. For additional
details, see “Recent Developments.”
In connection with the closing of the Adelphia Acquisition, TW
NY paid $8.935 billion in cash, after giving effect to
certain purchase price adjustments, that was funded by an
intercompany loan from TWC and the proceeds of the private
placement issuance of $300 million of TW NY Series A
Preferred Membership Units with a mandatory redemption date of
August 1, 2013 and a cash dividend rate of 8.21% per
annum. The intercompany loan was financed by borrowings under
the Cable Revolving Facility and the Cable Term Facilities
described below and the issuance of commercial paper. In
connection with the TWC Redemption, Comcast received 100% of the
capital stock of a subsidiary of TWC holding both cable systems
and approximately $1.857 billion in cash that was funded
through the issuance of TWC commercial paper and borrowings
under the Cable Revolving Facility. In addition, in connection
with the TWE Redemption, Comcast received 100% of the equity
interests in a subsidiary of TWE holding both cable systems and
approximately $147 million in cash that was funded by the
repayment of a pre-existing loan TWE had made to TWC (which
repayment TWC funded through the issuance of commercial paper
and borrowings under the Cable Revolving Facility).
Additionally, ATC’s 1% common equity interest and
$2.4 billion preferred equity interest in TWE were
contributed to TW NY Holding in exchange for an approximately
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WARNER CABLE INC.
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF RESULTS
OF
OPERATIONS AND FINANCIAL
CONDITION — (Continued)
12.4% non-voting common stock interest in TW NY Holding.
Following these transactions, TW NY also exchanged certain cable
systems with Comcast and TW NY paid Comcast approximately
$67 million for certain adjustments related to the
Exchange. See “Bank Credit Agreements and Commercial Paper
Programs,” “Mandatorily Redeemable Preferred
Equity” and “TW NY Mandatorily Redeemable Non-voting
Series A Preferred Membership Units” for additional
information on the indebtedness incurred and preferred
membership units issued in connection with the Adelphia
Acquisition and the Redemptions.
TWC is a participant in a wireless spectrum joint venture with
several other cable companies and Sprint (the “Wireless
Joint Venture”), which was a winning bidder in an FCC
auction of certain advanced wireless spectrum licenses. In 2006,
TWC paid approximately $633 million related to its
investment in the Wireless Joint Venture. The licenses were
awarded to the Wireless Joint Venture on November 29, 2006.
Under the joint venture agreement, Sprint has the ability to
exit the venture upon 60 days’ notice and to require
that the venture purchase its interests for an amount equal to
Sprint’s capital contributions to that point. In addition,
under certain circumstances, the cable operators that are
members of the venture have the ability to exit the venture and
receive, subject to certain limitations and adjustments,
advanced wireless spectrum licenses covering their operating
areas. There can be no assurance that the venture will
successfully develop mobile and related services.
On October 2, 2006, TWC received approximately
$630 million from Comcast for the repayment of debt owed by
TKCCP to TWE-A/N that had been allocated to the Houston Pool.
Cash
Flows
Details of cash provided by operating activities are as follows
(in millions):
Cash provided by operating activities increased from
$2.540 billion in 2005 to $3.595 billion in 2006. This
increase was primarily related to an increase in OIBDA
(attributable to the impact of the Acquired Systems and revenue
growth in the Legacy Systems (particularly high margin
high-speed data revenues), partially offset by increases in
costs of revenues and selling, general and administrative
expenses) and a decrease in working capital requirements,
partially offset by lower net cash flows from discontinued
operations and an increase in merger-related and restructuring
payments. The decrease in working capital requirements was
primarily due to impacts
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WARNER CABLE INC.
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF RESULTS
OF
OPERATIONS AND FINANCIAL
CONDITION — (Continued)
from the Transactions, as well as the timing of accounts payable
and accrual payments, partially offset by lower cash collections
on receivables.
Cash provided by operating activities decreased from
$2.661 billion in 2004 to $2.540 billion in 2005. This
decrease was principally due to an increase in net cash tax
payments, partially offset by an increase in OIBDA (attributable
to revenue growth (particularly high margin high-speed data
revenues), partially offset by increases in costs of revenues,
selling, general and administrative expenses and merger-related
and restructuring costs), and a decrease in contributions to the
Company’s pension plans.
Investing
Activities
Details of cash used by investing activities are as follows (in
millions):
Cash used by investing activities increased from
$2.132 billion in 2005 to $11.999 billion in 2006.
This increase was principally due to the Adelphia Acquisition
and the Exchange and an increase in capital expenditures from
continuing operations, driven by capital expenditures associated
with the integration of the Acquired Systems, the continued
roll-out of advanced digital services, including Digital Phone
services, and continued growth in high-speed data services. The
increase also reflects the investment in the Wireless Joint
Venture and cash used in the TWE Redemption, partially offset by
decreases in investment spending related to the Company’s
equity investments and other acquisition-related expenditures
and capital expenditures from discontinued operations.
Cash used by investing activities increased from
$1.816 billion in 2004 to $2.132 billion in 2005. This
increase was principally due to increases in capital
expenditures from continuing operations, cash used by investing
activities of discontinued operations and acquisition-related
expenditures, partially offset by decreases in investment
spending related to the Company’s equity investments and
capital expenditures from discontinued operations. The increase
in capital expenditures from continuing operations in 2005 was
primarily associated with increased spending associated with the
continued roll-out of advanced digital services, including
Digital Phone.
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WARNER CABLE INC.
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF RESULTS
OF
OPERATIONS AND FINANCIAL
CONDITION — (Continued)
TWC’s capital expenditures from continuing operations
included the following major categories (in millions):
TWC incurs expenditures associated with the construction of its
cable systems. Costs associated with the construction of the
cable transmission and distribution facilities and new cable
service installations are capitalized. TWC generally capitalizes
expenditures for tangible fixed assets having a useful life of
greater than one year. Capitalized costs include direct
material, labor and overhead and interest. Sales and marketing
costs, as well as the costs of repairing or maintaining existing
fixed assets, are expensed as incurred. With respect to certain
customer premise equipment, which includes converters and cable
modems, TWC capitalizes installation charges only upon the
initial deployment of these assets. All costs incurred in
subsequent disconnects and reconnects are expensed as incurred.
Depreciation on these assets is provided, generally using the
straight-line method, over their estimated useful lives. For
converters and modems, the useful life is 3 to 4 years,
and, for plant upgrades, the useful life is up to 16 years.
In connection with the Transactions, TW NY acquired significant
amounts of property, plant and equipment, which were recorded at
their estimated fair values. The remaining useful lives assigned
to such assets were generally shorter than the useful lives
assigned to comparable new assets, to reflect the age, condition
and intended use of the acquired property, plant and equipment.
As a result of the Transactions, the Company has made and
anticipates continuing to make significant capital expenditures
over the next 12 to 24 months related to the continued
integration of the Acquired Systems, including improvements to
plant and technical performance and upgrading system capacity,
which will allow the Company to offer its advanced services and
features in the Acquired Systems. The Company estimates that
these expenditures will range from approximately
$450 million to $550 million (including amounts
incurred during 2006). TWC does not believe that these
expenditures will have a material negative impact on its
liquidity or capital resources.
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WARNER CABLE INC.
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF RESULTS
OF
OPERATIONS AND FINANCIAL
CONDITION — (Continued)
Details of cash provided (used) by financing activities are as
follows (in millions):
Cash provided by financing activities was $8.443 billion in
2006 compared to cash used by financing activities of
$498 million in 2005. This increase in cash provided (used)
by financing activities was due to an increase in net borrowings
primarily associated with the Transactions, the issuance of the
TW NY Series A Preferred Membership Units and other
financing activities, partially offset by cash used in the TWC
Redemption.
Cash used by financing activities decreased from
$1.072 billion in 2004 to $498 million in 2005. This
decrease was primarily due to a decline in net repayments of
debt, partially offset by increases in net partnership tax
distributions and stock option distributions and cash used by
financing activities of discontinued operations in 2005.
Reconciliation of Cash provided by operating activities to
Free Cash Flow. The following table reconciles Cash provided
by operating activities to Free Cash Flow (in millions):
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TIME
WARNER CABLE INC.
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF RESULTS
OF
OPERATIONS AND FINANCIAL
CONDITION — (Continued)
Free Cash Flow increased to $735 million during 2006, as
compared to $435 million during 2005. This increase of
$300 million was primarily driven by a $906 million
increase in OIBDA, as previously discussed, and a decrease in
working capital requirements, partially offset by an increase in
capital expenditures from continuing operations.
Free Cash Flow decreased to $435 million during 2005 as
compared to $851 million during 2004. This decrease of
$416 million was primarily driven by increases in net cash
tax payments and capital expenditures from continuing
operations, partially offset by an increase in OIBDA, as
previously discussed, and a decrease in contributions to the
Company’s pension plans.
Debt, mandatorily redeemable preferred equity and unused
borrowing capacity, as of December 31, 2006 were as follows
(in millions):
(a) Amount
excludes unamortized discount on commercial paper of
$17 million at December 31, 2006.
Primarily as a result of the Adelphia Acquisition and the
Redemptions, borrowings under the Cable Revolving Facility,
Cable Term Facilities and commercial paper program increased to
approximately $925 million, $8.0 billion and
$2.152 billion, respectively, at December 31, 2006.
Additionally, TW NY issued $300 million of TW NY
Series A Preferred Membership Units, and ATC’s 1%
common equity interest and $2.4 billion preferred equity
interest in TWE were contributed to TW NY Holding in exchange
for a 12.4% non-voting common stock interest in TW NY Holding.
See “Bank Credit Agreements and Commercial Paper
Programs,” “Mandatorily Redeemable Preferred
Equity” and “TW NY Mandatorily Redeemable Non-voting
Series A Preferred Membership Units” for additional
information on the indebtedness incurred and preferred
membership units issued in connection with the Adelphia
Acquisition and the Redemptions.
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TIME
WARNER CABLE INC.
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF RESULTS
OF
OPERATIONS AND FINANCIAL
CONDITION — (Continued)
In the first quarter of 2006, the Company entered into
$14.0 billion of bank credit agreements, which consist of
an amended and restated $6.0 billion five-year revolving
credit facility (including $2.0 billion of increased
commitments), a new $4.0 billion five-year term loan
facility and a new $4.0 billion three-year term loan
facility. Collectively, these facilities refinanced
$4.0 billion of previously existing committed bank
financing, while the $2.0 billion increase in the revolving
credit facility and the $8.0 billion of new term loan
facilities were used to finance, in part, the cash portions of
the Transactions. As discussed below, the increase in the
revolving credit facility and the two term loan facilities
became effective concurrent with the closing of the Adelphia
Acquisition, and the term loans were fully utilized at that time.
Following the financing transactions described above, TWC has a
$6.0 billion senior unsecured five-year revolving credit
facility with a maturity date of February 15, 2011 (the
“Cable Revolving Facility”). This represents a
refinancing of TWC’s previous $4.0 billion of
revolving bank commitments with a maturity date of
November 23, 2009, plus an increase of $2.0 billion
effective concurrent with the closing of the Adelphia
Acquisition. Also effective concurrent with the closing of the
Adelphia Acquisition are two $4.0 billion term loan
facilities (the “Cable Term Facilities” and,
collectively with the Cable Revolving Facility, the “Cable
Facilities”), with maturity dates of February 24, 2009
and February 21, 2011, respectively. TWE is no longer a
borrower in respect of any of the Cable Facilities, although TWE
and TW NY Holding guarantee the obligations of TWC under the
Cable Facilities. As of December 31, 2006, there were
borrowings of $8.0 billion outstanding under the Cable Term
Facilities.
On October 18, 2006, TW NY Holding executed and delivered
unconditional guaranties of the obligations of TWC under the
Cable Facilities. In addition, contemporaneously with the
completion by TW NY of the TWE GP Transfer described below, TW
NY was released from its guaranties of TWC’s obligations
under the Cable Facilities in accordance with the terms of the
Cable Facilities. In addition, following the adoption of the
amendments to the TWE Indenture pursuant to the Eleventh
Supplemental Indenture described below, the guaranties
previously provided by ATC and Warner Communications Inc.
(“WCI”), subsidiaries of Time Warner, of TWC’s
obligations under the Cable Facilities were automatically
terminated in accordance with the terms of the Cable Facilities.
Borrowings under the Cable Revolving Facility bear interest at a
rate based on the credit rating of TWC, which rate was LIBOR
plus 0.27% per annum as of December 31, 2006. In
addition, TWC is required to pay a facility fee on the aggregate
commitments under the Cable Revolving Facility at a rate
determined by the credit rating of TWC, which rate was
0.08% per annum as of December 31, 2006. TWC may also
incur an additional usage fee of 0.10% per annum on the
outstanding loans and other extensions of credit under the Cable
Revolving Facility if and when such amounts exceed 50% of the
aggregate commitments thereunder. Borrowings under the Cable
Term Facilities bear interest at a rate based on the credit
rating of TWC, which rate was LIBOR plus 0.40% per annum as
of December 31, 2006. In addition, TWC paid a facility fee
on the aggregate commitments under the Cable Term Facilities for
the period prior to the closing of the Adelphia Acquisition at a
rate of 0.08% per annum.
The Cable Revolving Facility provides
same-day
funding capability and a portion of the commitment, not to
exceed $500 million at any time, may be used for the
issuance of letters of credit. The Cable Facilities contain a
maximum leverage ratio covenant of 5.0 times the consolidated
EBITDA of TWC. The terms and related financial metrics
associated with the leverage ratio are defined in the Cable
Facility agreements. At December 31, 2006, TWC was in
compliance with the leverage covenant, with a leverage ratio,
calculated in accordance with the agreements, of approximately
3.3 times. The Cable Facilities do not contain any credit
ratings-based defaults or covenants or any ongoing covenant or
representations specifically relating to a material adverse
change in the financial condition or results of operations of
Time Warner or TWC. Borrowings under the Cable Revolving
Facility may be used for general corporate purposes and unused
credit is available to support borrowings under TWC’s
commercial paper program. Borrowings under the Cable Facilities
were used to finance, in part, the cash portions of the
Transactions. As of December 31, 2006, there were
borrowings of $925 million and letters of credit totaling
$159 million outstanding under the Cable Revolving
Facility, and approximately $2.152 billion of commercial
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paper was supported by the Cable Revolving Facility. TWC’s
unused committed capacity as of December 31, 2006 was
$2.798 billion, net of $17 million unamortized
discount on commercial paper and including $51 million of
cash and equivalents.
On December 4, 2006, TWC entered into a $6.0 billion
unsecured commercial paper program (the “New Program”)
that replaced its previous $2.0 billion commercial paper
program (the “Prior Program”). TWC’s obligations
under the New Program are guaranteed by TW NY Holding and TWE,
both subsidiaries of TWC, while TWC’s obligations under the
Prior Program were guaranteed by ATC, WCI (both subsidiaries of
Time Warner but not of TWC) and TWE. Commercial paper issued
under the New Program is supported by the unused committed
capacity of the Cable Revolving Facility. The commercial paper
issued under the New Program ranks pari passu with TWC’s,
TWE’s and TW NY Holding’s other unsecured senior
indebtedness.
No new commercial paper was issued under the Prior Program after
December 4, 2006, and the Prior Program was terminated on
February 14, 2007, upon the repayment of the last remaining
notes issued thereunder. As of December 31, 2006, there was
approximately $1.500 billion of commercial paper
outstanding under the New Program and approximately
$652 million of commercial paper outstanding under the
Prior Program.
During 1992 and 1993, TWE issued the TWE Notes publicly in a
number of offerings. The maturities of these outstanding
issuances ranged from 15 to 40 years and the fixed interest
rates range from 7.25% to 10.15%. The fixed-rate borrowings
include an unamortized debt premium of $140 million and
$154 million as of December 31, 2006 and 2005,
respectively. The debt premium is amortized over the term of
each debt issue as a reduction of interest expense. As discussed
below, TWC and TW NY Holding have each guaranteed TWE’s
obligations under the TWE Notes. Prior to November 2, 2006,
ATC and WCI each guaranteed pro rata portions of the TWE Notes
based on the relative fair value of the net assets that each
contributed to TWE prior to the TWE Restructuring. On
September 10, 2003, TWE submitted an application with the
SEC to withdraw its 7.25% Senior Debentures (due
2008) from listing and registration on the NYSE. The
application to withdraw was granted by the SEC effective on
October 17, 2003. As a result, TWE has no obligation to
file reports with the SEC under the Securities Exchange Act of
1934, as amended (the “Exchange Act”).
Pursuant to the Ninth Supplemental Indenture to the TWE
Indenture, TW NY, a subsidiary of TWC and a successor in
interest to Time Warner NY Cable Inc., agreed to waive, for so
long as it remained a general partner of TWE, the benefit of
certain provisions in the TWE Indenture which provided that it
would not have any liability for the TWE Notes as a general
partner of TWE (the “TW NY Waiver”). On
October 18, 2006, TW NY contributed all of its general
partnership interests in TWE to TWE GP Holdings LLC, its wholly
owned subsidiary (the “TWE GP Transfer”), and, as a
result, the TW NY Waiver, by its terms, ceased to be in effect.
In addition, on October 18, 2006, TWC, together with TWE,
TW NY Holding, ATC, WCI and The Bank of New York, as Trustee,
entered into the Tenth Supplemental Indenture to the TWE
Indenture. Pursuant to the Tenth Supplemental Indenture to the
TWE Indenture, TW NY Holding fully, unconditionally and
irrevocably guaranteed the payment of principal and interest on
the TWE Notes.
On October 19, 2006, TWE commenced a consent solicitation
to amend the TWE Indenture to simplify the guaranty structure of
the TWE Notes and to amend TWE’s reporting obligations
under the TWE Indenture. On November 2, 2006, the consent
solicitation was completed, and TWE, TWC, TW NY Holding and The
Bank of New York, as Trustee, entered into the Eleventh
Supplemental Indenture to the TWE Indenture, which
(i) amended the guaranty of the TWE Notes previously
provided by TWC to provide a direct guaranty of the TWE Notes by
TWC, rather than a guaranty of the TW Partner Guaranties (as
defined below), (ii) terminated the guaranties (the
“TW Partner Guaranties”) previously provided by ATC
and WCI, which entities are subsidiaries of Time Warner, and
(iii) amended TWE’s reporting obligations under the
TWE Indenture to allow TWE to provide holders of the TWE Notes
with quarterly and annual reports that TWC (or any other
ultimate parent guarantor, as described in the
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Eleventh Supplemental Indenture) would be required to file with
the SEC pursuant to Section 13 of the Exchange Act, if it
were required to file such reports with the SEC in respect of
the TWE Notes pursuant to such section of the Exchange Act,
subject to certain exceptions as described in the Eleventh
Supplemental Indenture.
In connection with the financing of the Adelphia Acquisition, TW
NY issued $300 million of its Series A Preferred
Membership Units to a limited number of third parties. The TW NY
Series A Preferred Membership Units pay cash dividends at
an annual rate equal to 8.21% of the sum of the liquidation
preference thereof and any accrued but unpaid dividends thereon,
on a quarterly basis. The TW NY Series A Preferred
Membership Units are subject to mandatory redemption by TW NY on
August 1, 2013 and are not redeemable by TW NY at any time
prior to that date. The redemption price of the TW NY
Series A Preferred Membership Units is equal to their
liquidation preference plus any accrued and unpaid dividends
through the redemption date. Except under limited circumstances,
holders of TW NY Series A Preferred Membership Units have
no voting rights.
The terms of the TW NY Series A Preferred Membership Units
require that holders owning a majority of the TW NY
Series A Preferred Membership Units must approve any
agreement for a material sale or transfer by TW NY and its
subsidiaries of assets at any time during which TW NY and its
subsidiaries maintain, collectively, cable systems serving fewer
than 500,000 cable subscribers, or that would (after giving
effect to such asset sale) cause TW NY to maintain, directly or
indirectly, fewer than 500,000 cable subscribers, unless the net
proceeds of the asset sale are applied to fund the redemption of
the TW NY Series A Preferred Membership Units and the sale
occurs on or immediately prior to the redemption date.
Additionally, for so long as the TW NY Series A Preferred
Membership Units remain outstanding, TW NY may not merge or
consolidate with another company, or convert from a limited
liability company to a corporation, partnership or other entity,
unless (i) such merger or consolidation is permitted by the
asset sale covenant described above, (ii) if TW NY is not
the surviving entity or is no longer a limited liability
company, the then holders of the TW NY Series A Preferred
Membership Units have the right to receive from the surviving
entity securities with terms at least as favorable as the TW NY
Series A Preferred Membership Units and (iii) if TW NY
is the surviving entity, the tax characterization of the TW NY
Series A Preferred Membership Units would not be affected
by the merger or consolidation. Any securities received from a
surviving entity as a result of a merger or consolidation or the
conversion into a corporation, partnership or other entity must
rank senior to any other securities of the surviving entity with
respect to dividends and distributions or rights upon a
liquidation.
On July 28, 2006, ATC, a subsidiary of Time Warner,
contributed its $2.4 billion of mandatorily redeemable
preferred equity interest and a 1% common equity interest in TWE
to TW NY Holding in exchange for a 12.4% non-voting common
equity interest in TW NY Holding. TWE originally issued the
$2.4 billion mandatorily redeemable preferred equity to ATC
in connection with the TWE Restructuring. The issuance was a
noncash transaction. The preferred equity pays cash
distributions on a quarterly basis, at an annual rate of 8.059%
of its face value, and is required to be redeemed by TWE in cash
on April 1, 2023.
Under a shareholder agreement entered into between TWC and Time
Warner on April 20, 2005 (the “Shareholder
Agreement”), TWC is required to obtain Time Warner’s
approval prior to incurring additional debt (except for the
issuance of commercial paper or borrowings under TWC’s
current revolving credit facility up to the limit of that credit
facility, to which Time Warner has consented) or rental expenses
(other than with respect to certain approved leases) or issuing
preferred equity, if its consolidated ratio of debt, including
preferred equity, plus six times its annual rental expense to
EBITDAR (the “TW Leverage Ratio”) then exceeds, or
would as a result of the incurrence or issuance exceed, 3:1.
Under certain circumstances, TWC also includes the indebtedness,
annual rental
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expense obligations and EBITDAR of certain unconsolidated
entities that it manages
and/or in
which it owns an equity interest, in the calculation of the TW
Leverage Ratio. The Shareholder Agreement defines EBITDAR, at
any time of measurement, as operating income plus depreciation,
amortization and rental expense (for any lease that is not
accounted for as a capital lease) for the twelve months ending
on the last day of TWC’s most recent fiscal quarter,
including certain adjustments to reflect the impact of
significant transactions as if they had occurred at the
beginning of the period.
The following table sets forth the calculation of the TW
Leverage Ratio for the year ended December 31, 2006 (in
millions, except ratio):
As indicated in the table above, as of December 31, 2006,
the TW Leverage Ratio did not exceed 3:1.
Contractual
and Other Obligations
Firm
Commitments
The Company has commitments under various firm contractual
arrangements to make future payments for goods and services.
These firm commitments secure future rights to various assets
and services to be used in the normal course of operations. For
example, the Company is contractually committed to make some
minimum lease payments for the use of property under operating
lease agreements. In accordance with current accounting rules,
the future rights and obligations pertaining to these contracts
are not reflected as assets or liabilities on the accompanying
consolidated balance sheet.
The following table summarizes the material firm commitments of
the Company at December 31, 2006 and the timing of and
effect that these obligations are expected to have on the
Company’s liquidity and cash flow in future periods. This
table excludes certain Adelphia and Comcast commitments, which
TWC did not assume, and excludes commitments related to other
entities, including certain unconsolidated equity method
investees. TWC expects to fund these firm commitments with cash
provided by operating activities generated in the ordinary
course of business.
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