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AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON OCTOBER 15, 1999
REGISTRATION NO.
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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KNOLOGY, INC.
(Exact name of registrant as specified in its charter)
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DELAWARE 4812 52-242458
(State or of Incorporation) (Primary Standard Industrial (I.R.S. Employer
Identification No.) Classification Code Number)
</TABLE>
1241 O.G. SKINNER DRIVE
WEST POINT, GEORGIA 31833
(706) 645-8553
(Address, including zip code, and telephone number, including
area code, of registrant's principal executive offices)
CHAD S. WACHTER
VICE PRESIDENT, GENERAL COUNSEL AND SECRETARY
KNOLOGY, INC.
1241 O.G. SKINNER DRIVE
WEST POINT, GEORGIA 31833
(706) 645-8553
(Name, address, including zip code, and telephone number,
including area code, of registrant's agent for service)
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Copies to:
STEVEN M. KAUFMAN, ESQ.
HOGAN & HARTSON L.L.P.
555 THIRTEENTH STREET, N.W.
WASHINGTON, D.C. 20004
(202) 637-5600
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after this Registration Statement becomes effective.
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act,
check the following box. [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant Rule 462(c) under
the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
check the following box. [ ]
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CALCULATION OF REGISTRATION FEE
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TITLE OF EACH CLASS OF PROPOSED MAXIMUM AMOUNT OF
SECURITIES AGGREGATE REGISTRATION
TO BE REGISTERED OFFERING PRICE(1) FEE
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<S> <C> <C>
Common Stock $.01 par value
Series A Preferred Stock, $.01 par value
Options to Purchase Common Stock............................ $238,613,580 $66,334.58
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(1) Estimated solely for purposes of calculating the registration fee pursuant
to Rule 457(o) under the Securities Act of 1933.
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THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.
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The information in this preliminary prospectus is not complete and may be
changed. We may not sell these securities until the registration statement filed
with the Securities and Exchange Commission is effective. This preliminary
prospectus is not an offer to sell these securities and is not seeking an offer
to buy these securities in any state where the offer or sale is not permitted.
SUBJECT TO COMPLETION, DATED OCTOBER 15, 1999
PRELIMINARY PROSPECTUS
KNOLOGY, INC.
(KNOLOGY LOGO)
COMMON STOCK
SERIES A PREFERRED STOCK
OPTIONS TO PURCHASE COMMON STOCK
This prospectus is being furnished to the stockholders and option holders
of ITC Holding Company, Inc., a Delaware corporation, in connection with the
proposed distribution by ITC Holding to its stockholders and option holders of
43,918,649 shares of Series A preferred stock and 6,315,789 options to purchase
common stock of our company. ITC Holding has declared a dividend payable to
holders of record of ITC Holding capital stock at the close of business on
December 1, 1999. For every share of ITC Holding common stock, ITC Holding
Series A preferred stock or ITC Holding Series B preferred stock you hold, you
will receive 1.0968 shares of our Series A preferred stock. ITC Holding has
decided to distribute options to purchase 1.0968 shares of our common stock for
each outstanding option to purchase one share of ITC Holding common stock. We
expect the stock dividend and options will be distributed on or about December
30, 1999. The eligible holders of ITC Holding's capital stock or stock options
will receive a check for the cash value of any fractional interest in our
capital stock or options. This prospectus also relates to the common stock into
which our preferred stock is convertible and the common stock underlying our
stock options being distributed by ITC Holding.
In the distribution, ITC Holding will distribute all of its shares of our
Series A preferred stock and stock options to its stockholders and option
holders. Immediately after the distribution is completed, ITC Holding will not
own any shares of our Series A preferred stock or any of our stock options.
No action is necessary on the part of ITC Holding stockholders or option
holders to receive the shares of our capital stock or stock options which ITC
Holding proposes to distribute. ITC Holding stockholders and option holders do
not need to pay any consideration to ITC Holding or to us in connection with
this distribution. ITC Holding stockholders and option holders do not need to
surrender any shares of ITC Holding capital stock or stock options to receive
their shares of our capital stock or stock options.
THE SECURITIES TO BE DISTRIBUTED PURSUANT THIS PROSPECTUS INVOLVE A HIGH
DEGREE OF RISK. YOU SHOULD CAREFULLY CONSIDER THE FACTORS DESCRIBED UNDER THE
HEADING "RISK FACTORS" BEGINNING ON PAGE 4 OF THIS PROSPECTUS.
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NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED THESE SECURITIES OR DETERMINED IF THIS
PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
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, 1999
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TABLE OF CONTENTS
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PAGE
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PROSPECTUS SUMMARY.......................................... 1
RISK FACTORS................................................ 4
THE DISTRIBUTION............................................ 11
TAX CONSEQUENCES OF
THE DISTRIBUTION............................................ 13
NO MARKET FOR OUR STOCK..................................... 15
DIVIDEND POLICY............................................. 15
CAPITALIZATION.............................................. 16
SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA.......... 17
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS................................. 19
OUR BUSINESS................................................ 29
MANAGEMENT.................................................. 50
CERTAIN TRANSACTIONS AND RELATIONSHIPS...................... 56
PRINCIPAL STOCKHOLDERS...................................... 59
DESCRIPTION OF SECURITIES................................... 61
LEGAL MATTERS............................................... 63
EXPERTS..................................................... 63
WHERE YOU CAN FIND MORE INFORMATION......................... 64
INDEX TO OUR CONSOLIDATED FINANCIAL STATEMENTS.............. F-1
</TABLE>
i
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PROSPECTUS SUMMARY
This summary highlights more detailed information and financial statements
contained later in this prospectus. This summary does not contain all of the
information that you should consider with respect to owning the shares. You
should read the entire prospectus carefully, especially the risks of holding the
shares discussed under "Risk Factors."
This prospectus assumes the completion of a number of events that we expect
to take place in November 1999. All numbers in this prospectus have been
adjusted to reflect a 600-to-1 stock split of our Series A preferred stock and a
4-to-1 stock split of our common stock which we expect will occur in November
1999.
KNOLOGY, INC.
We were formed in September 1998. We own 100% of KNOLOGY Holdings, Inc. and
100% of several other companies previously owned by ITC Holding Company, Inc.
KNOLOGY Holdings is our principal subsidiary. We offer our residential and
business customers broadband communication services, including analog and
digital cable television, local and long distance telephone, high-speed Internet
access service, and broadband carrier services.
We provide these services using high-speed, high-capacity networks in
Montgomery, Alabama; Columbus, Georgia; Augusta, Georgia; Panama City, Florida;
and Charleston, South Carolina. We provide analog and digital cable television
services in Huntsville, Alabama. Our Huntsville facilities are being upgraded to
provide local and long distance telephone and high-speed Internet access
services. We provide local exchange services and other broadband services
throughout the Georgia/Alabama border area known as the Valley. We also provide
telephone services in Newnan, Georgia.
We offer the following services:
- Cable television. We offer our customers four levels of cable television
services: basic, expanded basic, premium and digital.
- Telephony. Our telephony service includes residential and business local
and long distance telephone service, and access services.
- Internet Services. Our high speed Internet data service offers our
customers high-speed connections to the Internet using cable modems.
- Broadband Carrier Services. Our broadband carrier services consist of
local transport and interconnection services for other carriers.
We believe that our networks may enable us in the future to provide
additional broadband services, including:
- Interactive energy management services in partnership with power
companies, which involve active monitoring by the customer of energy
usage and cost.
- Security services, including closed-circuit television security
monitoring and alarm systems.
- Voice over Internet Protocol.
- High-speed, high-capacity local transport services using the Asynchronous
Transfer Mode method of transmission.
We plan to expand our business to new markets as well as to increase our
customer base in our current markets by:
- building reliable high-speed, high-capacity networks;
- offering our customers savings through a bundle of communications
services;
1
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- being the first company in our markets to offer multiple broadband
communications services;
- expanding to additional mid-sized cities in the southeastern United
States;
- focusing on the customer and offering superior customer service;
- pursuing strategic relationships with other service providers; and
- taking advantage of unused capacity on our networks to generate revenues
from other exchange carriers and service providers.
We are incorporated in the State of Delaware. Our principal executive
offices are located at 1241 O.G. Skinner Drive, West Point, Georgia 31833, and
our telephone number is (706) 645-8553.
RECENT DEVELOPMENTS
In November 1999, a subsidiary of ITC Holding, our parent company,
contributed to us
- stock representing approximately 85% of the outstanding equity of KNOLOGY
Holdings, Inc.;
- stock representing 100% of each of Interstate Telephone Company, Inc.,
Valley Telephone Company, Inc., Globe Telecommunications, Inc. and ITC
Globe, Inc.;
- a note of KNOLOGY Holdings in the principal amount of $13 million;
- 272,832 shares of preferred stock of ClearSource, Inc.; and
- cash in the amount of approximately $5.6 million, to be used for required
subscription payments to ClearSource.
Concurrently with this contribution, we completed an exchange with other KNOLOGY
Holdings stockholders in which we received KNOLOGY Holdings common stock and
preferred stock in exchange for our common stock and Series A preferred stock.
We now hold 100% of the outstanding capital stock of KNOLOGY Holdings.
In November 1999, after the contribution and exchange discussed above, we
entered into a loan agreement and note with a subsidiary of ITC Holding. This
subsidiary has agreed to lend us up to $30 million until March 31, 2000. The ITC
Holding subsidiary may elect, in lieu of repayment, to convert the amount
outstanding under the note into options to purchase up to 6,315,789 shares of
our Series A preferred stock based on the current fair value.
THE DISTRIBUTION
ITC Holding is distributing to its stockholders of record at the close of
business on December 1, 1999, a dividend consisting of 1.0968 shares of our
Series A preferred stock for every share of ITC Holding common and preferred
stock. ITC Holding has decided to distribute an option to purchase 1.0968 shares
of our common stock for each option to purchase one share of ITC Holding common
stock outstanding. Any stockholder and option holder who would be entitled to
receive a fractional interest will receive a check for the cash value of the
fractional interest.
INTENDED SUBSEQUENT PRIVATE PLACEMENT
Shortly after this distribution, we intend to make a private offering of
shares of our Series B preferred stock. This offering is expected to be to a
small group of institutional investors for approximately $100 million. Each
share of Series B preferred stock is expected to be convertible initially into
one share of our common stock. The terms of this private offering could change
and it is possible that the offering will not be consummated. The private
offering is contingent upon the completion of the distribution of our capital
stock described by this prospectus.
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SUMMARY CONSOLIDATED FINANCIAL DATA
The following table sets forth our summary consolidated financial data. The
summary financial data set forth below should be read in conjunction with the
section of the prospectus entitled "Management's Discussion and Analysis of
Financial Condition and Results of Operations", our financial statements and
related notes, and other financial data included elsewhere in this prospectus.
See Note 1 to our financial statements regarding the Reorganization.
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SIX SIX
YEAR YEAR YEAR MONTHS MONTHS
ENDED ENDED ENDED ENDED ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31, JUNE 30, JUNE 30,
1996 1997 1998(A) 1998 1999
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(UNAUDITED) (UNAUDITED)
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STATEMENT OF OPERATIONS DATA:
Operating Revenues......................... $17,527,208 $ 17,633,313 $ 45,132,522 $ 18,598,331 $ 31,208,818
Operating expenses:
Cost of services......................... 2,991,412 3,121,108 12,739,540 3,691,377 9,796,850
Selling, operations and administrative... 8,331,795 9,498,461 37,323,345 15,897,426 25,514,407
Depreciation and amortization............ 3,022,056 2,781,800 17,914,537 5,564,836 19,694,361
----------- ------------ ------------ ------------ ------------
Total operating expenses........... 14,345,263 15,401,369 67,977,422 25,153,639 55,005,618
----------- ------------ ------------ ------------ ------------
Operating income (loss).................... 3,181,945 2,231,944 (22,844,900) (6,555,308) (23,796,800)
----------- ------------ ------------ ------------ ------------
Other income and expense................... (379,889) (2,048,506) (18,645,199) (7,354,969) (15,023,402)
----------- ------------ ------------ ------------ ------------
Income (loss) before minority interest,
income tax (provision) benefit and
cumulative effect of a change in
accounting principle..................... 2,802,056 183,438 (41,490,099) (13,910,277) (38,820,202)
Minority interest.......................... -- -- 13,294,079 9,199,846 4,642,791
Income tax (provision) benefit............. (1,371,865) (1,010,779) 5,631,618 (530,270) 6,548,791
Cumulative effect of a change in accounting
principle................................ -- -- (582,541) (582,541) --
Net income (loss).......................... $ 1,430,191 $ (827,341) $(23,146,943) $ (5,823,242) $(27,628,620)
----------- ------------ ------------ ------------ ------------
Subsidiary preferred stock dividends....... -- (4,193,276) (1,424,222) -- --
----------- ------------ ------------ ------------ ------------
Net income (loss) attributable to common
stockholders............................. $ 1,430,191 $ (5,020,617) $(24,571,165) $ (5,823,242) $(27,628,620)
=========== ============ ============ ============ ============
PER SHARE DATA:
Basic and diluted net income (loss)
attributable to common stockholders per
share:................................... 23.84 (83.68) (409.52) (97.05) (460.48)
Basic and diluted weighted average common
share equivalents outstanding:........... 60,000 60,000 60,000 60,000 60,000
OTHER FINANCIAL DATA:
Capital expenditures....................... 995,320 1,727,079 120,227,057 48,885,972 47,870,456
Cash provided by (used in) operating
activities............................... 4,770,730 3,680,116 23,035,488 7,328,169 (5,289,536)
EBITDA (b)................................. 5,640,550 2,509,854 8,564,129 8,190,914 (469,044)
Ratio of earnings to fixed charges......... 283.10 15.76 0.01 0.55 --
</TABLE>
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DECEMBER 31, DECEMBER 31, DECEMBER 31, JUNE 30,
1996 1997 1998 1999
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(UNAUDITED)
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BALANCE SHEET DATA:
Working capital......................................... (1,442,508) $(1,142,308) $ 51,991,522 $ 8,786,266
Property and equipment, net............................. 11,374,950 11,260,846 211,885,668 248,466,949
Total assets............................................ 18,481,623 30,294,364 388,367,064 368,575,037
Long-term debt, including accrued interest.............. -- -- 276,165,900 293,578,228
Total liabilities....................................... 2,833,902 6,754,189 314,384,110 326,892,350
Minority interest....................................... -- -- 22,623,713 17,980,922
Retained earnings (accumulated deficit)................. 9,598,225 3,181,179 (21,389,986) (49,018,606)
Total stockholders' equity.............................. 15,647,721 $23,540,175 $ 48,872,281 $ 21,214,805
</TABLE>
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(a) See note 9 to our financial statements, Cable Alabama acquisition, for
further information regarding presentation.
(b) EBITDA represents earnings before interest expense, income taxes,
depreciation and amortization. EBITDA is provided because it is a measure
commonly used in the industry. EBITDA is not a measurement of financial
performance under generally accepted accounting principles. It should not be
considered an alternative to net income as a measure of performance or to
cash flow as a measure of liquidity. EBITDA is not necessarily comparable
with similarly titled measures for other companies.
3
<PAGE> 7
RISK FACTORS
The securities being distributed pursuant to this prospectus involve a high
degree of risk, including those risks described below.
WE HAVE LOST MONEY ON OUR OPERATIONS TO DATE, AND WE EXPECT TO LOSE MORE MONEY
DURING THE NEXT SEVERAL YEARS.
We have had net losses and negative cash flow from our operations since we
began operations. As of June 30, 1999, we had an accumulated deficit of $49.0
million. We expect to have more net losses and negative cash flow during the
next several years as we build our networks. Our ability to generate profits and
positive cash flow will depend in large part on our obtaining enough subscribers
for our services to offset the costs of constructing and operating our networks.
If we cannot achieve operating profitability or positive cash flows from
operating activities, our business, financial condition and operating results
will be adversely affected.
FAILURE TO OBTAIN ADDITIONAL FUNDING WOULD LIMIT OUR ABILITY TO EXPAND OUR
BUSINESS.
We expect to spend approximately $177.0 million during the next three years
to expand or upgrade our Panama City, Augusta, Charleston and Huntsville
networks. If we expand to new cities, we estimate the cost of constructing and
implementing networks in additional cities at approximately $50 million to $75
million per city. Actual costs may exceed this estimate. We will need
significant additional financing to complete this expansion and upgrade, to
expand into additional cities, for new business activities and for any
additional acquisitions. If we cannot obtain sufficient funds we may be required
to defer or abandon our expansion plans, which could limit our growth and
prospects.
COMPETITION FROM OTHER PROVIDERS COULD CAUSE US TO LOSE SUBSCRIBERS.
To be successful, we will need to attract subscribers away from our
competitors. We have many competitors in each of our broadband services. Some of
our competitors have competitive advantages such as long-standing customer
relationships and greater experience, resources, marketing capabilities and name
recognition than we do.
In providing cable television service, we currently compete with:
- other cable television providers;
- broadcast television stations;
- direct broadcast satellite companies;
- multichannel multipoint distribution services;
- satellite master antenna systems; and
- private home dish earth stations.
We expect in the future to compete with new wireless local multipoint
distribution services and telephone companies providing cable television service
within their service areas.
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In providing local and long distance telephone service and long distance
access services, we compete with the incumbent local exchange carrier in each of
our markets. BellSouth is the incumbent local exchange carrier and is a
particularly strong competitor in our current markets and in most of our
targeted markets. We also compete with long distance carriers such as AT&T, MCI
WorldCom and Sprint. Our other competitors include:
- independent local exchange carriers;
- other Regional Bell Operating Companies;
- competitive local exchange carriers;
- microwave, wireless and satellite carriers; and
- utilities.
In providing Internet access services, we compete with:
- providers of satellite-based Internet services;
- other long distance carriers;
- cable television companies; and
- network providers that offer Internet access services.
Technologies such as Integrated Services Digital Network (ISDN) and direct
broadcast satellite also offer high-speed or broadband connections to the
Internet. We will compete with companies offering broadband connections such as
DirecPC, one of the principal providers of satellite-based Internet services in
the United States; long distance carriers such as AT&T and MCI WorldCom;
traditional dial-up Internet service providers; and cable modem services such as
Excite@Home, a joint venture among TCI and other companies, including AT&T.
IF WE ARE REQUIRED TO PROVIDE ACCESS TO OUR NETWORKS TO OTHER SERVICE PROVIDERS
WE COULD LOSE AN IMPORTANT COMPETITIVE ADVANTAGE.
There are proposals before the United States Congress and the Federal
Communications Commission to require all cable operators to make a portion of
their cable systems' bandwidth available to other Internet service providers,
such as telephone companies. Certain local franchising authorities are
considering or have already approved similar open access requirements. If
regulators decide to require us to provide competing telephone or Internet
service providers with access to our broadband networks, much of the competitive
advantage we have from owning our own networks could be eliminated.
OUR PROGRAMMING COSTS ARE INCREASING, WHICH COULD REDUCE OUR CASH FLOW AND
OPERATING MARGINS.
Programming has been our largest single expense item and we expect this to
continue. In recent years, the cable industry has experienced a rapid increase
in the cost of programming, particularly sports programming. This increase may
continue and we may not be able to pass programming costs increases on to our
customers. In addition, as we increase the channel capacity of our systems and
add programming to our basic and expanded basic programming tiers, we may face
additional market constraints on our ability to pass programming costs on to our
customers. The inability to pass programming cost increases on to our customers
will have an adverse impact on our cash flow and operating margins.
PROGRAMMING EXCLUSIVITY IN FAVOR OF OUR COMPETITORS COULD ADVERSELY AFFECT THE
DEMAND FOR OUR CABLE SERVICES.
We obtain our programming by entering into contracts or arrangements with
cable programming vendors. A cable programming vendor may enter into an
exclusive arrangement with one of our cable television competitors. This could
prevent us from offering certain programming on our cable television systems,
which could adversely affect the demand for our cable services.
5
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THE SIGNIFICANT AMOUNT OF DEBT WE HAVE COULD HARM OUR BUSINESS.
As of June 30, 1999, we had $293.5 million of debt, including accrued
interest and our stockholders' equity was $21.2 million. Our debt could
adversely affect our business in a number of ways, as:
- we have to use a lot of our money to pay interest and repay principal on
debt;
- we may have trouble obtaining future financing;
- we may have limited flexibility in planning for or reacting to changes in
our business;
- we may have more debt relative to our competitors, which may place us at
a disadvantage; and
- we may be more vulnerable to any economic downturn.
Our earnings have not been sufficient to cover our fixed charges. If we cannot
meet our debt payments, we may need to seek additional financing or sell some of
our assets, which would affect our business, operations and the value of our
company.
RESTRICTIONS ON OUR BUSINESS IMPOSED BY OUR DEBT AGREEMENTS COULD LIMIT OUR
GROWTH OR ACTIVITIES.
Our indenture and credit facility agreements place operating and financial
restrictions on us and our subsidiaries. These restrictions affect our and our
subsidiaries' ability to:
- incur additional debt;
- create liens on our assets;
- use the proceeds from any sale of assets; and
- make distributions on or redeem our stock.
In addition, our credit facility requires us to maintain certain financial
ratios. These limitations may affect our ability to finance our future
operations or to engage in other business activities that may be in our
interest.
WE MAY ENCOUNTER DIFFICULTIES EXPANDING INTO ADDITIONAL MARKETS.
To expand into additional cities we will have to obtain pole attachment
agreements, construction permits, franchises and other regulatory approvals.
Delays in receiving the necessary construction permits and in conducting the
construction itself have adversely affected our schedule in the past and could
do so again in the future.
IF WE ARE NOT ABLE TO MANAGE OUR GROWTH, OUR BUSINESS WILL BE HARMED.
Our ability to grow will depend, in part, upon our:
- successfully implementing our strategy;
- evaluating markets;
- securing financing;
- constructing facilities;
- obtaining any required government authorizations; and
- hiring and retaining qualified personnel.
In addition, as we increase our service offerings and expand our targeted
markets, we will have additional demands on our customer support, sales and
marketing, administrative resources and network infrastructure. If we cannot
effectively manage our growth, our business and results of operations will be
harmed.
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ACQUISITIONS AND JOINT VENTURES COULD STRAIN OUR BUSINESS AND RESOURCES.
If we acquire existing companies or networks, or enter into joint ventures,
we may be subject to:
- miscalculation of the value of the acquired company or joint venture;
- diversion of resources and management time;
- difficulties in integration of the acquired business or joint venture
with our operations;
- relationship issues as a result of changes in management;
- additional liabilities or obligations as a result of the acquisition or
joint venture; and
- additional financial burdens or dilution incurred with the transaction.
IF WE ARE NOT ABLE TO OBTAIN AND RENEW OUR FRANCHISES IN A TIMELY MANNER AND ON
ACCEPTABLE TERMS AND CONDITIONS, OUR BUSINESS WILL BE HARMED.
Our business depends on our ability to obtain and renew our franchises in a
timely manner and on acceptable terms and conditions. We cannot predict whether
we will obtain franchises in new cities on terms that will make construction of
a network and provision of broadband communications services economically
attractive for us. In addition, franchises may be withheld and are subject to
non-renewal or termination under some circumstances. Our franchises for
Montgomery, Columbus, Panama City, Augusta, Charleston, Huntsville and the
Valley area will expire in March 2005, March 2009, July 2007, January 2013,
April 2013, March 2001 and January 2013, respectively.
LOSS OF ACCESS TO OTHER COMPANIES' NETWORKS COULD IMPAIR OUR TELEPHONE SERVICE.
We rely on other companies to provide:
- communications capacity between our telephone switch and our local
networks;
- switched and switchless long distance telephone services;
- collocation and interconnection facilities; and
- Asynchronous Transfer Mode network services for internet transport
requirements.
Our business would be hurt if we lost any of these services.
CHANGES IN DEMAND FOR OUR TELEPHONE SERVICES COULD HARM OUR BUSINESS.
We could be affected by changes in demand for our local and long distance
telephone services, including:
- traditional telephone services;
- premium telephone service;
- additional access lines per household;
- billing and collection services; and
- local competition in the Georgia/Alabama border area known as the Valley.
Any downturn in demand will harm our business, profitability and growth
prospects. In addition, recent price decreases and promotional activities by
major long distance carriers could have a material adverse impact on our cash
flow and margins.
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WE DO NOT KNOW THE DEMAND FOR OUR BUNDLED COMMUNICATIONS SERVICES.
Our plan to provide bundled broadband communications services is fairly new
and untested. It could be unsuccessful due to:
- competition;
- pricing;
- regulatory uncertainties; and
- operating and technical difficulties.
In addition, the demand for some of our planned broadband communications
services, either alone or as part of a bundle, cannot readily be determined. Our
business could be adversely affected if demand for bundled services is
materially lower than we expect.
FUTURE TECHNOLOGICAL DEVELOPMENTS MAY HURT OUR BUSINESS.
Future technological developments may reduce our network's competitiveness
or require expensive and time-consuming upgrades or additional equipment. In
addition, we may be required to select in advance one technology over another
and may not choose the technology that turns out to be the most economic,
efficient or attractive to customers.
WE DEPEND UPON A VERY SMALL NUMBER OF SUPPLIERS FOR CERTAIN MATERIALS.
We purchase customer premises equipment and plant materials from a small
number of outside vendors. We currently purchase each customer premises
component from a single vendor and have one or two suppliers for plant
materials. If one or more suppliers cannot meet our needs as we continue to
build our network, we could experience delays and increased costs in the
expansion of our network.
WE HAVE EXPERIENCED DIFFICULTY ENGAGING SUFFICIENT CONSTRUCTION CONTRACTORS AND
OUR CONSTRUCTION COSTS ARE INCREASING.
The expansion and upgrade of our existing networks and the development of
future networks require us to hire construction contractors. We could have
difficulty hiring experienced contractors because of increases in demand for
cable construction services. Our construction costs may increase significantly
over the next few years as demand for cable construction services continues to
grow.
WE COULD BE HURT BY FUTURE INTERPRETATION OR IMPLEMENTATION OF REGULATIONS.
The current communications and cable legislation is complex and in many
areas sets forth policy objectives to be implemented by regulation. It is
generally expected that the Telecommunications Act of 1996 will continue to
undergo considerable interpretation and implementation over the next several
years. Our ability to compete successfully in the provision of service will
depend on the timing of such implementing regulations and whether they are
favorable to us.
OUR RELATIONSHIPS WITH ITC HOLDING'S COMPANIES AND AT&T MAY CAUSE CONFLICTS OF
INTERESTS.
We have relationships with several of ITC Holding's subsidiary and
affiliated companies. Some members of our board of directors are directors,
stockholders, and/or officers of various ITC Holding companies. AT&T venture
funds collectively are a significant stockholder and also have a representative
on our board of directors. When the interests of ITC Holding, other ITC Holding
companies or AT&T venture funds differ from ours, the ITC Holding companies and
AT&T venture funds act in their own respective best interests, which could be
adverse to our interests.
8
<PAGE> 12
PROBLEMS RELATED TO THE YEAR 2000 ISSUE COULD DISRUPT OUR OPERATIONS AND HARM
OUR BUSINESS.
The year 2000 issue affects our owned and licensed computer systems and
equipment used in connection with internal operations. It also affects our
non-information technology systems, including embedded systems in our buildings
and other infrastructure. Additionally, we rely directly and indirectly, in the
regular course of business, on the proper operation and compatibility of third
party systems, and the year 2000 problem could cause these systems to fail, err
or become incompatible with our systems.
Much of our assessment effort regarding the year 2000 problem has involved,
and depends on, inquiries to third party service providers. If we, or
significant third parties with whom we communicate and do business through
computers, fail to become year 2000 ready, or if the year 2000 problem causes
our systems to become internally incompatible or incompatible with key third
party systems, our business could suffer material disruptions. We could also
face disruptions if the year 2000 problem causes general widespread problems or
an economic crisis. We cannot now estimate the extent of these potential
disruptions. We cannot assure you that our efforts to date and our ongoing
efforts to prepare for the year 2000 problem will be sufficient to prevent a
material disruption of our operations. As a result of any such disruption our
growth, profitability and operating results could suffer materially.
WE COULD BE DAMAGED BY THE LOSS OF OUR KEY PERSONNEL.
Our business is currently managed by a small number of key management and
operating personnel. We do not have any employment agreements with, nor do we
maintain "key man" insurance on, these or any other employees. As we have
numerous new employees resulting from our recent growth, we are particularly
dependent upon our management and longer-term employees who are familiar with
our company and our needs and can train our new hires.
NO TRADING MARKET EXISTS FOR OUR SECURITIES.
Prior to this distribution, you could not buy or sell our stock publicly.
Our securities are not listed on any stock exchange or on the Nasdaq National
Market System, and no market makers currently make a market in our securities.
We do not expect that an active public market for our stock will develop after
the distribution. In addition, all shares of our stock are subject to transfer
restrictions. If one of our stockholders decides to sell his shares of our
stock, he must first offer those shares to us to purchase before he can offer
the shares to a third party. With the lack of an active public market for our
stock and our rights of first refusal on the sale of our stock, your ability to
sell our securities will be limited.
FAILURE OF ITC HOLDING'S DISTRIBUTION TO QUALIFY AS A TAX-FREE SPIN-OFF COULD
RESULT IN MATERIAL ADVERSE TAX CONSEQUENCES.
The ruling ITC Holding obtained from the Internal Revenue Service, that the
distribution of our stock to ITC Holding stockholders would qualify as a
tax-free spin-off under Section 355 of the Internal Revenue Code of 1986, as
amended, is subject to factual representations made by ITC Holding to the IRS
about existing matters and future events. If such factual representations are or
become incorrect in any material respect, the ruling could become invalid.
If the distribution were not to qualify as a tax-free spin-off, each holder
of ITC Holding stock who received shares of our stock in the spin-off would
generally be treated as having received a taxable dividend, to the extent of
current-year and accumulated earnings and profits, includible in income in an
amount equal to the fair market value of our stock received at the time of the
spin-off. In addition, ITC Holding would recognize a taxable gain equal to the
difference between the fair market value of the shares of our stock and its
adjusted basis in those shares at the time of the spin-off.
Furthermore, ITC Holding may be required to recognize gain in connection
with the spin-off as a result of future actions of ITC Holding or our company,
or as a result of certain changes in ownership of ITC Holding's or our company's
stock. Under Section 355(e) of the Internal Revenue Code, if the spin-off were
considered to be part of a plan or series of related transactions in which a 50%
or greater interest
9
<PAGE> 13
in our company or ITC Holding were acquired by one or more persons, the spin-off
would be taxable to ITC Holding at the corporate level. Any cumulative 50%
change of ownership within the four-year period beginning two years before the
date of the spin-off, including any change in the ownership of shares
distributed to ITC Holding stockholders in the spin-off, will be presumed under
applicable tax regulations to be pursuant to such a plan. This presumption, if
it applies, would need to be rebutted by a showing that the spin-off and the 50%
ownership shift are not part of such a plan to retain tax-free treatment.
There is a Tax Separation Agreement between ITC Holding and our company.
Material adverse tax, consequences could result if the distribution fails to
qualify under Section 355, including Section 355(e), of the Internal Revenue
Code. Neither ITC Holding nor our company has any present intention of taking
any action that would cause the distribution not to qualify as a transaction
described in Section 355 of the Code.
ANTI-TAKEOVER PROVISIONS IN DELAWARE LAW AND OUR CHARTER DOCUMENTS COULD MAKE IT
HARD FOR A THIRD PARTY TO ACQUIRE US.
As a Delaware company we are subject to the anti-takeover provisions of
Section 203 of the Delaware General Corporation Law. Section 203 could delay or
prevent a third party or a significant stockholder from acquiring control of us.
In addition, our charter and bylaws may have the effect of discouraging,
delaying or preventing a merger, tender offer or proxy contest involving our
company. Any of these ant-takeover provisions could lower the market price of
our stock. No active market for our stock exists.
FORWARD-LOOKING STATEMENTS SHOULD BE READ WITH CAUTION.
This prospectus contains certain forward-looking statements regarding our
operations and business. Statements in this document that are not historical
facts are "forward-looking statements." Such forward-looking statements include
those relating to:
- future business developments;
- projected or anticipated expansion or construction;
- possible acquisitions and alliances;
- projected revenues, working capital, liquidity, capital needs, interest
costs and income; and
- year 2000 readiness.
The words "estimate," "project," "intend," "expect," "believe," "may,"
"could" and similar expressions are intended to identify forward-looking
statements. Wherever they occur in this prospectus or in other statements
attributable to us, forward-looking statements are necessarily estimates
reflecting our best judgment. However, these statements still involve a number
of risks and uncertainties that could cause actual results to differ materially
from those suggested by the forward-looking statements. We caution you not to
place undue reliance on these forward-looking statements, which speak only as of
today's date. We disclaim any intent or obligation to update forward-looking
statements.
10
<PAGE> 14
THE DISTRIBUTION
BACKGROUND AND REASONS FOR THE DISTRIBUTION
We have determined that we will need substantial capital in the near term
to fund our planned upgrades and expansion. Our ability to expand will depend on
the amount of capital available. We have decided to obtain equity capital by
making a private offering of our capital stock. Our board of directors
considered two alternatives with regard to raising equity capital. The first
alternative entailed making a private offering of our stock as a majority-owned
indirect subsidiary of ITC Holding, who would remain our parent company. The
second alternative required the distribution of our shares to the current
stockholders of our parent company, ITC Holding, prior to making the private
offering of our stock. Our board of directors, based in part on advice from
Morgan Stanley & Co. Incorporated, our financial advisor, has determined that
the distribution will enhance our ability to raise capital by providing easier
access to capital in the private equity market and achieving a higher per-share
value.
In situations where a single party or a small number of related parties own
a large majority of the stock of a company or otherwise control a company,
minority investors are typically concerned about potential conflicts of interest
with large stockholders and the potential negative impact on per-share trading
price of large blocks of stock being offered for sale at a later date by large
holders. These concerns can result in decreased demand and/or a lower price
per-share that investors are willing to pay for stock of companies with large
majority holders. If we had a private offering to raise capital after the
subsidiary alternative, the large majority of our stock would be owned by a
subsidiary of ITC Holding. If we have a private offering after the distribution,
our stock will be more broadly distributed.
The potential conflicts of interest between stockholder groups that can
arise when a single party or small number of related parties own a large
majority of the stock or otherwise control a company could be a significant
issue if we tried to raise equity capital under the subsidiary alternative. One
such conflict would be an offer from a third party to acquire us. While any such
offer might represent a fair value, strategic considerations by the controlling
party might lead it to refuse the offer, even though the offer might provide
minority investors a higher return than they otherwise would be able to achieve.
Given the potential for consolidation in the broadband market, this potential
conflict of interest could have been a significant issue for us.
Another likely concern among investors in a private placement is the
potential for significant amounts of stock to be offered for sale in the future
by holders of large amounts of stock, often referred to as over-hang. Large
amounts of stock offered in the market on a secondary basis, especially by
control stockholders perceived by the market to be extremely knowledgeable about
a company and its prospects, can materially affect a company's valuation. Given
the diffuse ownership profile resulting from the distribution and the
correspondingly lower risk of a large number of investors acting in concert to
sell a given amount of stock, the distribution alternative should significantly
decrease investor concern regarding over-hang.
The private placement we intend to pursue shortly after the distribution is
contingent on our completing the distribution.
MANNER OF EFFECTING THE DISTRIBUTION
ITC Holding will distribute to its stockholders and option holders all of
its common stock, Series A preferred stock and stock options of our company. ITC
Holding currently has 43,918,649 shares of our Series A preferred stock and
options to purchase 6,315,789 shares of our common stock. Immediately after
11
<PAGE> 15
the distributions are completed, ITC Holding will not own any shares of our
capital stock or options to purchase any of our stock.
ITC Holding has declared a dividend payable to holders of record of ITC
Holding's capital stock at the close of business on December 1, 1999. The
dividend will include 1.0968 shares of our Series A preferred stock for every
share of ITC Holding common stock and for every share of ITC Holding preferred
stock. ITC Holding has decided to distribute an option to purchase 1.0968 shares
of our common stock for each option to purchase one share of ITC Holding common
stock outstanding. We expect the stock dividend to be paid and the option
distribution to occur on or about December 30, 1999.
ITC Holding will not issue any fractional interests in our capital stock or
options as part of the distribution. Any holder who would be entitled to receive
a fractional interest will receive a check for the cash value of such fractional
interest.
Holders of ITC capital stock and ITC Holding stock options should not send
any stock certificates or option grant documents to us or to ITC Holding. ITC
Holding stock certificates will continue to represent shares of ITC Holding's
capital stock after the distribution in the same amount shown on the
certificates.
ITC Holding stock options will continue to represent options to purchase
ITC Holding capital stock. We have been advised that ITC Holding will adjust the
option exercise price of the outstanding ITC Holding stock options upon the
distribution so that the aggregate exercise price of these options and of the
options ITC Holding is distributing to purchase our stock will be the same for
each ITC Holding option holder as the exercise price of the ITC Holding stock
options held by each ITC Holding option holder before the distribution.
Under the agreement through which a subsidiary of ITC Holding acquired
options to purchase our stock, ITC Holding has the right to specify the terms of
those options, including the exercise price. Any proceeds of option exercises
received by us will be paid by us to ITC Holding under a residual note. In the
event of a cashless exercise of any of these options, an amount equal to the
exercise price will be paid by us in cash to ITC Holding.
The ITC Holding stock options and the options to purchase our stock to be
distributed by ITC Holding consist of two types of stock options -- incentive
stock options and nonqualified stock options. Incentive stock options are
options intended to qualify under Section 422 of the Internal Revenue Code as
"incentive stock options." Nonqualified stock options are options that are not
intended to qualify under Section 422 of the Internal Revenue Code.
Internal Revenue Code Section 422(a)(2) provides that incentive stock
options on our stock held by ITC Holding employees will cease to be incentive
stock options three months after the distribution. Similarly, ITC Holding stock
options which are held by our employees and which are incentive stock options
will cease to be incentive stock options three months after the distribution.
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<PAGE> 16
TAX CONSEQUENCES OF THE DISTRIBUTION
STOCKHOLDERS
On September 24, 1998, ITC Holding requested a ruling from the Internal
Revenue Service regarding the federal income tax treatment of the proposed
distribution of our stock to ITC Holding stockholders. On April 1, 1999, the IRS
ruled that the distribution of our stock to ITC Holding stockholders as
described to the IRS would qualify as a tax-free spin-off under Section 355 of
the Internal Revenue Code of 1986, as amended. This means that:
- no gain or loss will be recognized by, and no amount will be included in
the income of, the holders of ITC Holding stock upon their receipt of our
stock;
- the holding period applicable to our stock for federal income tax
purposes in the hands of a distributee would include such stockholder's
holding period for the ITC Holding stock;
- the basis of our stock and ITC Holding stock in the hands of the ITC
Holding stockholders after the distribution would be the same as the
basis of the ITC Holding stock immediately before the distribution,
allocated in proportion to the fair market value of each and decreased by
the tax basis that is allocable by any fractional share interests in our
stock for which ITC Holding stockholders receive cash; and
- the receipt of cash in lieu of fractional share interests in our stock
will be treated as received in exchange for the fractional share and gain
or loss will be recognized to a recipient stockholder to the extent of
the difference between the stockholder's basis in the fractional share
and the amount received for the fractional share. If the fractional share
interest is held as a capital asset by the recipient stockholder, the
gain or loss will be capital gain or loss.
The IRS ruling is premised on the accuracy of certain factual
representations and assumptions. If the factual representations and assumptions
made by ITC Holding were incorrect in any material respect, ITC Holding's
ability to rely on the IRS ruling will be jeopardized. However, ITC Holding is
not aware of any facts or circumstances that would cause such representations
and assumptions to be untrue.
If the distribution were not to constitute a tax-free spin-off, then ITC
Holding would be treated as recognizing a taxable gain equal to the difference
between the fair market value of the shares of our stock and its adjusted basis
in these shares at the time of the spin-off. In addition, each holder of ITC
Holding stock who received shares of our stock in the spin-off would generally
be treated as having received a taxable dividend, to the extent of current-year
and accumulated earnings and profits, includible in income in an amount equal to
the fair market value of our stock received at the time of the spin-off.
Under Code Section 355(e), if the spin-off were considered to be part of a
plan or series of related transactions in which a 50% or greater interest in our
company or ITC Holding were acquired by one or more persons, the spin-off would
be taxable at the corporate level, though it would remain tax-free to the ITC
Holding stockholders. Although neither ITC Holding nor our company believes the
spin-off is part of a plan to effect a 50% ownership shift, any cumulative 50%
change of ownership within the four-year period beginning two years before the
date of the spin-off, including any change in the ownership of shares
distributed to ITC Holding stockholders in the spin-off, will be presumed to be
pursuant to such a plan. This presumption may be rebutted by a showing that the
spin-off and the 50% ownership shift are not part of such a plan.
There is a Tax Separation Agreement between ITC Holding and our company.
Material adverse tax consequences could result if the distribution fails to
qualify under Section 355, including Section 355(e), of the Internal Revenue
Code. Neither ITC Holding nor our company has any present intention of taking
any action that would cause the distribution not to qualify as a transaction
described in Section 355 of the Code.
IRS regulations provide that each ITC Holding stockholder who receives
shares of our stock in the distribution must attach to his or her federal income
tax return for 1999 a detailed statement with respect
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<PAGE> 17
to the applicability of Code Section 355. ITC Holding will make available the
required information to each stockholder of record of ITC Holding as of the
record date for the distribution.
OPTIONHOLDERS
The tax treatment of the optionholders was not the subject of the April 1,
1999 IRS ruling.
We believe that the distribution of the options to purchase our stock and
the adjustments to the ITC Holding options in connection with the distribution
should not result in taxable income to the holders of ITC Holding incentive
stock options or nonqualified stock options. There is, however, some risk that
the IRS may find the distribution of the options to purchase our stock and the
adjustment to the outstanding ITC Holding stock options a taxable event for the
holders of certain nonqualified stock options. The tax consequences for holders
of the incentive stock options and the nonqualified stock options, and the risks
associated with the nonqualified stock options are discussed below.
INCENTIVE STOCK OPTIONS. At the time of the grant of an incentive stock
option, an employee does not recognize any taxable income because there is no
transfer of property to the employee at the time of the grant. See Treas. Reg.
Section 1.83-3(a)(2). Although modifications to the terms of incentive stock
options once the options are granted may cause the options to become
disqualified or to be treated as a new grants of options, Internal Revenue Code
Sections 424(a) and 424(h)(3), along with Treas. Reg. Section 1.425, provide
that division of one option into two options in the context of a spin-off will
not be viewed as a modification of the old option provided that (i) the
aggregate spread in the new option does not exceed that in the old option, and
(ii) the new option does not otherwise have more favorable terms than the old
option. A modification creating more favorable terms could come from amending an
option to:
- include more favorable payment terms (such as the right to tender company
stock for the exercise price);
- extend the period when the option may be exercised; or
- provide an additional benefit upon exercise (such as payment of a cash
bonus to the optionee).
The adjustment of the aggregate exercise prices in connection with the division
of the ITC Holding incentive stock options into options to purchase our stock
and options to purchase ITC Holding stock is intended to satisfy the
requirements of Treas. Reg. Section 1.425. Therefore, we believe that the
division of the incentive stock options will not be a taxable event for the
holders of the incentive stock options. If the conditions of Treas. Reg. Section
1.425 are not satisfied, the division of the options will be treated as the
grant of two new options, and the grants must be tested at the time of the
division to determine whether they qualify as incentive stock options.
NONQUALIFIED STOCK OPTIONS. Internal Revenue Code Section 83 and the
regulations thereunder govern the transfer of property in connection with the
performance of services. Code Section 83(e)(3) and Treas. Reg. Sections
1.83-7(a) and 1.83-8(a)(3) provide that the grant of a nonqualified stock option
without a readily ascertainable fair market value by an employer to an employee
does not result in the recognition of income or loss at the time of grant.
Similarly, the grant of a nonqualified stock option does not give rise to any
income tax consequences to the employer corporation. IRS regulations provide
that the taxable event for both the optionee and the employer occurs upon the
exercise of the option. At the time the option is exercised the optionee
recognizes ordinary income equal to the excess of the fair market value of the
stock at the time of the exercise over the exercise price and the employer is
entitled to a compensation expense deduction for the corresponding amount. IRS
regulations provide that in general an option has a readily ascertainable fair
market value if four conditions are met:
- the option is transferable by the optionee;
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<PAGE> 18
- the option is exercisable immediately in full by the optionee;
- the option or the property subject to the option is not subject to any
restriction or condition which has a significant effect upon the fair
market value on the option; and
- the fair market value of the option privilege is readily ascertainable.
As neither the ITC Holding stock options nor the options to purchase our
stock are publicly traded or transferable, these options do not have a
readily ascertainable fair market value.
Unlike incentive stock options, no specific section of the Internal Revenue
Code provides rules governing the division of one nonqualified stock option into
two nonqualified stock options or the adjustment of outstanding nonqualified
stock options in the context of a spin-off transaction. If the rules governing
incentive stock options are applied by analogy to the division of the
nonqualified ITC Holding options, the division should not be treated as a
taxable event because the division is a proportional adjustment preserving the
option spread and not granting additional benefits to the optionees. If the
incentive stock options rules cannot be applied by analogy, and there is some
IRS authority that the incentive stock option rules are not applicable to
adjustments to nonqualified stock options, the distribution of the option to
purchase our stock and the corresponding adjustment to the ITC Holding
nonqualified stock options may be treated as a new grants of options. If the
distribution and adjustments are treated as creating new grants of nonqualified
stock options, we believe that the new grants would not create a taxable event
for the option holders as the options would not have a readily ascertainable
fair market value at the time of grant.
Although we believe that it is appropriate to treat the division of the
outstanding options pursuant to the spin-off as a non-taxable event, there is
some risk that the IRS may find the division of the options to be a taxable
event for the optionees because many of the options following the distribution
will be both fully vested and have an option exercise price that is much less
than the fair market of the stock underlying the option. Based on these two
facts, the IRS may take the position that the nonqualified options are not in
fact options at the time of the distribution, but rather are new, outright
grants of stock. In that event, the distribution of the options on our stock and
the adjustment of the outstanding ITC Holding options would result in immediate
taxation under Internal Revenue Code Section 83 for each optionee. There is very
little authority concerning the tax treatment arising out of adjustments to non-
qualified stock options in connection with spin-off transactions.
The summary of Federal Income Tax consequences set forth above does not
purport to cover all federal income tax consequences that may apply to all
categories of stockholders. All stockholders should consult their own tax
advisors regarding the particular federal, foreign, state and local tax
consequences of the distribution to such stockholders.
NO MARKET FOR OUR STOCK
There is no established public trading market for our capital stock, and
accordingly, no high and low bid information or quotations are available with
respect to our common stock.
Following this distribution, the 600-to-1 stock split of our Series A
preferred stock and the 4-to-1 stock split of our common stock, we expect to
have 62,401 shares of common stock outstanding held of record by two
stockholders and 48,739,711 Series A preferred stock outstanding held of record
by 346 stockholders.
DIVIDEND POLICY
We have never declared or paid any cash dividends on our capital stock and
we do not anticipate paying cash dividends on our capital stock in the
foreseeable future. Our current policy is to retain earnings to finance the
expansion of our operations. Future declaration and payment of dividends, if
any, will be determined based on the then-current conditions, including our
earnings, operations, capital requirements, financial condition, and other
factors the board of directors deems relevant. In addition, our ability to pay
dividends is limited by the terms of the indenture governing our outstanding
notes and by the terms of our credit facility.
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<PAGE> 19
CAPITALIZATION
The following table sets forth our capitalization at June 30, 1999, and as
adjusted to give effect to the distribution set forth in this prospectus. To
better understand this table, you should review "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and our consolidated
financial statements, including the accompanying notes, included in this
prospectus.
<TABLE>
<CAPTION>
AT JUNE 30, 1999
------------------------------
AS ADJUSTED
FOR THIS
ACTUAL DISTRIBUTION(1)
------------ ---------------
<S> <C> <C>
Advances from affiliates.................................... $ 1,900,181 $ 1,900,181
Short-term debt............................................. -- 30,000,000
Long-term debt, including current maturities:
Senior Discount Notes..................................... 262,702,729 262,702,729
Capital lease obligations................................. 131,750 131,750
------------ ------------
Total long-term debt, including current
maturities..................................... $264,734,660 $294,734,660
------------ ------------
Warrants.................................................... $ 2,486,960 $ 2,486,960
------------ ------------
Stockholders' equity:
Series A preferred stock, $.01 par value, 75,000,000
authorized; 0 and 48,739,711 shares issued and
outstanding at June 30, 1999 and as adjusted December
31, 1999, respectively(2).............................. $ -- $ 487,397
Series B preferred stock, $.01 par value, 50,000,000
authorized; 0 and 21,052,632 shares issued and
outstanding at June 30, 1999 and as adjusted December
31, 1999, respectively................................. -- 210,526
Common Stock, $.01 par value, 200,000,000 shares
authorized; 60,000 and 62,401 shares issued and
outstanding at June 30, 1999 and as adjusted December
31, 1999, respectively................................. 600 624
Additional paid-in-capital................................ 70,259,279 169,561,332
Accumulated deficit....................................... (49,018,606) (49,018,606)
Unrealized losses......................................... (26,468) (26,468)
------------ ------------
Total stockholders' equity........................ $ 21,214,805 $121,214,805
============ ============
Total capitalization.............................. $288,436,425 $418,436,425
============ ============
</TABLE>
- ---------------
(1) Reflects $100 million from private placement transaction and $30 million
loan from ITC Holding.
(2) Reflects the exercise of the SCANA warrants into 451,800 shares of Series A
preferred stock.
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<PAGE> 20
SELECTED CONSOLIDATED FINANCIAL DATA
The following table sets forth our selected consolidated financial data.
The selected financial data as of and for the years ended December 31, 1996,
1997 and 1998 have been derived from our audited financial statements. The
selected financial data as of and for the six months ended June 30, 1998 and
1999 have been derived from our unaudited consolidated financial statements and,
in our opinion, include all adjustments, consisting of normal recurring
accruals, necessary for a fair presentation of such information. Operating
results for the six months ended June 30, 1999 are not necessarily indicative of
the results that we may expect for the entire year. The selected financial data
set forth below should be read in conjunction with our section entitled
"Management's Discussion and Analysis of Financial Condition and Results of
Operations", our financial statements and related notes, and other financial
data included elsewhere in this prospectus. See Note 1 to our financial
statements regarding the Reorganization.
<TABLE>
<CAPTION>
SIX
YEAR YEAR YEAR YEAR YEAR MONTHS
ENDED ENDED ENDED ENDED ENDED ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, JUNE 30,
1994 1995 1996 1997 1998(A) 1998
------------ ------------ ------------ ------------ ------------ ------------
(UNAUDITED) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Operating revenues...................... $17,679,873 $18,929,279 $17,527,208 $17,633,313 $ 45,132,522 $ 18,598,331
Operating expenses:
Cost of services....................... 5,253,503 5,593,083 2,991,412 3,121,108 12,739,540 3,691,377
Selling, operations and
administrative....................... 7,664,748 8,740,090 8,331,795 9,498,461 37,323,345 16,000,313
Depreciation and amortization.......... 1,965,874 3,185,901 3,022,056 2,781,800 17,914,537 5,564,836
----------- ----------- ----------- ----------- ------------ ------------
Total operating expenses................ 14,884,125 17,519,074 14,345,263 15,401,369 67,977,422 25,256,526
----------- ----------- ----------- ----------- ------------ ------------
Operating income (loss)................. 2,795,748 1,410,205 3,181,945 2,231,944 (22,844,900) (6,658,195)
----------- ----------- ----------- ----------- ------------ ------------
Other income and expense................ 603,847 (362,331) (379,889) (2,048,506) (18,645,199) (7,354,969)
----------- ----------- ----------- ----------- ------------ ------------
Income (loss) before minority interest,
income tax (provision) benefit and
cumulative effect of a change in
accounting principle................... 3,399,595 1,047,874 2,802,056 183,438 (41,490,099) (14,013,164)
Minority interest....................... -- 667,038 -- -- 13,294,079 9,199,846
Income tax (provision) benefit.......... (1,208,939) (573,327) (1,371,865) (1,010,779) 5,631,618 (530,270)
Cumulative effect of a change in
accounting principle................... -- -- -- -- (582,541) (479,654)
Net income (loss)....................... $ 2,190,656 $ 1,141,585 $ 1,430,191 $ (827,341) $(23,146,943) $ (5,823,242)
Subsidiary preferred stock dividends.... 0 0 0 (4,193,276) (1,424,222) 0
----------- ----------- ----------- ----------- ------------ ------------
Net income (loss) attributable to common
stockholders........................... $ 2,190,656 $ 1,141,585 $ 1,430,191 $(5,020,617) $(24,571,165) $ (5,823,242)
=========== =========== =========== =========== ============ ============
PER SHARE DATA:
Basic and diluted net income (loss)
attributable to common stockholders per
share:................................. 36.51 19.03 23.84 (83.68) (409.52) (97.05)
Basic and diluted weighted average
common share equivalents
outstanding:........................... 60,000 60,000 60,000 60,000 60,000 60,000
OTHER FINANCIAL DATA:
Capital expenditures.................... 3,686,035 837,346 995,320 1,727,079 120,227,057 48,825,972
Cash provided by (used in) operating
activities............................. 5,230,950 1,067,775 4,770,730 3,680,116 23,035,488 7,328,169
EBITDA(b)............................... 5,515,186 5,565,993 5,640,550 2,509,854 8,564,129 8,190,914
Ratio of earnings to fixed charges(c)... 23.71 2.89 283.10 15.76 0.01 0.55
<CAPTION>
SIX
MONTHS
ENDED
JUNE 30,
1999
------------
(UNAUDITED)
<S> <C>
STATEMENT OF OPERATIONS DATA:
Operating revenues...................... $ 31,208,818
Operating expenses:
Cost of services....................... 9,796,850
Selling, operations and
administrative....................... 25,514,407
Depreciation and amortization.......... 19,604,361
------------
Total operating expenses................ 55,055,618
------------
Operating income (loss)................. (23,796,800)
------------
Other income and expense................ (15,023,402)
------------
Income (loss) before minority interest,
income tax (provision) benefit and
cumulative effect of a change in
accounting principle................... (38,820,202)
Minority interest....................... 4,642,791
Income tax (provision) benefit.......... 6,548,791
Cumulative effect of a change in
accounting principle................... --
Net income (loss)....................... $(27,628,620)
Subsidiary preferred stock dividends.... 0
------------
Net income (loss) attributable to common
stockholders........................... $(27,628,620)
============
PER SHARE DATA:
Basic and diluted net income (loss)
attributable to common stockholders per
share:................................. (460.48)
Basic and diluted weighted average
common share equivalents
outstanding:........................... 60,000
OTHER FINANCIAL DATA:
Capital expenditures.................... 47,870,456
Cash provided by (used in) operating
activities............................. (5,289,536)
EBITDA(b)............................... 469,044
Ratio of earnings to fixed charges(c)... --
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, JUNE 30,
1995 1996 1997 1998 1999
------------ ------------ ------------ ------------ -----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working capital......................................... 832,057 (1,442,508) (1,142,308) 51,991,522 8,786,266
Property and equipment, net............................. 20,406,060 11,374,950 11,260,846 211,885,668 248,466,949
Total assets............................................ 38,544,328 18,481,623 30,294,364 388,367,064 368,575,037
Long-term debt, including accrued interest.............. 11,075,698 -- -- 276,165,900 293,578,228
Total liabilities....................................... 22,034,469 2,833,902 6,754,189 314,384,110 326,892,350
Minority interest....................................... 2,981,968 -- -- 22,623,713 17,989,922
Retained earnings (accumulated deficit)................. 8,168,034 9,598,225 3,181,179 (21,389,986) (49,018,606)
Total stockholders' equity.............................. 13,527,891 15,647,721 23,540,175 48,872,281 21,214,805
</TABLE>
- ---------------
(a) See note 9 to the financial statements, Cable Alabama acquisition, for
further information regarding presentation.
17
<PAGE> 21
(b) EBITDA represents earnings before preferred stock dividends, interest
expense, income taxes, depreciation and amortization. EBITDA is provided
because it is a measure commonly used in the industry. EBITDA is not a
measurement of financial performance under generally accepted accounting
principles. It should not be considered an alternative to net income as a
measure of performance or to cash flow as a measure of liquidity. EBITDA is
not necessarily comparable with similarly titled measures for other
companies.
(c) Earnings consist of income before preferred stock dividends, income taxes,
plus fixed charges. Fixed charges consist of interest charges and the
portion of rent expense under operating leases representing interest, which
is estimated to be 1/3 of such expense. Earnings were insufficient to cover
fixed charges for the year ended December 31, 1998 and the six months ended
June 30, 1998 and 1999 by $28,778,561, $6,353,484 and $34,177,411,
respectively. On a pro forma basis, after giving effect to the bridge loan
and the equity private placement, our earnings would have been insufficient
to cover our fixed charges for the year ended December 31, 1998 and the six
months ended June 30, 1999 by 36,468,661 and 33,361,061, respectively.
18
<PAGE> 22
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion together with our "Selected
Consolidated Financial Data" section and our financial statements and related
notes elsewhere in this prospectus. The following discussion contains, in
addition to historical information, forward-looking statements that involve
risks and uncertainties. Our actual results may differ significantly from the
results discussed in the forward-looking statements.
This prospectus assumes the completion of a number of events that we expect
to take place in November 1999. All numbers in this prospectus have been
adjusted to reflect a 600-to-1 stock split of our Series A preferred stock and a
4-to-1 stock split of our common stock which will occur in November 1999.
Our historical financial statements include the assets, liabilities and
results of operations of our subsidiaries which have been majority-owned by ITC
Holding during each year. Accordingly, our financial statements include the
assets, liabilities and results of operations of all of our subsidiaries for the
years 1995, 1998 and the first six months of 1998 and 1999, but do not include
the assets, liabilities and results of operations of KNOLOGY Holdings for 1996
and 1997, when it was not majority-owned by ITC Holding.
OVERVIEW
We are a newly formed holding company that owns 100% of KNOLOGY Holdings,
Inc., Interstate Telephone Company, Inc., Valley Telephone Company, Inc., Globe
Telecommunications, Inc. and ITC Globe, Inc. We acquired these interests in
November 1999 from ITC Holding Company, Inc., and other stockholders of KNOLOGY
Holdings. Our structure is as follows:
- Interstate Telephone, Valley Telephone and Globe Telecommunications are
our direct subsidiaries.
- KNOLOGY Holdings is a direct subsidiary of Valley Telephone.
- ITC Globe is a direct subsidiary of Globe Telecommunications.
In November 1999, a subsidiary of ITC Holding, our parent company,
contributed to us stock representing approximately 85% of the outstanding equity
of KNOLOGY Holdings, Inc.; stock representing 100% of Interstate Telephone
Company, Inc., Valley Telephone Company, Inc., Globe Telecommunications, Inc.
and ITC Globe, Inc.; a note of KNOLOGY Holdings in the principal amount of $13
million; 272,832 shares of preferred stock of ClearSource, Inc.; and cash in the
amount of approximately $5.6 million to be used for required subscription
payments to ClearSource.
Concurrent with this contribution, we completed the exchange of other
KNOLOGY Holdings common stock and preferred stock for our common stock and
Series A preferred stock. We now hold 100% of the outstanding stock of KNOLOGY
Holdings.
In November 1999, after the contribution and exchange discussed above, we
entered into a note agreement and a promissory note with a subsidiary of ITC
Holding. This subsidiary has agreed to lend us up to $30 million until March 31,
2000. The ITC Holding subsidiary may elect, in lieu of repayment, to convert the
amount outstanding under the note into options to purchase up to 6,315,789
shares of our Series A preferred stock based on the current fair value.
ITC Holding is distributing to its stockholders of record 1.0968 shares of
our Series A preferred stock for every share of ITC Holding common stock. Our
board of directors, based in part on advice from Morgan Stanley & Co.
Incorporated, our financial advisor, has determined that we would have easier
access to capital in the private equity market and would achieve a higher per
share value by distributing these shares.
19
<PAGE> 23
HISTORY
Interstate Telephone began as West Point Telephone and Electric Company,
founded in 1896 by J. Smith Lanier. Interstate Telephone has been a provider of
local telephone service in western Georgia and a small part of eastern Alabama
since 1896. In 1961, the Lanier Company bought Valley Telephone from West Point
Manufacturing Co. Globe Telecommunications was formed in 1983 to be a
deregulated provider of services for Valley Telephone. Globe Telecommunications
has been providing deregulated services to Interstate Telephone since 1996. ITC
Holding was formed in 1989 as a holding company for the combined Interstate
Telephone, Valley Telephone and Globe Telecommunications companies. ITC Holding
Company formed ITC Globe in 1997 to be a provider of local broadband services in
the West Point, Georgia and Alabama/Georgia border area.
ITC Holding formed KNOLOGY Holdings in 1995, but its percentage ownership
fell below 50% during 1996. ITC Holding acquired additional stock in KNOLOGY
Holdings in 1998, becoming the holder of approximately 85% of KNOLOGY Holdings.
Our subsidiary KNOLOGY Holdings, Inc. has been providing cable television
service since 1995, telephone and high-speed Internet access services since 1997
and broadband carrier services since 1998. KNOLOGY Holdings owns, operates and
manages interactive broadband networks in the five metropolitan areas of
Montgomery, Alabama; Columbus and Augusta, Georgia; Panama City, Florida and
Charleston, South Carolina; and it plans to expand to additional mid-sized
cities in the southeastern United States. In addition, KNOLOGY Holdings provides
analog and digital cable television services in Huntsville, Alabama. The
Huntsville facilities are being upgraded to provide local and long distance
telephone and high-speed Internet access services.
KNOLOGY Holdings began providing cable television service by acquiring
cable television systems in Montgomery, Alabama and Columbus, Georgia in 1995
and using those systems as a base for constructing new interactive broadband
networks. Since acquiring the Montgomery and Columbus systems, we have
significantly expanded these networks and upgraded the acquired networks to
offer additional broadband communications services.
In December 1997, KNOLOGY Holdings acquired a cable television system in
Panama City Beach, Florida. We are currently upgrading this cable system and
extending the network into the Panama City metro area. We expect to complete
this upgrade in 2000.
In early 1998, KNOLOGY Holdings began expanding into Augusta, Georgia and
Charleston, South Carolina by obtaining new franchise agreements with the local
governments and by constructing new interactive broadband networks. We expect to
complete construction of these networks by 2003.
In June 1998, KNOLOGY Holdings acquired TTE Inc., a non-facilities based
reseller of local, long distance and operator services to small and medium-sized
business customers throughout South Carolina.
In October 1998, KNOLOGY Holdings acquired the Cable Alabama cable
television system serving the Huntsville, Alabama area. The existing Cable
Alabama plant is being upgraded to an interactive broadband network which will
be completed by 2001.
Interstate Telephone and Valley Telephone provide local exchange services
throughout the Georgia/Alabama border area known as the Valley, which includes
the towns of West Point, Georgia, Lanett, Alabama and Valley, Alabama and
unincorporated portions of counties in both states. Globe Telecommunications
provides long distance services, leases customer premise equipment and sells and
maintains key systems and private branch exchange switches. ITC Globe has been
providing competitive local exchange carrier services to residential and
business customers located in the Newnan, Georgia area since April 1998 and
likely will begin providing these services to Fariburn and Union City, Georgia
in the fourth quarter of 1999. ITC Globe (d/b/a "KNOLOGY Connecting The Valley")
also provides analog cable television, digital cable television and high-speed
Internet access to customers within the local exchange territory of Interstate
Telephone and Valley Telephone.
20
<PAGE> 24
REVENUES AND EXPENSES
We can group our revenues into four categories: cable television revenues,
telephone revenues, Internet revenues and other revenues.
- Cable television revenues. Our cable television revenues consist of
fixed monthly fees for basic, digital and premium cable television
services, as well as fees from pay-per-view movies and events, such as
boxing matches and concerts, that involve a charge for each viewing.
- Telephone revenues. Our telephone revenues consist primarily of fixed
monthly fees for local service, enhanced services such as call waiting
and voice mail, and usage fees for long distance service.
- Internet revenues. Our Internet revenues consist primarily of fixed
monthly fees for Internet access service and rental of cable modems.
- Other revenues. Our other revenues result principally from broadband
carrier services and video production services.
Our operating expenses include cost of services expenses, selling,
operations and administrative expenses and depreciation and amortization
expenses.
Cost of services expenses include:
- Cable television cost of services. Cable television cost of services
consist primarily of monthly fees to the National Cable Television
Cooperative and other programming providers, and are generally based on
the average number of subscribers to each program.
- Telephone and Internet access services. Cost of services related to our
telephone and Internet access services include costs of Internet
transport and telephone switching, and interconnect and transport charges
payable to local and long distance carriers.
Selling, operations and administrative expenses include:
- Sales and marketing costs. Sales and marketing costs include the cost of
sales and marketing personnel and advertising and promotional expenses.
- Network operations and maintenance expenses. Network operations and
maintenance expenses include payroll and departmental costs incurred for
network design and maintenance monitoring.
- Customer service expenses. Customer service expenses include payroll and
departmental costs incurred for customer service representatives and
management.
- General and administrative expenses. General and administrative expenses
consist of corporate and subsidiary general management and administrative
costs.
Depreciation and amortization expenses include:
- Depreciation and amortization expenses. Depreciation and amortization
expenses include depreciation of our interactive broadband networks and
equipment, and amortization of cost in excess of net assets and other
intangible assets related to acquisitions.
RESULTS OF OPERATIONS
Six Months Ended June 30, 1999 Compared to Six Months Ended June 30, 1998
Revenues. Operating revenues increased 67.7% from $18.6 million for the
six months ended June 30, 1998 to $31.2 million for the six months ended June
30, 1999. Our increased revenues are primarily due to
21
<PAGE> 25
a higher number of revenue generating units during the three months ended June
30, 1999 compared to the same period in 1998. The additional revenue generating
units resulted primarily from:
- the extension of our broadband networks in the Montgomery, Columbus and
Panama City markets;
- the continued growth of broadband services in the Augusta and Charleston
markets; and
- the acquisition of the TTE and Cable Alabama systems in June 1998 and
October 1998, respectively.
Expenses. Our operating expenses, excluding depreciation and amortization,
increased 80.1%, from $19.6 million for the six months ended June 30, 1998 to
$35.3 million for the six months ended June 30, 1999. The cost of services
component of operating expenses increased 164.9%, from $3.7 million for the 1998
period to $9.8 for the 1999 period. Our selling, operations, and administration
expenses increased 60.4%, from $15.9 million for the 1998 period to $25.5
million for the 1999 period. The increase in our cost of services and other
operating expenses is consistent with the growth in revenues and is a result of
the expansion of our operations and the increase in the number of employees
associated with such expansion and growth into new markets.
Our depreciation and amortization expenses increased from $5.6 million for
the six months ended June 30, 1998 to $19.7 million for the six months ended
June 30, 1999. The increase in depreciation and amortization is due to
significant additions in property, plant, equipment and intangible assets
resulting from the expansion of our networks; the acquisition of the TTE and
Cable Alabama systems; and the purchase of buildings, computers and office
equipment at the corporate and subsidiary locations.
Our interest expense increased from $14.1 million for the six months ended
June 30, 1998 to $16.1 million for the six months ended June 30, 1999. The
increase in interest expense reflects the accrual of the interest attributable
to the Senior Discount Notes issued in October 1997.
Our interest income was $6.1 million for the six months ended June 30,
1998, compared to $1.1 million for the same period in 1999. The interest income
reflects the interest earned from the investment of certain proceeds received
from the issuance of the Senior Discount Notes in October 1997. The decrease in
interest income is due to the draw down of marketable securities to fund planned
expansion and acquisitions.
Income Tax (Provision) Benefit. We recorded an income tax provision of
$530,000 for the six months ended June 30, 1998 compared to an income tax
benefit of $6.5 million for the six months ended June 30, 1999. The income tax
benefit in 1999 resulted from our utilizing net tax losses under a tax sharing
agreement with ITC Holding. The tax sharing agreement was effective August 1998
upon the acquisition by ITC Holding of its majority-owned interest of KNOLOGY
Holdings, Inc. After the reorganization is complete, we will not be able to
utilize the net operating losses generated to create an income tax benefit.
Net Loss. We incurred a net loss of $5.8 million for the six months ended
June 30, 1998 compared to a net loss of $27.6 million for the six months ended
June 30, 1999. The increase in net loss is a result of the expansion of our
operations and the increase in the number of employees associated with such
expansion and growth into new markets. We expect net losses to continue to
increase as we proceed with the expansion of our business.
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
As explained above, our results for the year ended December 31, 1998
include the results of all of our current subsidiaries. However, our 1997
results do not include the results of KNOLOGY Holdings, Inc., which was not
majority-owned by ITC Holding during 1997 and therefore, was accounted for as an
equity method investment in 1997.
Revenues. Our operating revenues increased $27.5 million, or 156.3%, from
$17.6 million for the year ended December 31, 1997 to $45.1 million for the year
ended December 31, 1998. Excluding
22
<PAGE> 26
operating revenues of $25.8 million of KNOLOGY Holdings in 1998, our operating
revenues increased $1.7 million, or 9.7%, due primarily to the addition of a
competitive local exchange carrier and broadband services operations in the
Valley.
Expenses. Our operating expenses, excluding depreciation and amortization,
increased $37.5 million, or 297.6%, from $12.6 million for the year ended
December 31, 1997 to 50.1 million for the year ended December 31, 1998.
Excluding operating expenses of $37.3 million of KNOLOGY Holdings in 1998, our
operating expenses increased $195,000, or 1.5%.
Our depreciation and amortization expenses increased from $2.8 million for
the year ended December 31, 1997 to $17.9 million for the year ended December
31, 1998, an increase which primarily reflects the inclusion of $12.4 million of
KNOLOGY Holdings depreciation and amortization for the 1998 period which was
consolidated in our 1998 results.
Our interest expense and interest income increased $9.6 million and $29.0
million, respectively, from 1997 to 1998, primarily due to the inclusion of
KNOLOGY Holdings' results in the 1998 period. The interest expense and interest
income reported in the 1998 period reflects the accrual of the interest
attributable to the Senior Discount Notes issued in October 1997 and the
interest income from the investment of the proceeds of the notes into marketable
securities.
Equity and losses of subsidiaries decreased $2.4 million from the year
ended December 31, 1997 compared to the same period in 1998. The decrease
represents the acquisition of the majority of KNOLOGY Holdings, Inc. stock in
1998 which acquisition required us to consolidate the operations of KNOLOGY
Holdings, Inc. in 1998.
Other income (expense) changed from $(59,000) for the year ended December
31, 1997 to $783,000 for the year ended December 31, 1998 and is primarily due
to the 1997 period reflecting a gain on the sale of an investment.
Minority Interests. Our minority interests increased from $0 in 1997 to
$13.3 million in 1998. Minority interests in 1998 reflects the minority
stockholders share of the losses and the pre-acquisition losses in connection
with the acquisition of KNOLOGY Holdings, Inc. in 1998. In accordance with
Accounting Principles Board Opinion No. 16, the reorganization of KNOLOGY
Holdings was recorded at ITC Holding's historical cost for the 85% controlling
interest obtained. The remainder was treated as an acquisition of minority
interest at fair value.
Income Tax (Provision) Benefit. We recorded an income tax benefit of $5.6
million for the year ended December 31, 1998 compared to a provision of $1.0
million for the year ended December 31, 1997. The income tax benefit in 1998
results from our utilizing net tax losses under a tax sharing agreement with ITC
Holding. The provision in 1997 reflects tax expense of all of our subsidiaries.
The change in the amount of $6.6 million results from the consolidation of
KNOLOGY Holdings due to the acquisition of the majority interest by ITC Holding
in 1998. After the reorganization is complete, we will not be able to utilize
the net operating losses generated to create an income tax benefit.
Preferred Dividends. Preferred dividends in the amount of $4.2 million in
1997 and $1.4 million in 1998 represent profits of the Interstate Telephone
Company, Inc., Valley Telephone Company, Inc., Globe Telecommunications, Inc.
and ITC Globe, Inc. contributed to ITC Holding Company. The decrease in 1998 as
compared to 1997 relates to the increased capital deployed to launch operations
of Globe Telecommunications, Inc., and ITC Globe, Inc. in 1998.
Net Loss Attributable to Common Shareholder. We incurred a net loss of
$5.0 million for the year ended December 31, 1997 compared to a net loss of
$24.6 million for the year ended December 31, 1998. The increase in net loss was
due primarily to the development of new properties.
23
<PAGE> 27
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996
As explained above, our results for the years ended December 31, 1997 and
1996 do not include the results of KNOLOGY Holdings, Inc., which was not
majority-owned by ITC Holding during the 1997 and 1996 periods.
Revenues. Our operating revenues increased $106,000, or 0.6%, from the
year ended June 30, 1996 compared to the same period in 1997.
Expenses. Our operating expenses, excluding depreciation and amortization,
increased 11.5%, from $11.3 million for the year ended December 31, 1996 to
$12.6 million for the year ended December 31, 1997. The cost of services
component of operating expenses increased $130,000, or 3.3%, from $3.0 million
for the year ended December 31, 1996 to $3.1 million for the same period in
1997. Our selling, operations, and administration expenses increased 14.5%, from
$8.3 million for 1996 to $9.5 million for 1997. The increase in selling,
operations and administration expense was primarily due to a credit (reduction
of expense) of approximately $700,000 recorded in 1996 related to a settled
dispute with carriers.
Our depreciation and amortization expenses decreased $240,000, or 8.0%,
from 1996 to 1997.
Our other expenses increased from $380,000 for the year ended December 31,
1996 to $2.0 million for the year ended December 31, 1997. The increase was
primarily due to the reporting of our share of KNOLOGY Holding's loss based on
our minority-owned interest for the 1996 and 1997 periods.
Preferred Dividends. Preferred dividends in the amount of $0 in 1996 and
$4.2 million in 1997 represent certain profits of the Interstate Telephone
Company, Inc., Valley Telephone Company, Inc., Globe Telecommunication, Inc. and
ITC Globe, Inc. contributed to ITC Holding Company. In 1996 the Company invested
profits into its businesses.
Net Loss. We incurred net income of $1.4 million for the year ended
December 31, 1996 compared to a net loss of $827,000 for the year ended December
31, 1997.
LIQUIDITY AND CAPITAL RESOURCES
As of June 30, 1999, we had net working capital of $8.8 million, compared
to $52.0 million and ($1.1) million at December 31, 1998 and 1997, respectively.
We have required equity infusions and debt proceeds to finance a
significant portion of our operating, investing and financing activities in the
development of our business. Net cash provided by operations totaled $4.8
million, $3.7 million and $23.0 million for 1996, 1997 and 1998, respectively,
and net cash used by operations totaled $5.3 million for the six months ended
June 30, 1999. The net cash flow activity related to operations consists
primarily of changes in operating assets and liabilities and adjustments to net
income for non-cash transactions including:
- depreciation and amortization;
- loss on disposition of assets;
- cumulative effect of an accounting change;
- deferred income taxes;
- deferred investment tax credit;
- equity in net loss of subsidiary; and
- minority interest in subsidiaries' net loss.
Net cash used for investing activities was $0.2 million, $22.2 million and
$40.7 million for the years ended December 31, 1996, 1997 and 1998,
respectively, and net cash provided by investing activities totaled $1.5 million
for the six months ended June 30, 1999. The net cash flow from investing
activities in 1996 represented $1.0 million of capital expenditures funded in
part by $0.8 million in proceeds from sales
24
<PAGE> 28
of investments. Our investing activities in 1997 consisted primarily of $1.7
million of capital expenditures, $14.3 million for the purchase of the Panama
City cable system, $4.2 million of dividends paid to an affiliate and a $2.1
million increase in construction related payables. In 1998, our investing
activities consisted primarily of $120.2 million of capital expenditures, $67.7
million for the acquisition of the Huntsville, Alabama cable system, $12.3
million for the purchase of equity interests in KNOLOGY Holdings, Inc., $1.4
million of dividends paid to an affiliate and $0.8 million for an investment in
ClearSource, Inc. These investing activities are offset by $162.2 million in
proceeds from the sale of short-term investments. Our investing activities for
the six months ended June 30, 1999 consisted of $47.9 million of capital
expenditures principally funded by $49.3 million in proceeds from the sale of
short-term investments.
Net cash flow from financing activities was cash used of $4.5 million, cash
provided of $18.7 million, cash provided of $16.1 million and cash used of $0.2
million for the years ended December 31, 1996, 1997 and 1998 and the six months
ended June 30, 1999, respectively. Net cash used in financing activities in 1996
included $0.9 million payments on debt and short term borrowings and $4.4
million of advances to affiliates offset by $0.9 million of additional infusion
of equity. Cash flow from investing activity in 1997 consisted of $14.3 million
of additional infusion of equity and $4.4 million of reimbursement of advances
previously made to an affiliate. Investing activities in the 1998 period
primarily consisted of $15.6 million of additional infusion of equity and $2.0
million repayment from an affiliate, offset by $1.5 million in expenditures
related to the issuance of debt. These numbers do not include $242.4 million
raised by KNOLOGY Holdings in 1997 as KNOLOGY Holdings was not majority-owned by
ITC Holding during 1997.
FUNDING TO DATE
On October 22, 1997, KNOLOGY Holdings received net proceeds of
approximately $242.4 million from the offering of Senior Discount Notes. These
notes were sold at a substantial discount from their principal amount at
maturity and there will not be any payment of interest on the notes prior to
April 15, 2003. The notes will fully accrete to face value of $444.1 million on
October 15, 2002. From and after October 15, 2002, the notes will bear interest,
which will be payable in cash, at a rate of 11 7/8% per annum on April 15 and
October 15 of each year, commencing April 15, 2003. The Indenture contains
covenants that affect, and in certain cases significantly limit or prohibit, the
ability of KNOLOGY Holdings to:
- incur indebtedness;
- pay dividends;
- prepay subordinated indebtedness;
- redeem capital stock;
- make investments;
- engage in transactions with stockholders and affiliates;
- create liens;
- sell assets; and
- engage in mergers and consolidations.
If KNOLOGY Holdings fails to comply with these covenants, KNOLOGY Holdings'
obligation to repay the notes may be accelerated. However, these limitations are
subject to a number of important qualifications and exceptions. In particular,
while the Indenture restricts KNOLOGY Holdings' ability to incur additional
indebtedness by requiring compliance with specified leverage ratios, it permits
KNOLOGY Holdings and its subsidiaries to incur an unlimited amount of
indebtedness to finance the acquisition of equipment, inventory and network
assets and to secure such indebtedness, and to incur up to $50 million of
additional secured indebtedness. Upon a change of control of KNOLOGY Holdings,
as
25
<PAGE> 29
defined in the Indenture, KNOLOGY Holdings would be required to make an offer to
purchase the notes at a purchase price equal to 101% of their accreted value,
plus accrued interest.
In connection with the Senior Discount Notes offering, KNOLOGY Holdings
completed an equity private placement, in which KNOLOGY Holdings issued
approximately 21,400 additional shares of Preferred Stock at $1,500 per share
for aggregate proceeds of approximately $32.2 million.
On December 22, 1998, KNOLOGY Holdings entered into a $50 million four-year
senior secured credit facility with First Union National Bank and First Union
Capital Markets Corp. The credit facility allows KNOLOGY Holdings to borrow up
to five times certain individual subsidiary's annualized consolidated adjusted
cash flow, as defined in the Credit Facility agreement. The credit facility may
be used for working capital and other purposes, including capital expenditures
and permitted acquisitions. At KNOLOGY Holdings' option, interest will accrue
based on either the Alternate Base Rate plus applicable margin or the LIBOR rate
plus applicable margin. The applicable margin may vary from .50% to 2.50% based
on the leverage ratio of KNOLOGY Holdings. The credit facility contains a number
of covenants including, among others, covenants limiting the ability of KNOLOGY
Holdings and its subsidiaries to:
- incur debt;
- create liens;
- pay dividends;
- make distributions or stock repurchases;
- make certain investments;
- engage in transactions with affiliates;
- sell assets; and
- engage in mergers and acquisitions.
The credit facility also includes covenants requiring compliance with certain
operating and financial ratios on a consolidated basis, including the number of
revenue generating units and average revenue per subscriber. KNOLOGY Holdings is
currently in compliance with these covenants, however, there are no assurances
that KNOLOGY Holdings will remain in compliance through the end of the year.
Should KNOLOGY Holdings not be in compliance with the covenants, KNOLOGY
Holdings will be in default and will require a waiver from the lender. In the
event the lender would not provide a waiver, amounts outstanding against the
facility could be payable to the lender on demand. The maximum amount currently
available under the credit facility at September 30, 1999 was approximately $25
million, assuming compliance with all of the operating and financial covenants.
As of September 30, 1999, $19 million of the $25 million currently available had
been drawn against the credit facility.
FUTURE FUNDING
Our business requires substantial investment to finance capital
expenditures and related expenses, to expand and/or upgrade the interactive
broadband networks, to fund subscriber equipment, to fund operating losses and
to maintain the quality of its networks. We currently expect to spend
approximately $94 million for capital expenditures during 1999, of which $48
million had been expended in the first six months of 1999, including for the
planned expansion and/or upgrade of the Montgomery, Columbus, Panama City,
Augusta, Charleston and Huntsville networks. Failure to have access to
additional funds during 1999 could require us to delay some of our construction
plans and possibly require us to constrain certain operations.
We presently estimate the cost to complete construction of the networks in
the existing markets to be approximately $177 million and the cost of
constructing networks and funding initial subscriber equipment in additional new
cities at approximately $50 to $75 million per city. The actual costs may vary
significantly from this range and will depend in part on the number of miles of
network to be constructed,
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the geographic and demographic characteristics of the city, other factors
affecting construction costs, costs associated with the cable franchise in each
city, the number of subscribers, the mix of services purchased, the cost of
subscriber equipment we paid for or financed and other factors. We will need
additional financing to expand into additional cities for new business
activities or in the event we decide to make additional acquisitions.
We expect to enter into purchase agreements for programming services and
construction related services to expand our service offerings and to expand and
upgrade our current systems, which will commit us to make some of these planned
expenditures. We believe that present cash reserves, cash flow from operations,
amounts available under the KNOLOGY Holdings credit facilities, and proceeds
from a promissory note agreement will provide us with sufficient funds to expand
our current networks as planned through 1999. The promissory note provides $13
million of funding from Intercall, Inc., an ITC Holding subsidiary, which closed
in October 1999. In November 1999, after the contribution and exchange, we
entered into a note agreement with a different subsidiary of ITC Holding. This
subsidiary agreed to lend us up to $30 million until March 31, 2000. The ITC
Holding subsidiary may elect, in lieu of repayment, to convert the amount
outstanding under the note into options to purchase up to 6,315,789 shares of
our common stock.
Shortly following the distribution we intend to make a private offering of
shares of our Series B stock. This offering is expected to be made to a small
group of institutional investors for approximately $100 million. The proceeds
are expected to be used to complete the existing KNOLOGY Holdings buildout and
launch additional markets. We will continue to need additional financing to fund
further expansion and to make potential acquisitions.
THE YEAR 2000 ISSUE
General
The Year 2000 issue is a general term used to describe the various problems
that may result in computers and other machinery as we reach the year 2000.
These problems generally arise from the fact that most of the world's computers
have historically used only two digits to identify the year in a date, often
meaning that the computer will fail to distinguish dates in the 2000's from
dates in the 1900's.
These problems are expected to increase in frequency and severity as the
year 2000 approaches. This issue impacts our owned or licensed computer systems
and equipment used in connection with internal operations.
Third Parties
We also rely directly and indirectly, in the regular course of business, on
the proper operation and compatibility of third party systems. The year 2000
problem could cause these systems to fail, err, or become incompatible with our
systems.
If we or a significant third party on which we rely fails to become year
2000 ready, or if the year 2000 problem causes our systems to become internally
incompatible or incompatible with such third party systems, our business could
suffer from material disruptions, including the inability to process
transactions, send invoices, accept customer orders or provide customers with
our services. We could also face similar disruptions if the year 2000 problem
causes general widespread problems or an economic crisis. We cannot now estimate
the extent of these potential disruptions.
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Our State of Readiness
We established a Year 2000 program office to coordinate activity and report
to our executive management and board of directors with regard to the Year 2000
issue. Our Year 2000 program office developed a plan for us to become Year 2000
ready by the middle of the fourth quarter 1999. This plan covers:
- our technology and operating systems;
- billing of our cable, telephone and Internet services;
- customer service;
- financial operations and reporting;
- network monitoring; and
- the systems of our major vendors, third party service providers and other
material service and content providers.
We are addressing our Year 2000 plan with respect to our internal
operations in six phases:
- an awareness phase, in which we inventory and evaluate our systems,
components and other significant infrastructure;
- an assessment phase, in which we identify those elements that reasonably
could be expected to be affected by year 2000 problems;
- a remediation phase, in which we remediate or replace equipment that we
believe will fail to operate properly in the year 2000;
- a testing and validation phase, in which we test the remediation and
replacement conducted and validate its ability;
- an implementation phase, in which we add our new or updated equipment to
our current systems; and
- a contingency phase, in which we develop contingency plans for our
at-risk business functions.
We have completed the awareness, assessment, remediation and contingency phases
of our plan for all of our services and systems. We have substantially completed
the testing and validation and implementation phases for all of these services
and systems.
Certain actions in the remediation phase have been conducted by the third
parties who provide hardware, software, or services that comprise our systems.
We have polled all the third parties who provide material hardware, software, or
services as part of our information technology and operating systems with regard
to each of such third party's Year 2000 compliance plan and state of readiness.
We have actively sought responses from all vendors and third parties as to Year
2000 compliance, status of plans and readiness. All key vendors have responded
and most of the third parties have assured us that their hardware and/or
software is currently or will be Year 2000 compliant before the end of the year.
We expect to have any remaining non-compliant systems in compliance before the
end of 1999.
Interstate Telephone and Valley Telephone will be Year 2000 ready by
December 1999. Both companies rely on third party vendors for the telephony
customer care and billing and switching services, and both use a legacy system
for telephony carrier access billing services.
Costs
To date, we have incurred approximately $450,000 of costs in connection
with our Year 2000 plan and we anticipate spending approximately $150,000 in
additional funds. We expense all costs associated with our Year 2000 plan as we
incur them and anticipate funding the costs of our plan from cash flows. To
date, we have not deferred any specific information technology projects because
of the costs of our plan.
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Risks
The failure to correct a material year 2000 problem or to implement a
contingency plan could result in system failures leading to a disruption in, or
failure of certain normal business activities or operations. Such failures could
materially and adversely affect our business, profitability and operating
results.
Contingency Plans
We have a Year 2000 Contingency Planning committee, which has developed
Year 2000 contingency plans for all of our information technology and operating
systems and for each of our locations. This committee identified key business
risks which were used to drive the development of these plans. Additionally, we
use an outside consulting service to assist in our Year 2000 readiness, project
coordination and execution of the Year 2000 Plan.
Contingency planning to maintain and restore service in the event of
natural disasters, power failures and systems-related problems is a routine part
of our operations. We believe that such contingency plans will assist us in
responding to any failure by outside service providers to successfully address
Year 2000 issues. In addition, we have developed complete contingency plans that
address our most reasonably likely worst case Year 2000 scenarios including
identification of alternate vendors and service providers and manual
alternatives to system operations.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
We do not engage in trading market risk sensitive instruments and do not
purchase as investments, as hedges, or for purposes "other than trading"
instruments that are likely to expose us to market risk, whether it be from
interest rate, foreign currency exchange, commodity price or equity price risk.
We have entered into no forward or futures contracts, purchased no options and
entered into no swaps.
Our primary market risk exposure is that of interest rate risk. A change in
LIBOR or the Prime Rate as set by First Union National Bank would affect the
rate at which we could borrow funds under our credit facility.
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OUR BUSINESS
GENERAL
KNOLOGY, Inc. was formed in September 1998. We are the parent company of
KNOLOGY Holdings, Inc. and other companies previously owned by ITC Holding
Company, Inc. KNOLOGY Holdings is our principal subsidiary. We offer our
customers broadband communications services, including:
- analog and digital cable television;
- local and long distance telephone;
- high-speed Internet access service; and
- broadband carrier services.
We provide these broadband communications services using high-speed,
high-capacity hybrid fiber-coaxial networks that are two-way interactive.
We own, operate and manage interactive broadband networks in five
metropolitan areas: Montgomery, Alabama; Columbus and Augusta, Georgia; Panama
City, Florida and Charleston, South Carolina, and we plan to expand to
additional mid-sized cities in the southeastern United States. In addition, we
provide analog and digital cable television services in Huntsville, Alabama. Our
Huntsville facilities are being upgraded to provide local and long distance
telephone and high-speed Internet access services. We also provide local
exchange services throughout the Georgia/Alabama border area known as the
Valley, which includes the towns of West Point, Georgia, Lanett, Alabama and
Valley, Alabama and unincorporated portions of counties in both states. Further,
we provide competitive local exchange service in Newnan, Georgia.
BROADBAND COMMUNICATIONS SERVICES STRATEGY
We have developed the following strategy for the implementation and
operation of our broadband communications services business:
- Build and Operate Reliable Interactive Broadband Networks. By designing,
constructing and operating our own high-capacity, interactive broadband
networks, we provide our residential and business customers a wide range
of high-quality broadband communications services. We believe that this
gives us a competitive advantage over cable, telephone and wireless
systems that do not have the capability to provide a wide range of
broadband services.
We also believe that our high-capacity networks, which are substantially
protected by redundant paths for communications segments, give us a
quality and reliability advantage over other and lower-capacity coaxial
cable systems that do not have significant redundancy protection. We use
a specially designed powering system, which is backed up at each hub site
by a generator and uninterruptable power source, to allow service to
continue in case of a power outage. The interactive broadband networks
contain equipment which can be monitored 24 hours per day, seven days per
week, at our network operations center.
- Provide Bundled Offerings. We believe that by bundling up to three
broadband communications services we can distinguish ourself from our
competition. We believe that the cost savings on a bundle of services and
the advantages of one-stop shopping will be attractive to new customers,
particularly since most of our prospective customers presently buy
services from multiple sources. We also believe that because of the cost
savings associated with purchasing a bundle of services from us,
customers will be less likely to switch should competitors offer lower
prices on individual services. The ability to realize an overall profit
on a bundle of services should give us greater pricing flexibility.
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- Be First To Market Multiple Broadband Communications Services. We
believe that we are the first provider of a bundled video, voice and data
broadband services package in Montgomery, Columbus, Panama City, Augusta,
Charleston and Huntsville. We intend to be the first to market a similar
services package in each new market. We want to capitalize on our
position as a new communications company that brings competition and
choice to cities. We believe that many companies may seek to provide
multiple broadband communications services over the next several years.
We expect that later entrants in a market will have greater difficulty
making a profit. In addition, constructing networks uses space on various
rights of way, which may be limited or more expensive for later entrants.
- Expand To Additional Markets. We intend to expand to additional
mid-sized cities in the southeastern United States. We intend to target
cities:
- that have enough people to permit a network plant to serve an average
of 70 homes per mile;
- that generally have populations of at least 100,000; and
- in which we believe we can capture a substantial portion of the cable
television customers and can be the leading provider of bundled
broadband services.
We believe that such cities will support a broadband communications
services business and that most of the large cable companies and other
service providers currently are focusing primarily on larger
metropolitan areas.
- Focus On The Customer. We believe the quality and responsiveness of our
customer service differentiates us from our competitors. Our customer
service representatives in each market handle customer-related functions
24-hours a day. We also monitor our networks 24 hours a day, seven days a
week.
- Broadband Carrier Services Strategy. We plan to continue to use extra,
unused capacity on our networks to develop and offer wholesale services
to other competitive local exchange carriers, interexchange carriers,
Internet services providers and other integrated services providers. Our
entry into a local market with a newly constructed interactive broadband
network offers other service providers a reliable and cost competitive
alternative to telephone services provided by the incumbent local
exchange carrier. We believe that we have a competitive advantage due to
the fact that our networks are fiber-intensive and pass substantially
every home and business in our service area.
INDUSTRY STRUCTURE AND TECHNOLOGY
General
As a result of the Telecommunications Act of 1996, cable television
companies may provide telephone service and vice versa, local telephone
companies may provide long distance service and vice versa, and all may provide
numerous ancillary services. Municipalities must grant cable television
franchises to qualified applicants. This change in the regulatory landscape,
along with the substantial growth in use of the Internet, has led to a rush by
communications companies and others such as power companies to provide a full
range of voice, video and data communications services to consumers. Although
the process of building broadband networks and expanding to other services has
begun, we believe that most of the large cable companies and other service
providers will initially focus primarily on major metropolitan areas.
Communications Technologies And Services
We have set forth below a brief description of the current communications
industry structure and the technology generally used by each system, including
hurdles that providers face in offering new services.
Cable Television. Cable television systems generally consist of coaxial
cable, which carries signals via radio frequency, and/or fiber optic cable,
which carries signals via light waves generated by a laser. The
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cable runs through the air attached to poles or underground past the homes in a
service area, connecting to each house individually through a cable connection
box located outside of the house. Subscriber homes have internal wiring running
from the cable connection box to one or more boxes into which users connect
television sets and set-top terminals used for special services, descrambling,
pay-per-view and other features. Coaxial cable networks have numerous amplifiers
located along the network to restore the strength of the signal, which
diminishes as it travels. Amplifiers produce interference or noise which
increases as the number of amplifiers increases. Fiber optic networks do not use
amplifiers since their larger lasers send signals further so they do not need
amplifying.
The number of channels or features that a cable system can offer varies
with the capacity of the cable network and the electronic equipment which
compresses and amplifies the signal. Additional equipment may compensate for a
lower-capacity network, but too much equipment results in noise or interference,
leading to a lower-quality signal. Many traditional cable companies have sought
to increase capacity through the use of additional equipment, and customers have
experienced increased interference.
Many cable television systems use one-way noninteractive cable, and
accordingly do not have the ability to provide telephone service, which requires
a two-way interactive cable. Several cable companies, including large cable
companies, offer high-speed data transmission and provide Internet access using
cable modems which are one-way noninteractive. However, such service generally
cannot deliver high-speed performance until the cable has been upgraded to
increase capacity and add two-way interactivity.
Wireless Cable. Wireless cable, sometimes called multichannel multipoint
distribution service or MMDS, technology allows the transmission of television,
high-speed computer data, and facsimile transmissions via microwave frequencies.
Wireless cable has been used to serve primarily rural areas where laying
traditional cable is not economically feasible. The wireless cable system sends
signals from a centrally located facility equipped with transmitters, antennas,
satellite dishes and scrambling and descrambling equipment to subscribers with
rooftop antennas and the necessary converters. Because wireless cable signals
use microwaves, they require line-of-sight transmission from the central source
to the subscribers. Obstructions such as large buildings, trees and uneven
terrain can interfere with reception, although signal repeaters that receive and
re-transmit signals to avoid obstructions alleviate these shortcomings.
Other Satellite Technologies. Direct-to-home satellite television, or DTH,
companies provide satellite transmission of video and audio services. DTH
companies generally include hardware and software to receive and decrypt
satellite television programming. Echostar and DirecTV provide direct broadcast
satellite, or DBS, services using high-power communications satellites and small
dish receivers, and other companies provide direct-to-home video services using
lower-power satellites and larger receivers. DBS systems generally offer more
channels than cable systems, although some DBS providers do not offer local
programming. DBS and DTH do not require ground construction to install, maintain
or upgrade services. Rather, the programming is transmitted from a ground
station to the subscriber using a communications satellite. A subscriber must
purchase or lease a satellite dish to receive signals and a receiver system to
process and descramble signals for television viewing.
Currently small satellite dishes are not two-way interactive, and therefore
are not suitable for telephone or Internet services. Residential systems use
telephone lines to transmit to the Internet and satellite transmission for
reception from the Internet. This approach still has dial-up delays, but it has
many of the same advantages as broadband communications services. However,
satellite transmission may cause an echo during voice transmissions due to the
long distance to and from the satellite.
Wireline Telephony. Traditional telephone service is provided by local
wireline telephone systems consisting of a network of switches, transmission
facilities between switches, and connections between customer premises and a
local exchange switch. A call can be routed by the local exchange switch
directly to the called party if that party is served by the same switch, to
another local or toll switch for delivery to the called party, or through one or
more switches of a long distance carrier to a more distant local switch for
ultimate delivery to the called party. The transmission facilities connecting
switches are comprised primarily of high-capacity fiber optic cables. Customer
premises usually consist of twisted copper wire
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pairs that run through the air or underground to each of the premises served.
They generally carry analog transmissions and have relatively low transmission
capacity, sufficient to carry only one two-way voice conversation. Capacity can
be expanded by advanced techniques such as Integrated Services Digital Network
or ISDN, which permits voice and data transmissions to occur simultaneously and
can support some level of video teleconferencing. However, local connections,
even with Integrated Services Digital Network, generally do not have sufficient
capacity for large-scale provision of video services.
Digital subscriber line or DSL uses transmission equipment placed at the
customer premises and at the central office to increase transmission speeds on
copper wire local connections. Widespread deployment of digital subscriber line
technology is limited by the length and gauge of the copper wire connections
plus the existing use of extenders such as bridged taps, loading coils and
digital loop carriers.
Wireless Telephony. Wireless telephone technology, which includes cellular
and PCS, is based upon the division of a given market area into a number of
smaller geographic areas, or cells. Each cell has a base station or cell site,
which is a physical location equipped with transmitter-receivers and other
equipment that communicate by radio signal with wireless telephones located
within range of the cell. Cells generally have an operating range from two to 25
miles. Each cell site connects to a mobile telephone switching office, or MTSO,
which in turn connects to the local landline telephone network. When a
subscriber in a particular cell dials a number, the wireless telephone sends the
call by radio signal to the cell's transmitter-receiver, which then sends it to
the MTSO. The MTSO completes the call by connecting it with the landline
telephone network or another wireless telephone unit. Incoming calls are
received by the MTSO, which instructs the appropriate cell to complete the
communications link by radio signal between the cell's transmitter-receiver and
the wireless telephone. Like wireline local loops, wireless telephony
technologies generally do not have sufficient capacity for large scale provision
of video and data services, although some new higher-capacity technologies may
become available in the near future that support a wider range of services.
Internet Access. Most Internet access takes place over telephone lines
using computer modems. This form of transmission works well for smaller amounts
of data, but telephone lines generally cannot handle large volumes of
information, multimedia applications or high-speed data transmissions, resulting
in lengthy delays. Also, Internet service providers have limited numbers of
ports available for customers to dial in to the Internet, and their customers
may experience difficulties obtaining access to the Internet or be disconnected
if activity is too limited. High-speed cable modems used over traditional cable
networks permit high-speed broadband reception from the Internet, but require
communications from the user to the Internet to be over telephone lines.
Our Interactive Broadband Networks
Our interactive broadband networks are high-speed, high-capacity, two-way
interactive, hybrid fiber-coaxial networks. Each network includes hub sites with
a minimum of four fiber pairs running from each hub to nodes, each of which
serves an average of 500 homes. This design incorporates redundant fibers
running between hubs for restoration and security purposes, forming a
Synchronous Optical Network, or SONET, ring. By comparison, most traditional
cable television systems do not have significant redundancy protection. We
provide power to our system from the hub sites, each of which is equipped with a
generator and uninterruptable power source battery back-ups to allow service to
continue in a power outage.
Our interactive broadband networks can support numerous channels of basic
and premium cable television services, telephone services, Internet access and
other broadband communications services. Our networks have extra capacity, so we
can add new services as content and technology become available.
We offer local telephone service over these networks in much the same way
local phone companies provide service. We provide switching services and install
a network interface box outside a customer's home, and we may add inside wiring
as well. We can offer multiple lines of telephone service. Our networks
interconnect with those of other local phone companies through a nine-state
interconnection agreement with BellSouth Corp. We provide long distance service
using leased facilities from other telecommunications service providers.
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We provide high-speed Internet access services using high-speed cable
modems in much the same way customers currently receive Internet services over
modems linked to the local telephone network. The cable modems we presently use
are typically 50 times faster than regular phone dial-up modems. Our customer's
cable line with cable modem connects directly into the Internet. The Internet
connection is always active and there is no need to dial up for access to the
Internet or wait to connect through a port leased by an Internet service
provider.
OUR BROADBAND COMMUNICATIONS SERVICES
Cable Television. We offer our customers four levels of cable television
services: basic, expanded basic, premium, and digital. Customers generally pay
fixed monthly fees for cable programming and premium television services, which
constitute our principal sources of revenue.
Most customers choose to subscribe to basic and expanded basic levels of
service. Together, these services consist of approximately 65-75 channels of
programming, including:
- television signals available off-air;
- television signals from so-called super stations such as WGN (Chicago);
- numerous satellite-delivered non-broadcast channels such as Cable News
Network, MTV, ESPN, The Discovery Channel and Nickelodeon;
- displays of information featuring news, weather, stock and financial
market reports; and
- public, government and educational access channels.
We offer a variety of premium services for an extra monthly charge. Premium
services include channels with feature motion pictures such as HBO, Showtime and
Cinemax or other special channels. We also provide our customers:
- access to additional channels offering pay-per-view feature movies, live
and taped sports events, concerts and other special features which
involve a charge for each viewing;
- access to home shopping networks; and
- specialty services such as digital audio service.
Programming for our cable television systems comes from over 70 national
and local television networks. Since January 1, 1996, our arrangements with many
of these networks, constituting approximately 60% of our channels, have been
handled through the National Cable Television Cooperative, Inc. The National
Cable Television Cooperative obtains programming from most major networks and
provides it to its members. By obtaining programming through the cooperative, we
benefit from volume discounts not otherwise available to us and which more than
offset the fees to the cooperative. In addition, the cooperative handles our
contracting and billing arrangements with the networks.
We began offering digital video service in November 1998, which uses
compression technology to significantly increase the number of television
channels. Digital technology converts analog signals into a digital format and
compresses many such signals into the space normally occupied by one analog
signal. At the home, a set-top video terminal converts the digital signal back
into analog channels that can be viewed on a normal television set. We added
digital video as an additional service without reducing the current number of
expanded basic channels. Digital technology also permits us to offer near
video-on-demand, which include movies or other programs that commence in
frequent intervals, to customers for a fee per viewing.
Telephony. Our telephony service includes residential and small business
local and long distance telephone services. Our customers pay a fixed monthly
rate for all local calling. Customers may elect call waiting, call forwarding,
voice mail and other value-added services, which generally involve an additional
fixed charge per month per telephone line. We generally price our services at
rates comparable to those of our competitors, although typically our value-added
services are less expensive than those of our
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competition. We offer all of our cable television services customers a discount
on telephone service. Our long distance service offers features and prices
comparable to those of our competitors.
Internet Services. Our high-speed data service offers customers high-speed
connections to the Internet using cable modems. The Internet connection using a
cable modem is always active, so our customers do not have to dial in and wait
for access. Since a customer's service is offered over the coaxial network in
the home, no second phone line is required and there is no disruption of service
when the phone rings or when the television is on. We charge a fixed monthly fee
for connection to the Internet. We offer discounts on our high-speed Internet
service to customers who also purchase our cable television service or telephone
service.
Broadband Carrier Services. Our broadband carrier services include special
access, local private line, local exchange transport and local Internet
transport. We offer traditional special access and local private line services
through our local transport network by providing high capacity connections to
medium and large commercial users, incumbent local exchange carrier central
offices and other carriers throughout a metropolitan service area. We sell local
loops across our network to connect competitive local exchange carriers to small
business customers. Local Internet transport provides high-speed cable modem
access to connect certain Internet service providers and their residential
subscribers over our network.
We entered into a local Internet transport agreement with MindSpring
Enterprises, Inc. in August 1998 and launched the local Internet transport
service in Montgomery, Alabama in January 1999 and in Columbus, Georgia in April
1999. In addition, we launched Internet transport service in Charleston with A
World of Difference Inc., a large locally owned Internet service provider
serving the Charleston market, in August 1999.
Future Broadband Communications Services. We believe that our interactive
broadband networks may enable us to provide additional broadband services in the
future, including:
- Interactive energy management services in partnership with power
companies, which involve active monitoring by the customer of energy
usage and cost;
- Security services, including closed-circuit television security
monitoring and alarm systems;
- Voice over Internet Protocol; and
- High-speed, high-capacity local transport services using the
Asynchronous Transfer Mode method of transmission.
MARKETS AND SUBSCRIBERS
Current Markets
Our interactive broadband networks currently serve the Montgomery, Alabama;
Columbus and Augusta, Georgia; Charleston, South Carolina; Panama City, Florida;
and Huntsville, Alabama metropolitan areas and a rural area, the Valley, on the
Georgia/Alabama border. We also provide analog and digital cable television
services, telephone services and Internet services in the Huntsville, Alabama
area, and we are in the process of upgrading the Huntsville network to expand
our interactive broadband network.
We believe that our ability to increase and maintain our subscribers has
been due largely to:
- our commitment to customer service;
- the number of channels we offer; and
- our reliability and quality of the picture and sound over our
networks.
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New Markets
We plan to expand to additional mid-sized cities in the southeastern United
States, targeting cities:
- large enough to support a network plant to service an average of 70
homes per mile;
- with populations generally of at least 100,000; and
- in which we believe we can attract a significant portion of the
cable television customers and can become the leading provider of
bundled broadband communications services.
NETWORK CONSTRUCTION AND OPERATIONS
Network Construction
With the exception of the Valley area where we maintain our own
construction crews, we use contractors for the construction of our networks,
including both the laying of underground cable and attaching aerial cable to
utility poles. We serve as the manager of the construction process, directing
and supervising the various construction crews. We have 59 employees dedicated
to monitoring and facilitating the construction of our networks, including a
Vice President of Construction. Our approach to construction reflects our
commitment to customer service. We notify potential customers before commencing
underground construction and restore any damaged property. Based on past
experience, we believe the construction of a new network in a new market will
take approximately three years.
Network Operations and Maintenance
Technicians in each of our service areas schedule and perform installations
and repairs and monitor the performance of our interactive broadband networks.
We operate a network operations center in West Point, Georgia, and we monitor
our networks 24 hours a day, seven days a week. Our technicians perform
maintenance and repair of the network on an ongoing basis. We maintain the
quality of our networks to minimize service interruptions and extend the
networks' operational life.
Franchises
Cable television systems and local telephone systems generally are
constructed and operated under the authority of nonexclusive franchises, granted
by local and/or state governmental authorities. Franchises typically contain
many conditions, such as:
- time limitations on commencement and completion of system
construction;
- customer service standards;
- minimum number of channels; and
- the provision of free service to schools and certain other public
institutions.
We believe that the conditions in our franchises are fairly typical. Our
franchises generally provide for the payment of fees to the municipality ranging
from 3% to 5% of revenues from telephone and cable television service,
respectively. Our franchises generally have ten to fifteen year terms, and we
expect our franchises to be renewed before or upon expiration by the relevant
governmental agency.
SWITCHING
Our telephone subsidiaries switch voice and data traffic using a single
host DMS 500 switch. The switching platform allows these subsidiaries to provide
enhanced custom calling services including call waiting, call forwarding,
three-way-calling, and numerous others. Residences and businesses are connected
to the host or the remotes primarily with copper cable. We believe the outside
plant is in good condition. Much of the outside plant has been replaced within
the past three years.
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Interconnection
We rely on local telephone companies and other companies to provide
communications capacity for our local and long distance telephone service. We
have access to BellSouth's telephone network under a nine-state interconnection
agreement pursuant to the Telecommunications Act of 1996. The terms of such
interconnection agreement have been approved by the Georgia, Alabama, Florida
and South Carolina state public utility commissions. Approvals of other state
public utility commissions will be required in connection with our provision of
telephone service in other states. The Telecommunications Act established
certain requirements and standards for interconnection arrangements, and our
interconnection agreement with BellSouth is based on these requirements.
However, these requirements and standards are still being developed and
implemented by the FCC in conjunction with the states through a process of
negotiation and arbitration, as discussed below under the caption "Our
Business -- Legislation and Regulation -- Federal Regulation of
Telecommunications Services."
SALES AND MARKETING
Marketing Strategy
We believe that we are the first provider of a bundled video, voice and
data broadband communications services package in our current markets, and we
intend to be first to market a similar services package in new cities. We
believe that cost savings on a bundle of services and the advantages of one-stop
shopping will be attractive to new customers, particularly since most of our
prospective customers now buy services from multiple sources. We intend to
emphasize our position as a new communications company that brings competition
and choice to cities where we provide service. We also work to attract new cable
television subscribers in areas in which our network has expanded. Our focus
includes multiple dwelling units, many of which are subject to exclusivity
arrangements with other cable providers that have not yet expired or which
involve more complex arrangements with the property owner.
Cable Television. To attract cable television subscribers in new areas, we
mount extensive marketing campaigns prior to initiation of service with
door-to-door solicitations and flyers followed by direct mail and telemarketing.
We also use these solicitation efforts in our existing markets to encourage
people who previously have not chosen any cable service to use our cable service
or to encourage people who use another cable service to switch to our service.
We have a sales staff in each of our markets, including residential and business
sales managers, sales representatives and customer service representatives. We
use our own installation and repair crews and those of outside contractors to
install new service quickly.
Telephone and Internet. For our telephone and Internet marketing, we have
focused on subscribers of our cable television services through direct mail,
door-to-door solicitations, flyers and telemarketing. We offer our cable
television customers discounted rates for telephone service and high-speed
Internet services. We emphasize our bundle of services, which includes savings
on one or more services as additional services are added. We also provide
high-speed Internet access to certain Internet service providers who in turn
resell the service to their customers. We have sales managers for our telephone
and Internet services, and sales representatives focusing on bundled services.
Customer Service. Customer service is an essential element of our
operations and marketing, and we believe our quality and responsiveness
differentiates us from our competitors. A significant number of our employees
are dedicated to customer service activities, including
- order taking;
- customer activations;
- billing inquiries and collections;
- service upgrades;
- provision of customer premises equipment; and
- administration of our customer satisfaction program.
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In addition, we provide 24-hour customer service, operate customer phone centers
in each of our service areas, and operate a back-up customer phone center in
West Point, Georgia. We monitor our networks 24 hours a day, seven days a week
and strive to resolve problems prior to a customer being aware of any service
interruptions.
COMPETITION
Television
Cable television distributors compete for customers with other video
programming distributors and other providers of entertainment, news and
information. The competitors in these markets include:
- broadcast television and radio;
- satellite and wireless video distribution systems; and
- newspapers, magazines and other printed sources of information and
entertainment.
The Telecommunications Act of 1996 may create more competition for current cable
television distributors, as it allows local exchange carriers to provide video
services in their local service areas.
Other Cable Systems
Directly competitive cable television operations exist in each of our
current markets. Our competitors include AT&T, AT&T Charter Communications,
Comcast Cable Communications, Time Warner Cable, Mediacom and Charter
Communications. We expect that we will have competition with other cable
television providers in each of our future markets. In addition, Federal law
prohibits cities from granting exclusive cable franchises and from unreasonably
refusing to grant additional, competitive franchises. An increasing number of
cities are considering the feasibility of owning their own cable systems in a
manner similar to city-provided utility services. Finally, certain of our cable
television competitors may have exclusive arrangements with cable programming
vendors, which could prevent us from offering certain programming on our cable
television systems.
Other Television Providers
Alternative methods of distributing the same or similar video programming
offered by cable television systems exist. Congress and the FCC have encouraged
these alternative methods and technologies in order to offer services in direct
competition with existing cable systems. In addition to broadcast television
stations, we compete with other multichannel program service providers.
We encounter significant competition from communications direct broadcast
satellites, or DBS, that transmit signals to dish antennas owned by the
end-user. DirecTV and Echostar offer multichannel programming services through
high power communications satellites to a dish antenna with a diameter of only
approximately 18 inches. Although DBS providers presently serve a relatively
small percentage of pay television subscribers, their share has been growing
steadily. Competition from direct broadcast satellites could become substantial
as developments in technology increase satellite transmitter power and decrease
the cost and size of equipment.
Wireless cable, also called Multichannel multipoint distribution systems or
MMDS, represents another type of video distribution service. These systems
deliver programming services over microwave channels to subscribers who have a
special antenna. Multichannel multipoint distribution systems are less capital
intensive, are not required to obtain local franchises or pay franchise fees,
and are subject to fewer regulatory requirements than cable television systems.
Although there are relatively few systems in the United States right now, many
markets have been licensed or tentatively licensed. The FCC has granted the use
of certain frequencies to these services and expanded the channels reserved for
educational purposes. The FCC's actions enable a single entity to develop a
multichannel multipoint distribution system with up to 35 channels and thus
compete more effectively with cable television. Subscribership to these services
is projected to continue to increase over the next several years.
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We also compete with master antenna television systems and satellite master
antenna television systems. These systems provide multichannel program services
directly to hotel, motel, apartment, condominium and other multiunit complexes
within a cable television system's franchise area, generally free of any
regulation by state and local governmental authorities. Pursuant to the
Telecommunications Act of 1996, satellite master antenna television systems that
serve buildings that are not commonly owned or managed and do not cross public
rights-of-way do not need a franchise to operate.
The Telecommunications Act of 1996 eliminated many restrictions on local
exchange carriers offering video programming, and we may face increased
competition from local telephone companies. Several major local exchange
carriers, including BellSouth, have announced plans to provide video services to
homes.
Telephone
We expect to face intense competition in providing our telephone and
related telecommunications services. The Telecommunications Act of 1996 allows
service providers to enter markets that were previously closed to them.
Incumbent local exchange carriers are no longer protected from significant
competition in local service markets. In addition, under certain circumstances
Regional Bell Operating Companies may enter the long distance market. These
provisions blur the distinctions that previously existed between local and long
distance services.
One major impact of the Telecommunications Act of 1996 may be a trend
toward the use and acceptance of bundled service packages. As a result, we will
be competing with:
- incumbent local exchange carriers such as BellSouth;
- traditional providers of long distance services such as AT&T, MCI
WorldCom and Sprint;
- competitive local service providers; and
- other providers of cable television service such as those listed in the
table above.
Our ability to compete successfully will depend on the attributes of the overall
bundle of services we are able to offer, including our price, features, and
customer service.
Wireless telephone service such as cellular and PCS currently is viewed by
consumers as a supplement to, not a replacement for, wireline telephone service.
Wireless service generally is more expensive than wireline local service and is
priced on a usage-sensitive basis. In addition, the transmission quality of
wireless service is not comparable to wireline service. However, in the future
the rate and quality differential between wireless and wireline service may
decrease and lead to more competition between providers of these two types of
services. In that event, our telecommunications operations may also face
competition from wireless operators.
Internet Services
Internet service is provided to the public by Internet service providers,
long distance carriers, and other cable television companies. We provide
high-speed Internet service to our customers as well as offer high-speed
capacity to other Internet service providers for their customer bases.
A large number of companies provide businesses and individuals with direct
access to the Internet and a variety of supporting services. In addition, many
companies such as America Online, CompuServe, MSN, Prodigy and WebTV offer
online services consisting of access to closed, proprietary information networks
with services similar to those available on the Internet, in addition to direct
access to the Internet. These companies generally offer Internet services over
telephone lines using computer modems. A few Internet service providers also
offer high-speed Integrated Services Digital Network connections to the
Internet.
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A few satellite companies provide broadband access to the Internet from
desktop PCs using a small dish antenna and receiver kit comparable to that used
for satellite television reception. DirecPC is one of the largest providers of
satellite-based Internet services in the United States.
Long distance companies are aggressively entering the Internet access
markets. Long distance carriers have substantial transmission capabilities and
have an established billing system that permits them easily to add new services.
We expect competition from such companies to be vigorous due to their greater
resources, operating history and name recognition.
Other cable television companies may enter the Internet services market. We
believe that some of the existing cable television providers are beginning to
provide such services in some of their major markets or clusters, including
major metropolitan areas in the southeast. Excite@Home, a joint venture among
AT&T and several other large cable companies, is offering high-speed Internet
service using cable modems in areas where its affiliates have hybrid
fiber-coaxial networks. We believe that high-speed Internet services ultimately
will be offered by other cable providers and companies in most of our present
and future service areas.
LEGISLATION AND REGULATION
The cable television industry currently is regulated by the Federal
Communications Commission, some state governments and most local governments.
Telecommunications services are regulated by the FCC and state public utility
commissions. Internet services generally are not subject to regulation.
Legislative and regulatory proposals under consideration by Congress and federal
agencies may materially affect the cable television and telecommunications
industries. The following is a summary of federal laws and regulations affecting
the growth and operation of the cable television and telecommunications
industries and a description of certain state and local laws.
Cable Communications Policy Act Of 1984
The Cable Communications Policy Act of 1984 established comprehensive
national standards and guidelines for the regulation of cable television systems
and identified the boundaries of permissible federal, state and local government
regulation. The FCC has responsibility for adopting rules to implement this.
Among other things, the 1984 Cable Act affirmed the right of franchising
authorities to award one or more franchises within their jurisdictions. It also
prohibited non-grandfathered cable television systems from operating without a
franchise in such jurisdictions. The 1984 Cable Act provides that in granting or
renewing franchises, franchising authorities may establish requirements for
cable-related facilities and equipment, but may not establish or enforce
requirements for video programming or information services other than in broad
categories.
Cable Television Consumer Protection And Competition Act Of 1992
The Cable Television Consumer Protection and Competition Act of 1992
permitted a greater degree of regulation of the cable industry with respect to,
among other things:
- cable system rates for both basic and certain cable programming services;
- program access and exclusivity arrangements;
- access to cable channels by unaffiliated programming services;
- leased access terms and conditions;
- horizontal and vertical ownership of cable systems;
- customer service requirements;
- television broadcast signal carriage and retransmission consent;
- technical standards; and
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- cable equipment compatibility.
Additionally, the legislation encouraged competition with existing cable
television systems by:
- allowing municipalities to own and operate their own cable television
systems without a franchise;
- preventing franchising authorities from granting exclusive franchises or
unreasonably refusing to award additional franchises covering an existing
cable system's service area; and
- prohibiting the common ownership of cable systems and co-located
satellite master antenna television or multichannel multipoint
distribution systems.
The Cable Television Consumer Protection and Competition Act of 1992 also
precluded video programmers affiliated with cable television companies from
favoring cable operators over competitors and required such programmers to sell
their programming to other multichannel video distributors. The FCC has
responsibility for adopting rules to implement this Act.
Telecommunications Act Of 1996
On February 8, 1996, the Telecommunications Act of 1996 was enacted. The
Telecommunications Act of 1996 and the FCC rules implementing this Act radically
altered the regulatory structure of telecommunications markets by mandating that
states permit competition for local exchange services. The Telecommunications
Act of 1996 permitted Regional Bell Operating Companies to apply to the FCC for
authority to provide long distance services. The Telecommunications Act of 1996
also included significant changes in the regulation of cable operators. For
example, the FCC's authority to regulate the cable programming service tier
rates of all cable operators expired on March 31, 1999. The legislation also:
- repeals the anti-trafficking provisions of the Cable Television Consumer
Protection and Competition Act of 1992, which required cable systems to
be owned by the same person or company for at least three years before
they could be sold to a third party;
- limits the rights of franchising authorities to require certain
technology or to prohibit or condition the provision of
telecommunications services by the cable operator;
- requires cable operators to fully block or scramble both the audio and
video on sexually-explicit or indecent programming on channels primarily
dedicated to sexually-oriented programming;
- adjusts the favorable pole attachment rates afforded cable operators
under federal law such that they may be increased, beginning in 2001, if
the cable operator also provides telecommunications services over its
plant;
- allows cable operators to enter telecommunications markets which
historically have been closed to them; and
- allows some telecommunications providers to begin providing competitive
cable service in their local service areas.
Federal Regulation Of Cable Services
The FCC, the principal federal regulatory agency with jurisdiction over
cable television, has promulgated regulations covering many aspects of cable
television operations. The FCC may enforce its regulations through the
imposition of fines, the issuance of cease and desist orders and/or the
imposition of other administrative sanctions, such as the revocation of FCC
licenses. A brief summary of certain federal regulations follows.
Rate Regulation. The Cable Television Consumer Protection and Competition
Act of 1992 authorized rate regulation for certain cable communications services
and equipment in communities where the cable operator is not subject to
effective competition. The Cable Television Consumer Protection and Competition
Act of 1992 requires the FCC to resolve complaints about rates for cable
programming service tier services and to reduce any such rates found to be
unreasonable. It also limits the ability of
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many cable systems to raise rates for basic services. Cable services offered on
a per channel or on a per program basis are not subject to rate regulation by
either franchising authorities or the FCC. Notwithstanding the above, the
Telecommunications Act of 1996 deregulated cable programming service rates as of
March 31, 1999.
The Cable Television Consumer Protection and Competition Act of 1992
requires communities to certify with the FCC before regulating basic cable
rates. The FCC's rate regulations do not apply where a cable operator
demonstrates that it is subject to effective competition. We meet the FCC
definition of effective competition in the areas that we currently serve. To the
extent that any municipality attempts to regulate our basic rates or equipment,
we believe we could demonstrate to the FCC that our systems all face effective
competition and, therefore, are not subject to rate regulation.
Carriage Of Broadcast Television Signals. The Cable Television Consumer
Protection and Competition Act of 1992 established signal carriage requirements.
These requirements allow commercial television broadcast stations that are local
to a cable system to elect every three years whether to require the cable system
to carry the station or whether to require the cable system to negotiate for
consent to carry the station. The third must-carry elections were made in
October 1999. Stations are generally considered local to a cable system where
the system is located in the station's Nielsen designated market area. Cable
systems must obtain retransmission consent for the carriage of all distant
commercial broadcast stations, except for certain superstations, which are
commercial satellite-delivered independent stations such as WGN. We carry some
stations pursuant to retransmission consents and pay fees for such consents or
have agreed to carry additional services pursuant to retransmission consent
agreements.
Local non-commercial television stations are also given mandatory carriage
rights, subject to certain exceptions, within the larger of (i) a 50-mile radius
of the station's city of license; or (ii) the station's Grade B contour (a
measure of signal strength). Non-commercial stations are not given the option to
negotiate for retransmission consent.
Nonduplication Of Network Programming. Cable television systems that have
1,000 or more subscribers must, upon the appropriate request of a local
television station, delete or "black out" the simultaneous or nonsimultaneous
network programming of a distant same-network station when the local station has
contracted for such programming on an exclusive basis.
Deletion Of Syndicated Programming. Cable television systems that have
1,000 or more subscribers must, upon the appropriate request of a local
television station, delete or "black out" the simultaneous or nonsimultaneous
syndicated programming of a distant station when the local station has
contracted for such programming on an exclusive basis.
Registration Procedures And Reporting Requirements. Prior to commencing
operation in a particular community, all cable television systems must file a
registration statement with the FCC listing the broadcast signals they will
carry and certain other information. Additionally, cable operators periodically
are required to file various informational reports with the FCC. Cable operators
that operate in certain frequency bands, including our company, are required on
an annual basis to file the results of their periodic cumulative leakage testing
measurements. Operators that fail to make this filing or who exceed the FCC's
allowable cumulative leakage index risk being prohibited from operating in those
frequency bands in addition to other sanctions.
Technical Requirements. Historically, the FCC has imposed technical
standards applicable to the cable channels on which broadcast stations are
carried, and has prohibited franchising authorities from adopting standards
which were in conflict with or more restrictive than those established by the
FCC. The FCC has applied its standards to all classes of channels which carry
downstream National Television System Committee video programming. The FCC also
has adopted standards applicable to cable television systems using frequencies
in the 108-137 MHz and 225-400 MHz bands in order to prevent harmful
interference with aeronautical navigation and safety radio services and has also
established limits on cable system signal leakage. The Cable Television Consumer
Protection and Competition Act of 1992 requires the FCC to update periodically
its technical standards. Pursuant to the Telecommunications Act of 1996,
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the FCC adopted regulations to assure compatibility among televisions, VCRs and
cable systems, leaving all features, functions, protocols and other product and
service options for selection through open competition in the market. The
Telecommunications Act of 1996 also prohibits states or franchising authorities
from prohibiting, conditioning or restricting a cable system's use of any type
of subscriber equipment or transmission technology.
Franchise Authority. The 1984 Cable Act affirmed the right of franchising
authorities, which are the cities, counties or political subdivisions in which a
cable operator provides cable service, to award franchises within their
jurisdictions and prohibited non-grandfathered cable systems from operating
without a franchise in such jurisdictions. We hold cable franchises in all of
the franchise areas in which we provide service. The Cable Television Consumer
Protection and Competition Act of 1992 encouraged competition with existing
cable systems by:
- allowing municipalities to operate their own cable systems without
franchises;
- preventing franchising authorities from granting exclusive franchises or
from unreasonably refusing to award additional franchises covering an
existing cable system's service area; and
- prohibiting, with limited exceptions, the common ownership of cable
systems and co-located multichannel multipoint distribution or satellite
master antenna television systems, which prohibition is limited by the
Telecommunications Act of 1996 to cases in which the cable operator is
not subject to effective competition.
The Telecommunications Act of 1996 exempts from cable franchise
requirements those telecommunications services provided by a cable operator or
its affiliate although municipalities retain authority to regulate the manner in
which a cable operator uses the public rights-of-way to provide
telecommunications services. Franchise authorities may not require a cable
operator to provide telecommunications service or facilities, other than
institutional networks, as a condition of franchise grant, renewal, or transfer.
Similarly, franchise authorities may not impose any conditions on the provision
of such service.
Franchise Fees. Although franchising authorities may impose franchise fees
under the 1984 Cable Act, as modified by the Telecommunications Act of 1996,
such payments cannot exceed 5% of a cable system's annual gross revenues derived
from the operation of the cable system to provide cable services. In some areas,
cable services are defined to include Internet services. Franchise fees apply
only to revenues for cable services. Franchising authorities are permitted to
charge a fee for any telecommunications providers' use of public rights-of-way
on a competitively neutral and nondiscriminatory basis.
Franchise Renewal. The 1984 Cable Act established renewal procedures and
criteria designed to protect incumbent franchisees against arbitrary denials of
renewal. These formal procedures are mandatory only if timely invoked by either
the cable operator or the franchising authority. Even after the formal renewal
procedures are invoked, franchising authorities and cable operators remain free
to negotiate a renewal outside the formal process. Although the procedures
provide substantial protection to incumbent franchisees, renewal is by no means
assured, as the franchisee must meet certain statutory standards. Even if a
franchise is renewed, a franchising authority may impose new and more onerous
requirements such as upgrading facilities and equipment, although the
municipality must take into account the cost of meeting such requirements.
The Cable Television Consumer Protection and Competition Act of 1992 made
several changes to the process which may make it easier in some cases for a
franchising authority to deny renewal. The cable operator's timely request to
commence renewal proceedings must be in writing and the franchising authority
must commence renewal proceedings not later than six months after receipt of
such notice. Within a four-month period beginning with the submission of the
renewal proposal, the franchising authority must grant or deny the renewal.
Franchising authorities may consider the "level" of programming service provided
by a cable operator in deciding whether to renew. Franchising authorities
currently may deny renewal based on failure to substantially comply with the
material terms of the franchise, even if the franchising authority has
"effectively acquiesced" to such past violations. The franchising authority is
estopped only if, after giving the cable operator notice and opportunity to
cure, the authority fails to
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respond to a written notice from the cable operator of its failure or inability
to cure. Courts may not reverse a denial of renewal based on procedural
violations found to be harmless error.
Channel Set-Asides. The 1984 Cable Act permits local franchising
authorities to require cable operators to set aside certain channels for public,
educational and governmental access programming. The 1984 Cable Act further
requires cable television systems with 36 or more activated channels to
designate a portion of their channel capacity for commercial leased access by
unaffiliated third parties. The Cable Television Consumer Protection and
Competition Act of 1992 requires leased access rates to be set according to a
FCC-prescribed formula.
Ownership. The Telecommunications Act of 1996 eliminates the 1984 Cable
Act provisions prohibiting local exchange carriers from providing video
programming directly to customers within their local exchange telephone service
areas, except in rural areas or by specific waiver. Under the Telecommunications
Act of 1996, local exchange carriers may provide video programming by
radio-based systems, common carrier systems, open video systems, or cable
systems. Local exchange carriers that elect to provide open video systems must
allow others to use up to two-thirds of their activated channel capacity. These
local exchange carriers are relieved of regulation as common carriers, and are
not required to obtain local franchises, but are still subject to many other
regulations applicable to cable systems. Local exchange carriers operating as
cable systems are subject to all rules governing cable systems, including
franchising requirements.
The Telecommunications Act of 1996 prohibits a local exchange carrier or
its affiliate from acquiring more than a 10% financial or management interest in
any cable operator providing cable service in its telephone service area. It
also prohibits a cable operator or its affiliate from acquiring more than a 10%
financial or management interest in any local exchange carrier providing
telephone exchange service in its franchise area. A local exchange carrier and
cable operator whose telephone service area and cable franchise area are in the
same market may not enter into a joint venture to provide telecommunications
services or video programming. There are exceptions to these limitations for
rural facilities, very small cable systems, and small local exchange carriers in
non-urban areas, and such restrictions do not apply to local exchange carriers
that were not providing local exchange service prior to January 1, 1993.
Pole Attachments. The Telecommunications Act of 1996 requires utilities,
defined as all local exchange carriers and electric utilities except those owned
by municipalities and co-ops, to provide cable operators and telecommunications
carriers with nondiscriminatory access to poles, ducts, conduit and right-
of-way. The right to mandatory access is beneficial to facilities-based
providers such as our company. The Telecommunications Act of 1996 also
establishes principles to govern the pricing of such access. Presently, the
rates charged to cable and telecommunications providers are the same. Starting
in 2001, telecommunications providers will be charged a higher rate than cable
operators for pole attachments. Companies that provide both cable and
telecommunications services over the same facilities, such as us, may be
required to pay the higher telecommunications rate.
Inside Wiring Of Multifamily Dwelling Units. The FCC has adopted rules to
promote competition among multichannel video program distributors, or MVPDs, in
multifamily dwelling units. The rules provide generally that, in cases where the
MVPD owns the wiring inside a multifamily dwelling unit, but has no right of
access to the premises, the multifamily dwelling unit owner may give the cable
operator notice that it intends to permit another MVPD to provide service there.
An MVPD then must elect whether to remove the inside wiring, sell the inside
wiring to the multifamily dwelling unit owner at a price not to exceed the
replacement cost of the wire, on a per-foot basis, or abandon the inside wiring.
Privacy. The 1984 Cable Act imposes a number of restrictions on the manner
in which cable system operators can collect and disclose data about individual
system customers. The statute also requires that the system operator
periodically provide all customers with written information about its policies
regarding the collection and handling of data about customers, their privacy
rights under federal law and their enforcement rights. In the event that a cable
operator is found to have violated the customer privacy provisions of the 1984
Cable Act, it could be required to pay damages, attorneys' fees and other costs.
Under the Cable Television Consumer Protection and Competition Act of 1992, the
privacy requirements
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are strengthened to require that cable operators take such actions as are
necessary to prevent unauthorized access to personally identifiable information.
Franchise Transfer. The Telecommunications Act of 1996 repeals most of the
anti-trafficking restrictions imposed by the Cable Television Consumer
Protection and Competition Act of 1992, which prevented a cable operator from
selling or transferring ownership of a cable system within 36 months of
acquisition. However, a local franchise may still require prior approval of a
transfer or sale. The Cable Television Consumer Protection and Competition Act
of 1992 requires franchising authorities to act on a franchise transfer request
within 120 days after receipt of all information required by FCC regulations and
the franchising authority. Approval is deemed granted if the franchising
authority fails to act within such period.
Copyright. Cable television systems are subject to federal compulsory
copyright licensing covering carriage of broadcast signals. In exchange for
making semi-annual payments to a federal copyright royalty pool and meeting
certain other obligations, cable operators obtain a statutory license to
retransmit broadcast signals. The amount of the royalty payment varies,
depending on the amount of system revenues from certain sources, the number of
distant signals carried, and the location of the cable system with respect to
over-the-air television stations. Adjustments in copyright royalty rates are
made through an arbitration process supervised by the U.S. Copyright Office.
Various bills have been introduced in Congress in the past several years
that would eliminate or modify the cable television compulsory license. Without
the compulsory license, cable operators might need to negotiate rights from the
copyright owners for each program carried on each broadcast station
retransmitted by the cable system.
Copyrighted music performed in programming supplied to cable television
systems by pay cable networks, such as HBO, and cable programming networks, such
as USA Network, has generally been licensed by the networks through private
agreements with the American Society of Composers and Publishers and BMI, Inc.,
the two major performing rights organizations in the United States. The American
Society of Composers and Publishers and BMI, Inc. offer "through to the viewer"
licenses to the cable networks which cover the retransmission of the cable
networks' programming by cable television systems to their subscribers.
Internet Service Providers. In 1998, a number of Internet service
providers requested that the FCC adopt rules requiring cable operators that
provide Internet access service keep unaffiliated Internet service providers
with direct unbundled access to operators' underlying broadband cable
facilities. The FCC to date has rejected these requests, but it may in the
future require cable operators to provide such direct access to competing
Internet service providers. A number of local franchising authorities also are
considering this type of direct access requirement.
Regulatory Fees And Other Matters. The FCC requires payment of annual
regulatory fees by the various industries it regulates, including the cable
television industry. In 1997, cable television systems were required to pay
regulatory fees of $0.54 per subscriber. In 1998, the fee was $0.44 per
subscriber. In 1999, the fee was $0.48 per subscriber. Per-subscriber regulatory
fees may be passed on to subscribers as external cost adjustments to rates for
basic cable service. Fees are also assessed for other FCC licenses, including
licenses for business radio, cable television relay systems and earth stations.
These fees, however, may not be collected directly from subscribers as long as
the FCC's rate regulations remain applicable to the cable system.
In December 1994, the FCC adopted new cable television and broadcast
technical standards to support a new Emergency Alert System. Cable system
operators were required to install and activate equipment necessary to implement
the new Emergency Broadcast System by December 31, 1998 or October 1, 2002,
depending on the size of the system.
FCC regulations also address the carriage of local sports programming;
restrictions on origination and cablecasting by cable system operators;
application of the rules governing political broadcasts; customer service
standards; and limitations on advertising contained in nonbroadcast children's
programming.
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Regulation Of Telecommunications Services
Our telecommunications services are subject to varying degrees of federal,
state and local regulation. Pursuant to the Communications Act of 1934, as
amended by the Telecommunications Act of 1996, the FCC generally exercises
jurisdiction over the facilities of, and the services offered by,
telecommunications carriers that provide interstate or international
communications services. State regulatory authorities retain jurisdiction over
the same facilities to the extent that they are used to provide intrastate
communications services. Various international authorities may also seek to
regulate the provision of certain services.
Federal Regulation of Telecommunications Services
Tariffs And Detariffing. We are classified by the Federal Communications
Commission as a non-dominant carrier with respect to both our domestic
interstate and international long distance carrier services and our competitive
local exchange carrier services. As a non-dominant carrier, our rates presently
are not regulated by the FCC. All telecommunications carriers that provide
domestic interstate and international long distance services must file tariffs
with the FCC prescribing rates, terms and conditions of service. Carriers must
also file so-called informational tariffs with the FCC describing their operator
services. We have filed tariffs with the FCC for our domestic interstate and
international long distance services, interstate access services and interstate
operator services.
Valley Telephone and Interstate Telephone are regulated by the FCC as
dominant, rather than non-dominant carriers. As dominant carriers, Valley
Telephone and Interstate Telephone must file tariffs with the FCC and must
provide the FCC with notice prior to changing their rates, terms or conditions
of interstate services. Valley Telephone concurs in tariffs filed by the
National Exchange Carrier Association, while Interstate Telephone has its own
tariffs on file with the FCC.
Interconnection. The Telecommunications Act of 1996 establishes local
exchange competition as a national policy. This Act preempts laws that prohibit
competition for local exchange services and establishes uniform requirements and
standards for local network interconnection, local network unbundling and local
service resale. The Telecommunications Act of 1996 also requires incumbent local
exchange carriers to enter into mutual compensation arrangements with new local
telephone companies for transport and termination of local calls on each others'
networks. Most state Public Utility Commissions have ruled that traffic to
Internet service providers is covered by this requirement. The FCC recently
decided that calls to Internet service providers could be jurisdictionally
interstate, although the FCC did not preempt these state decisions. The
Telecommunications Act of 1996's interconnection, unbundling and resale
standards have been developed initially by the FCC and have been, and will
continue to be, implemented by the states in numerous proceedings and through a
process of negotiation and arbitration.
In August 1996, the FCC adopted a wide-ranging decision regarding the
statutory interconnection obligations of the local exchange carriers. Among
other things, the order established pricing principles, for use by the states to
determine rates for unbundled local network elements and to calculate discounts.
In July 1997, the United States Court of Appeals for the Eighth Circuit struck
down the pricing rules established by the FCC. The court ruled that the FCC did
not have jurisdiction under the Telecommunications Act of 1996 to establish
pricing rules to be applied by the states. In January 1999, the Supreme Court
reversed the Eighth Circuit decision, finding that the FCC had jurisdiction to
implement the pricing provisions of the Act. The Eighth Circuit is expected, on
remand, to rule on the merits of the FCC's pricing rules.
The Supreme Court also upheld the FCC's rule requiring local exchange
carriers to provide a platform that includes all of the network elements
required by a competitor to provide a retail telecommunications service.
Competitors using such platforms may be able to provide retail local services
entirely through the use of the local exchange carriers' facilities at lower
discounts than those available for local resale. The availability of such
platforms could benefit our local competitors who, unlike us, do not operate
their own facilities. The pricing of these platforms is still subject to a
pending FCC proceeding.
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<PAGE> 50
The 1996 Act includes an exemption from interconnection requirements for
rural telephone companies. Under this exemption, a competitor is not entitled to
interconnect with a rural telephone company absent a finding by the appropriate
state commission that the request is not unduly economically burdensome. Both
Valley Telephone and Interstate Telephone are considered rural telephone
companies under the Telecommunications Act of 1996, and the Alabama Public
Service Commission has determined that these companies should be exempt from the
interconnection requirements of the Telecommunications Act of 1996 at least
through June 2001.
Number Portability. Another new federal statute requires that all local
exchange service carriers provide customers with the ability to retain, at the
same location, existing telephone numbers without impairment of quality,
reliability or convenience. This number portability will remove one barrier to
entry faced by new competitors, which would otherwise have to persuade customers
to switch local service providers despite having to change telephone numbers.
The FCC ordered permanent number portability to be made available in the 100
largest metropolitan areas by December 31, 1998. Number portability will be
available in all of our markets by the end of 1999. While number portability
benefits our competitive local exchange carrier operations, it represents a
burden to Valley Telephone and Interstate Telephone. At this time, we are unable
to predict the impact, if any, of possible number portability delays or
complications in our service territories.
Universal Service and Access Charge Reform. The FCC has adopted rules
implementing the universal service requirements of the Telecommunications Act of
1996. Pursuant to those rules, all telecommunications providers must contribute
a small percentage of their telecommunications revenues to a newly established
Universal Service Fund. There is an exemption for providers whose contribution
would be less than $10,000 in a particular year. Interstate Telephone and Valley
Telephone presently contribute to the fund, and we expect that KNOLOGY Holdings
will be required to start contributing in 2000.
We can not be certain whether we will be able to either recover the costs
of fund contributions from our customers or to receive offsetting fund
disbursements. Moreover, in those areas where we use our own or our affiliated
cable plant for our comprehensive local exchange carriers operations, we are
largely unaffected by local exchange carriers' access charge fluctuations.
However, overall decreases in local exchange carriers; access charges as
contemplated by the FCC's access reform policies would likely put downward
pricing pressure on our charges to domestic interstate and international long
distance carriers for comparable access. Over time, statutory universal service
funding obligations, coupled with the FCC's new access charge regime, could
adversely affect us by limiting our ability to offset our fund contributions
through higher charges to domestic interstate and international long distance
carriers for originating and terminating interstate traffic over our cable
facilities.
Regional Bell Operating Company Entry into Long Distance. The
Telecommunications Act of 1996 also establishes standards for regional bell
operating companies and their affiliates to provide long distance
telecommunications services between a local access and transport area and points
outside that area. In 1997, BellSouth filed applications with the FCC for
authority to offer in-region, interLATA services in South Carolina and
Louisiana; in 1998, BellSouth filed a second application at the FCC for
authority to offer such services in Louisiana. In December 1997, the FCC
rejected the South Carolina application. The Louisiana applications were
rejected in February 1998, and October 1998, respectively. Notwithstanding these
decisions, BellSouth likely will file additional applications to offer interLATA
services for other states in its territory, including states in which we provide
these services. Because of its existing base of local exchange service customers
and its extensive telecommunications network, we anticipate that BellSouth will
be a significant competitor in the interLATA market in each of the states in
which it obtains in-region, interLATA authority from the FCC.
Additional Requirements. The FCC imposes additional obligations on all
telecommunications carriers, including obligations to:
- interconnect with other carriers and not to install equipment that cannot
be connected with the facilities of other carriers;
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<PAGE> 51
- ensure that their services are accessible and usable by persons with
disabilities;
- provide telecommunications relay service either directly or through
arrangements with other carriers or service providers, which service
enables hearing impaired individuals to communicate by telephone with
hearing individuals through an operator at a relay center;
- comply with verification procedures in connection with changing a
customer's carrier;
- protect the confidentiality of proprietary information obtained from
other carriers, manufacturers and customers;
- pay annual regulatory fees to the FCC; and
- contribute to the Telecommunications Relay Services Fund.
Forbearance. The Telecommunications Act of 1996 permits the FCC to forbear
from requiring telecommunications carriers to comply with certain regulations.
Specifically, the Act permits the FCC to forbear from applying statutory
provisions or regulations if the FCC determines that:
- enforcement is not necessary to protect consumers;
- a carrier's terms are reasonable and nondiscriminatory;
- forbearance is in the public interest; and
- forbearance will promote competition.
The FCC has exempted certain carriers from tariffing and reporting requirements
pursuant to this provision of the Telecommunications Act of 1996. The FCC may
take similar action in the future to reduce or eliminate other requirements.
Such actions could free us from regulatory burdens, but also might increase the
pricing flexibility of our competitors.
Advanced Services and Collocation. Section 706 of the Telecommunications
Act of 1996 requires the FCC to encourage the deployment of advanced
telecommunications capabilities to all Americans through the promotion of local
telecommunications competition. Recently, the FCC adopted rules designed to
improve competitor access to incumbent local exchange carriers collocation space
and to reduce the delays and costs associated with collocation. The FCC may take
future steps to facilitate competitors' access to local loops for purposes of
digital subscriber line deployment. Having better collocation arrangements at
incumbent local exchange carriers central offices benefits our competitive local
exchange operations. However, the FCC's advanced services proceeding, inasmuch
as it primarily benefits digital subscriber line providers who compete directly
with our broadband communications service offerings may prove on balance to have
an adverse competitive effect on us.
State Regulation of Telecommunications Services
The Telecommunications Act of 1996 contains provisions that prohibit states
and localities from adopting or imposing any legal requirement that may
prohibit, or have the effect of prohibiting, market entry by new providers of
interstate or intrastate telecommunications services. The FCC is required to
preempt any such state or local requirement to the extent necessary to enforce
the Telecommunications Act of 1996's open market entry requirements. State and
localities may, however, continue to regulate the provision of intrastate
telecommunications services and require carriers to obtain certificates or
licenses before providing service.
Alabama, Georgia, Florida, and South Carolina each have adopted statutory
and regulatory schemes that require us to comply with telecommunications
certification and other regulatory requirements. To date, we are authorized to
provide intrastate local exchange, interexchange and operator services in
Alabama, Georgia, Florida and South Carolina. In addition, we have executed
local network interconnection agreements with BellSouth for the transport and
termination of local exchange traffic. These agreements have been filed with,
and approved by, the applicable regulatory authority in each state
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<PAGE> 52
in which we conduct our operations. As a condition of providing intrastate
telecommunications services, we are required, among other things:
- to file and maintain intrastate tariffs or price lists describing the
rates, terms and conditions of our services;
- to comply with state regulatory reporting, tax and fee obligations; and
- to comply with, and to submit to, state regulatory jurisdiction over
consumer protection policies, complaints, transfers of control and
certain financing transactions.
Generally, state regulatory authorities can condition, modify, cancel, terminate
or revoke certificates of authority to operate in a state for failure to comply
with state laws or the rules, regulations and policies of the state regulatory
authority. Fines and other penalties may also be imposed for such violations.
Valley Telephone and Interstate Telephone are subject to additional
requirements under state law, including rate regulation and quality of service
requirements. In Alabama, both Valley Telephone and Interstate Telephone are
subject to a price cap form of rate regulation. Under price caps, the companies
have limited ability to raise rates for intrastate telephone services, but the
Alabama Public Service Commission does not regulate the rate of return earned by
the companies.
By order dated April 8, 1998, all local exchange carriers were required to
file intraLATA toll dialing parity plans. Initially the plans were to become
effective on or before February of 1999. By order dated June 25, 1998, the
Alabama Public Service Commission suspended certain requirements of Section
251(b) and (c) of the Telecommunications Act of 1996, including dialing parity,
for rural incumbent local exchange carriers operating in Alabama, including
Interstate Telephone and Valley Telephone. The suspension extends through June
of 2001. Rural local exchange carriers subject to the suspension were required
to update the Alabama Public Service Commission regarding their dialing parity
plans by October 1, 1999. Interstate Telephone and Valley Telephone have
notified the Alabama Public Service Commission that they intend to implement
dialing parity on or before the June 1, 2001 deadline, however, the actual
implementation date has not yet been determined.
On May 26, 1999, the Alabama Public Service Commission approved the dialing
parity plan of KNOLOGY of Alabama, Inc. Under the plan, KNOLOGY of Alabama will
provide primary interexchange carrier capability for interLATA and intraLATA
presubscription available in all local access and transport areas within Alabama
in which it provides local exchange service using its own facilities. Any
carrier authorized by the Alabama Public Service Commission to carry intraLATA
toll calls may request that KNOLOGY of Alabama implement primary interexchange
carrier capability provided that the carrier:
- has established, or has submitted firm, non-cancelable orders to
establish, direct interconnection of its network with KNOLOGY of Alabama;
- has ordered access services from KNOLOGY of Alabama that will permit the
carrier to receive primary interexchange carrier calls from KNOLOGY of
Alabama; and
- has identified the local access and transport areas in which it desires
to receive intraLATA toll calls.
A reasonable time for implementation will be necessary to allow KNOLOGY of
Alabama to make the necessary network, system and billing modifications to
implement the request. As of October 1, 1999, no carrier had requested primary
interexchange carrier capability from KNOLOGY of Alabama in Alabama under its
dialing parity plan.
Local Regulation
Occasionally we are required to obtain street use and construction permits
and franchises to install and expand our interactive broadband network using
state, city, county or municipal rights-of-way. Some municipalities where we
have installed or anticipate constructing networks require the payment of
license
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<PAGE> 53
or franchise fees which are based upon a percentage of gross revenues or on a
per linear foot basis. The Telecommunications Act of 1996 requires
municipalities to manage public rights-of-way in a competitively neutral and
non-discriminatory manner.
EMPLOYEES
At September 30, 1999, we had 690 full-time employees. We consider our
relations with our employees to be good, and we structure our compensation and
benefit plans in order to attract and retain high caliber personnel. We will
need to recruit additional employees in order to implement our expansion plan,
including general managers for each new city and additional personnel for
installation, sales, customer service and network construction. We recruit from
several major industries for employees with skills in voice, video and data
technologies. We do not believe we will have problems retaining personnel with
the necessary qualifications.
PROPERTIES
We own or lease property in the following locations:
<TABLE>
<CAPTION>
LOCATION ADDRESS LEASE/OWN PRIMARY USE
- -------- ------- --------- -----------
<S> <C> <C> <C>
West Point, GA......... 1241 O.G. Skinner Drive Own Corporate Admin. Offices
West Point, GA......... 206 West 9th Street Lease Network Operations Center
Montgomery, AL......... 1450 Ann Street Lease Headend & Technical Offices
Columbus, GA........... 1701 Boxwood Place Lease Admin. Offices & Headend
Panama City, FL........ 13200 P.C.B. Pkwy. Lease Admin. Offices & Headend
Augusta, GA............ 3714 Wheeler Road Own Admin. Offices & Headend
Charleston, SC......... 4506 Dorchester Road Own Admin. Offices and Headend
Huntsville, AL......... 2401 10th Street Own Admin. Offices and Headend
</TABLE>
In addition to these properties, we also hold operating leases for hub
sites in each market. Our principal physical assets consist of fiber optic and
coaxial broadband network and equipment, located either at the equipment site or
along the network. Our distribution equipment along the network is generally
attached to utility poles we own or use under pole rental agreements with local
public utilities, although in some areas the distribution cable is buried in
underground ducts or trenches. Our franchises give us rights of way for our
network. The physical components of the networks require maintenance and
periodic upgrading to keep pace with technological advances. We believe that our
properties, taken as a whole, are in good operating condition and are suitable
for our business operations.
LEGAL PROCEEDINGS
In the normal course of business, we are subject to litigation. However, in
our opinion, there is no legal proceeding pending against us which would have a
material adverse effect on our financial position, results of operations, or
liquidity. We are also party to regulatory proceedings affecting the relevant
segments of the communications industry generally.
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<PAGE> 54
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The following individuals are the current directors and executive officers
of KNOLOGY, Inc. These individuals include most of the members of management of
KNOLOGY Holdings at KNOLOGY, Inc. who became our management when we became the
holding company for KNOLOGY Holdings and other companies. Five additional
directors will be appointed in November 1999.
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
Rodger L. Johnson.................................. 51 President, Chief Executive Officer and
Director
Felix L. Boccucci, Jr. ............................ 42 Chief Financial Officer and Vice President
of Business Development
Anthony J. Palermo, Jr. ........................... 45 Vice President of Operations
Chad S. Wachter.................................... 33 Vice President, General Counsel and
Secretary
Marcus R. Luke, Ph.D. ............................. 44 Chief Technology Officer
James T. Markle.................................... 40 Vice President of Network Operations
Bret T. McCants.................................... 40 Vice President of Network Construction and
Maintenance
Peggy B. Warner.................................... 48 Vice President of Marketing and Carrier
Sales
Campbell B. Lanier, III(1)......................... 49 Chairman of the Board of Directors
Richard Bodman..................................... 61 Nominee for Director
Alan A. Burgess(1)................................. 64 Nominee for Director
Donald W. Burton(2)................................ 55 Nominee for Director
L. Charles Hilton, Jr.(1).......................... 68 Nominee for Director
William H. Scott, III(2)........................... 52 Director
Donald W. Weber(2)................................. 63 Nominee for Director
</TABLE>
- ---------------
(1) Member of the Audit Committee.
(2) Member of the Compensation and Stock Option Committee.
Rodger L. Johnson was named as our President and Chief Executive Officer
and as a director in October 1999. He has served as the President of KNOLOGY
Holdings since May 1999 and as its Chief Executive Officer and a director since
June 1999. Prior to joining KNOLOGY Holdings, Mr. Johnson had served as
President and Chief Executive Officer, as well as a Director, of Communications
Central Inc., a provider of coin-operated and inmate telephones, since November
1995. Prior to joining Communications Central, Mr. Johnson served as the
President and Chief Executive Officer of JKC Holdings, Inc., a consulting
company providing advice to the information processing industry. In that
capacity, Mr. Johnson also served as the Chief Operating Officer of Infomed
Systems, Inc., a publicly-held medical software manufacturer. Mr. Johnson will
retain his positions and continue to serve both JKC Holdings, Inc. and Infomed
Systems, Inc. in a more limited management capacity for the immediately
foreseeable future. Before founding JKC Holdings, Inc., Mr. Johnson served for
approximately eight years as the President and Chief Operating Officer and as
the President and Chief Executive Officer of Brock Control Systems, Inc., a
publicly-held sales and marketing software provider.
Felix L. Boccucci, Jr. has served as our Chief Financial Officer and Vice
President of Business Development since October 1999. He has served as Vice
President of Business Development of KNOLOGY Holdings since August 1997. He
served as our Chief Financial Officer, Treasurer and Secretary from November
1995 through August 1997. In addition, he currently serves as our Interim Chief
Financial Officer and Chief Financial Officer for Interstate and Valley
Telephone Companies. From October 1994 until December 1995, Mr. Boccucci served
as Vice President Finance Broadband of ITC Holding. Prior to such time, Mr.
Boccucci worked for GTE Corporation, a telecommunications company, which merged
with Contel Corporation in March 1991. From May 1993 to October 1994, he served
as a Senior Financial Analyst for GTE. From 1991 to 1993, Mr. Boccucci served as
Financial Director for
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<PAGE> 55
GTE's Central Area Telephone Operations. From 1987 to 1991, he was the Assistant
Vice President controller in charge of Contel's Eastern Region Telephone
Operations comprising 13 companies in twelve states.
Anthony J. Palermo, Jr. has served as our Vice President of Operations
since July 1999. Prior to joining KNOLOGY, Mr. Palermo served as a consultant to
Nokia and Optima Technologies from November 1998 through July 1999. From
November 1995 to November 1998, Mr. Palermo was employed at Communications
Central, Inc., where he served as Vice President of Sales, Marketing, and
Operations. Prior to Communications Central, Inc. he spent six years at Brock
Control Systems as Vice President of Operations and Chief Operating Officer. Mr.
Palermo has also spent eleven years in the communications industry with AT&T
Long Lines and RCA-Cylix.
Chad S. Wachter has served as our Vice President, General Counsel and
Secretary since October 1999. He joined KNOLOGY Holdings as its General Counsel
and Secretary in August 1998. From April 1997 to August 1998, Mr. Wachter served
as Assistant General Counsel of Powertel, Inc., an affiliate of ITC that
operates cellular and PCS businesses. From May 1990 until April 1997, Mr.
Wachter was an associate and then a partner with Capell, Howard, Knabe & Cobbs,
P.A. in Montgomery, Alabama.
Marcus R. Luke, Ph.D. has served as our Chief Technology Officer since
October 1999. He has served as the Chief Technology Officer of KNOLOGY Holdings
since August 1997. Prior to this he served as the Vice President of Network
Construction of KNOLOGY Holdings from November 1995 until August 1997, and
Director of Engineering of Cybernet Holding, L.L.C., from May 1995 until
November 1995. Prior to joining KNOLOGY Holdings, Dr. Luke served as Southeast
Division Construction Manager for TCI from July 1993 to May 1995. From July 1987
to June 1993, he served as Area Technical Manager for TCI's southeast area,
which included Montgomery. Dr. Luke worked for Storer Communications Inc. from
1985 to 1987 as Vice President of Engineering. Prior to 1985, he spent 12 years
in various engineering and management positions with Storer Communications Inc.
James T. Markle joined us in October 1999 as our Vice President of Network
Operations. He has served as Vice President of Network Operations for KNOLOGY
Holdings since March 1999. Prior to joining KNOLOGY Holdings, Mr. Markle was
employed by MindSpring Enterprises, Inc. where he served as the Executive Vice
President of Network Operations from March 1998 and as Vice President of Network
Operations from April 1995. Prior to joining MindSpring, from April 1994 until
April 1995, Mr. Markle served as the Director of Technical Support for Concert
Communications Co., a telecommunications company. From August 1990 to April
1994, Mr. Markle served as Senior Manager of Network Operations for MCI
Communications, a telecommunications company. Mr. Markle served in various
operation positions at SouthernNet/Telecom*USA, including Director of Operations
for a multistate region, from July 1985 until July 1990.
Bret T. McCants has served as our Vice President of Network Services since
October 1999. He has served as the Vice President of Network Services of KNOLOGY
Holdings since April 1997. Prior to joining KNOLOGY Holdings, Mr. McCants was a
co-founder of CSW Communications. From January 1996 to April 1997 he served as
CSW Communications, Director of Operations, and from 1994 to 1996, he
participated in the development and managed the deployment of voice, data and
interactive energy management equipment to homes in Laredo, Texas. Prior to
joining CSW Communications, Mr. McCants served in various capacities with
Central Power and Light Company including as Corporate Manager of Commercial and
Small Industrial Marketing from 1992 to 1994, and as Business Manager from 1990
to 1992. From 1982 to 1990, Mr. McCants held several positions in the Sales,
Marketing and Engineering departments at Central Power and Light Company.
Peggy B. Warner joined us as our Vice President of Marketing and Carrier
Sales in October 1999. She has been the Vice President of Marketing and Carrier
Sales of KNOLOGY Holdings since January 1998. Prior to joining KNOLOGY Holdings,
from February 1995 to December 1997, Ms. Warner held various positions at SCANA
Communications, Inc., including Manager Sales, Marketing and Customer Service
and General Manager. While at SCANA Communications, Inc., Ms. Warner was
responsible for the company's fiber optic carriers' carrier and 800 MHz trunked
radio lines of business. Prior to that time,
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<PAGE> 56
from December 1993 to January 1994, she was an Executive National Accounts
Manager with MCI Telecommunications Corporation where she developed and managed
a nationwide Government Systems regional sales organization. Ms. Warner also
held various other sales and marketing management positions with MCI between May
1986 and January 1995. She was an Account Manager with AT&T Information Systems
between January 1983 and April 1986, and she held various sales positions with
BellSouth prior to 1983.
Campbell B. Lanier, III has been one of our directors and our Chairman of
the Board since our inception. He has served as a director of KNOLOGY Holdings
since November 1995. Mr. Lanier serves as Chairman of the Board and Chief
Executive Officer of ITC Holding and has served as a director of ITC Holding
since the company's inception in 1989. In addition, Mr. Lanier is an officer and
director of several ITC Holding subsidiaries. Mr. Lanier also is Chairman of the
Board and a director of ITC DeltaCom, Inc., which provides wholesale and retail
telecommunications services; Powertel, Inc., which provides wireless
communications services; MindSpring Enterprises, Inc., an Internet services
provider; and Vista Eyecare, Inc., a full service optical retailer. Mr. Lanier
has served as a Managing Director of South Atlantic Private Equity Fund, IV,
Limited Partnership since July 1997.
Richard Bodman has been nominated to serve as one of our directors. He has
been a director of KNOLOGY Holdings since June 1996. Mr. Bodman is currently the
Managing General Partner of AT&T Ventures. From August 1990 to May 1996, Mr.
Bodman served as Senior Vice President of Corporate Strategy and Development for
AT&T. Mr. Bodman also is currently a director of the following public companies:
Internet Security Systems, Inc., Tyco International Inc. and Young and Rubicam
Inc.
Alan A. Burgess has been nominated to serve as one of our directors. He has
served as a director of KNOLOGY Holdings since January 1999. From 1967 until his
retirement in 1997, Mr. Burgess was a partner with Andersen Consulting. Over his
thirty-year career he held a number of positions as Managing Partner, including
Managing Partner of Regulated Industries from 1974 to 1989. In 1989 he assumed
the role of Managing Partner of the Communications Industry Group. In addition,
he served on Andersen Consulting's Global Management council and was a member of
the Partner Income Committee. Mr. Burgess is also the Chief Financial Officer of
Seventh Wave Technologies, Inc.
Donald W. Burton has been nominated to serve as one of our directors. He
has been a director of KNOLOGY Holdings since January 1996. Since January 1981,
he has served as Managing General Partner of South Atlantic Venture Fund I, II
and III, Limited Partnerships and Chairman of South Atlantic Private Equity Fund
IV, Limited Partnership. Mr. Burton has been the general partner of The Burton
Partnership, Limited Partnership since October 1979. Since January 1981, he has
served as President of South Atlantic Capital Corporation. Mr. Burton also
serves on the board of directors of several ITC companies, including ITC
Holding, ITC DeltaCom and Powertel. He is a director of the Heritage Group of
Mutual Funds and several private companies. Mr. Burton also serves as a director
of the National Venture Capital Association.
L. Charles Hilton, Jr. has been nominated to serve as one of our directors.
He has served as a director of KNOLOGY Holdings since KNOLOGY Holdings acquired
the beach cable system in Panama City, Florida in December 1997. Mr. Hilton was
the founder and sole stockholder of Beach Cable, Inc., and served as its Chief
Executive Officer from 1991 to December 1997. Since 1958, Mr. Hilton has served
as Chairman and Chief Executive Officer of Gulf Asphalt Corporation, a general
construction firm. Mr. Hilton has been a partner in the law firm of Hilton,
Hilton, Kolk & Roesch since 1984, and currently serves as Chief Executive
Officer of Hilton, Inc., a family corporation which owns and operates various
commercial buildings in Bay County, Florida. He also is a member of the board of
directors of several private companies.
William H. Scott, III has been one of our directors since our inception,
and he has served as a director of KNOLOGY Holdings since November 1995. He has
served as President of ITC Holding since December 1991 and has been a director
of ITC since May 1989. He also is an officer and director of several other ITC
Holding subsidiaries. In addition, Mr. Scott is a director of Powertel,
ITC DeltaCom, MindSpring, Innotrac Corporation, which provides customized
technology-based marketing support
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<PAGE> 57
services, HeadHunter.NET, Inc., a company providing online recruiting services
to employers, recruiters, and job-seekers, and nFront, Inc., a provider of
full-service Internet banking solutions for community banks.
Donald W. Weber has been nominated to serve as one of our directors. He has
served as a director of KNOLOGY Holdings since August 1998. Since 1997, Mr.
Weber has been a consultant and private investor. Since 1995, Mr. Weber served
as President and Chief Executive Officer of ViewStar Entertainment Services,
Inc., a digital satellite services company. From 1987 to 1991, Mr. Weber held
various executive positions, including President and Chief Executive Officer,
and served as a director of Contel Corporation, a telecommunications company.
Currently, Mr. Weber serves as director of Powertel, Inc., Pegasus
Communications Corporation, a media and communications company, HeadHunter.net,
an online job recruiting company, and HIE, Inc., a health care software
provider.
COMMITTEES OF THE BOARD OF DIRECTORS
Our Board currently has two committees, the Audit Committee and the
Compensation and Stock Option Committee.
The Audit Committee, among other things:
- recommends the firm to be appointed as independent accountants to audit
our financial statements;
- discusses the scope and results of the audit with the independent
accountants, reviews with management and the independent accountants our
interim and year-end operating results;
- considers the adequacy of our internal accounting controls and audit
procedures; and
- reviews the non-audit services to be performed by the independent
accountants.
The members of the Audit Committee will be Messrs. Hilton, Burgess and Lanier.
The Compensation and Stock Option Committee reviews and recommends the
compensation arrangements for management and administers our stock option plans.
The members of the Compensation and Stock Option Committee will be Messrs.
Scott, Weber, and Burton.
EXECUTIVE COMPENSATION
Our executive officers were appointed in October 1999. However, as all of
our executive officers were executive officers of KNOLOGY Holdings, Inc.
immediately prior to our formation, we have set forth below the compensation
received by our executive officers from KNOLOGY Holdings for the fiscal years
ended December 31, 1998, 1997 and 1996. The following table provides
compensation information for our chief executive officer and the most highly
compensated other executive officers whose total annual salary and bonus exceed
$100,000. We will use the term "named executive officers" to refer to these
people later in this prospectus.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG TERM
COMPENSATION AWARDS
-----------------------------
ANNUAL COMPENSATION SECURITIES
-------------------------------- UNDERLYING ALL OTHER
YEAR(1) SALARY BONUS OPTIONS(2) COMPENSATION(3)
------- -------- ------- ----------- ---------------
<S> <C> <C> <C> <C> <C>
Rodger L. Johnson................. 1998 -- -- -- --
President &
Chief Executive Officer(4)
William E. Morrow................. 1998 $134,539 $76,800 105,000 $ 8,014
Former President & 1997 102,462(5) 22,602 45,000 24,526
Chief Executive Officer
Felix L. Boccucci, Jr............. 1998 98,250 33,385 7,500 --
Chief Financial Officer and 1997 92,430 9,473 -- 36,159(7)
Vice President of 1996 84,015 46,102 16,516.5 68,464(8)
Business Development(6)
</TABLE>
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<PAGE> 58
<TABLE>
<CAPTION>
LONG TERM
COMPENSATION AWARDS
-----------------------------
ANNUAL COMPENSATION SECURITIES
-------------------------------- UNDERLYING ALL OTHER
YEAR(1) SALARY BONUS OPTIONS(2) COMPENSATION(3)
------- -------- ------- ----------- ---------------
<S> <C> <C> <C> <C> <C>
Bret T. McCants................... 1998 $101,494 $29,926 30,000 $ 5,041
Vice President of 1997 58,847(9) 21,177 10,500 35,535
Network Construction
and Maintenance
Marcus R. Luke.................... 1998 97,307 31,275 22,500 4,800
Chief Technology Officer 1997 90,292 6,102 -- 5,111
1996 72,547 7,102 6,405 5,076
</TABLE>
- ---------------
(1) As noted above, all of the named executive officers were initially employed
by KNOLOGY Holdings, Inc. The compensation table reflects the compensation
earned from KNOLOGY Holdings.
(2) All options are exercisable for shares of our common stock.
(3) Includes car allowances, relocation expenses and premiums on life insurance.
(4) Mr. Johnson has served as the president of KNOLOGY Holdings since May 1999
and as its chief executive officer since June 1999.
(5) Reflects amounts paid to Mr. Morrow based on an annual salary rate of
approximately $120,000.
(6) Mr. Boccucci served as chief financial officer, treasurer and secretary of
KNOLOGY Holdings from November 1995 through August 1997.
(7) Includes grants of ITC Holding capital stock valued at $30,789 at the time
of grant.
(8) Includes grants of ITC Holding capital stock valued at $63,448 at the time
of grant.
(9) Reflects amounts paid to Mr. McCants based on an annual salary rate of
approximately $90,000.
INCENTIVE COMPENSATION PLAN
We assumed KNOLOGY Holding, Inc.'s stock option plan as of November 1999.
Each outstanding option to purchase stock of KNOLOGY Holdings was converted into
an option to purchase one share of our common stock at the time we assumed the
stock option plan.
Our stock option plan allows us to grant options that are intended to
qualify as "incentive stock options" under Section 422 of the Internal Revenue
Code of 1986, as amended, as well as non-qualifying options to our key employees
and non-employee directors of KNOLOGY, Inc. and those of our subsidiaries. The
stock option plan authorizes the issuance of up to 6,000,000 shares of common
stock pursuant to options granted under the plan. The maximum number of shares
subject to options that may be awarded under the plan to any person is 1,800,000
shares. The Compensation and Stock Option Committee of the board of directors
administers the plan and grants options to purchase common stock.
The exercise price for incentive stock options granted under the stock
option plan must be at least 100% of the fair market value of the common stock
on the date of grant and must be at least 110% to an optionee beneficially
owning more than 10% of the outstanding common stock. The exercise price for
non-incentive stock options granted under the plan must be at least the par
value of the common stock. The maximum option term is ten years, or five years
to an optionee beneficially owning more than 10% of the outstanding common
stock. Options may be exercised at any time after grant except as otherwise
provided in the particular option agreement. There is also a $100,000 limit on
the value of common stock covered by incentive stock options that become
exercisable by an optionee in any year. The board of directors may amend,
suspend or terminate the stock option plan for shares of common stock for which
options have not been granted.
Upon assumption of the KNOLOGY Holdings plan on November 1, 1999, we had
options to purchase 1,160,700 shares of common stock outstanding pursuant to the
stock option plan.
The following table sets forth the information concerning individual grants
of stock options by KNOLOGY Holdings during the fiscal year ended December 31,
1998 to each of the named executive
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<PAGE> 59
officers during such periods and reflects the conversion into our options. No
stock appreciation rights have been granted.
OPTION GRANTS IN LAST FISCAL YEAR
INDIVIDUAL GRANTS (1)
<TABLE>
<CAPTION>
PERCENT OF
TOTAL OPTIONS
NUMBER OF GRANTED TO
SECURITIES EMPLOYEES IN
UNDERLYING OPTIONS FISCAL YEAR
NAME GRANTED (2) EXERCISE PRICE GRANT DATE EXPIRATION DATE
---- ------------------ ------------- -------------- ---------------- ----------------
<S> <C> <C> <C> <C> <C>
Rodger L. Johnson.... -- -- -- -- --
President & Chief
Executive Officer
William E. Morrow.... 420,000 18.6% $2.50 February 4, 1998 February 4, 2008
Former President
and Chief
Executive Officer
Felix L. Boccucci, 30,000 1.3 2.50 February 4, 1998 February 4, 2008
Jr.................
Vice President of
Business
Development
Bret T. McCants...... 120,000 5.3 2.50 February 4, 1998 February 4, 2008
Vice President of
Network
Construction and
Maintenance
Marcus R. Luke....... 90,000 4.0 2.50 February 4, 1998 February 4, 2008
Chief Technology
Officer
<CAPTION>
POTENTIAL REALIZED
VALUE AT ASSUMED
ANNUAL RATES OF STOCK
PRICE APPRECIATION
FOR OPTION TERM (3)
---------------------
NAME 5% 10%
---- -------- ----------
<S> <C> <C>
Rodger L. Johnson.... -- --
President & Chief
Executive Officer
William E. Morrow.... $660,450 $1,673,700
Former President
and Chief
Executive Officer
Felix L. Boccucci, 47,175 119,550
Jr.................
Vice President of
Business
Development
Bret T. McCants...... 188,700 478,200
Vice President of
Network
Construction and
Maintenance
Marcus R. Luke....... 141,525 358,650
Chief Technology
Officer
</TABLE>
- ---------------
(1) All options are exercisable for shares of common stock and are granted under
the stock option plan. Such options generally vest over five years unless
such person's employment is terminated, in which case options that have not
vested at that time will terminate.
(2) Based on 2,261,496 options granted.
(3) These amounts are based on compounded annual rates of stock price
appreciation of five and ten percent over the 10-year term of the options,
are mandated by rules of the Securities and Exchange Commission and are not
indicative of expected stock price performance. Actual gains, if any, on
stock option exercises are dependent on future performance of the common
stock, overall market conditions, as well as the option holders' continued
employment throughout the vesting period. The amounts reflected in this
table may not necessarily be achieved or may be exceeded.
OPTION EXERCISES AND FISCAL YEAR-END VALUES
None of the named executive officers exercised stock options during the
fiscal year ended December 31, 1998. Since our common stock is not traded, we
have no presently available estimates of the market value of such shares at
December 31, 1998.
COMPENSATION OF DIRECTORS
Our directors do not receive directors' fees. Directors are reimbursed for
their reasonable out-of-pocket travel expenditures. Our directors are also
eligible to receive grants of stock options under our Stock Option Plan.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The current members of our Compensation and Stock Option Committee are
Messrs. Scott, Weber and Burton. We have no compensation committee interlocks or
insider participation.
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<PAGE> 60
CERTAIN TRANSACTIONS AND RELATIONSHIPS
We were formed in 1998 to serve as a holding company of KNOLOGY Holdings,
Inc., Interstate Telephone Company, Inc., Valley Telephone Company, Inc., Globe
Telecommunications, Inc. and ITC Globe, Inc. We have described below certain
relationships and related transactions of our subsidiaries prior to our
ownership of such companies.
We have adopted a policy requiring that any material transactions between
us and others affiliated with our officers, directors or principal stockholders
be on terms no less favorable to us than reasonably could have been obtained in
arm's-length transactions with independent third parties.
TRANSACTIONS WITH ITC COMPANIES
In November 1999, we acquired KNOLOGY Holdings, Inc., Interstate Telephone
Company, Inc., Valley Telephone Company, Inc., Globe Telecommunications, Inc.
and ITC Globe, Inc. from ITC Holding Company, Inc., our parent company. ITC
Holding contributed to us stock representing approximately 85% of the
outstanding equity of KNOLOGY Holdings, Inc., stock representing 100% of each of
Interstate Telephone, Valley Telephone, Globe Telecommunications and ITC Globe,
272,832 shares of preferred stock of ClearSource, Inc., approximately $5.6
million in cash to be used for required subscription payments to ClearSource and
a note of KNOLOGY Holdings in the principal amount of $13 million.
Concurrently with this November 1999 acquisition, we completed an exchange
with other KNOLOGY Holdings stockholders in which we received KNOLOGY Holdings
common stock and preferred stock in exchange for our common stock and Series A
preferred stock. We now hold 100% of the outstanding capital stock of KNOLOGY
Holdings.
Prior to this November 1999 acquisition, ITC Holding indirectly owned
approximately 85% of the outstanding capital stock of KNOLOGY Holdings, and 100%
of the outstanding capital stock of Interstate Telephone, Valley Telephone,
Globe Telecommunications and ITC Globe. As of December 31, 1998, Campbell B.
Lanier, III beneficially owned approximately 23% of the common stock of ITC
Holding, and William Scott and Donald Burton beneficially owned approximately 1%
and 8%, respectively, of the common stock of ITC Holding.
Mr. Lanier and Mr. Scott serve as executive officers and directors of ITC
Holding and as executive officers and directors of a number of ITC companies,
including ITC DeltaCom and Powertel, Inc. Mr. Burton serves as a director of
several ITC companies, including ITC Holding, ITC DeltaCom and Powertel. Felix
Boccucci served as an executive officer of ITC Holding prior to October 1997.
Mr. Boccucci currently serves as Chief Financial Officer of Interstate Telephone
and Valley Telephone.
In October 1999, we entered into a mutual services agreement with ITC
Service Company. Under this agreement, the companies will provide certain
services and facilities to each other.
In October 1999, a subsidiary of ITC Holding agreed to lend up to $13
million to KNOLOGY Holdings under a line of credit which matures on December 31,
1999. Interest accrues on the loan at a rate of 11 3/4% per year. This loan is
subordinate to the senior secured credit facility KNOLOGY Holdings has with
First Union National Bank and First Union Capital Markets.
In November 1999, after the contribution and exchange discussed above, a
subsidiary of ITC Holding agreed to lend us up to $30 million under a line of
credit. The proceeds of this loan are to be used for construction of the network
by KNOLOGY Holdings and for working capital. This loan accrues interest at a
rate of 11 3/4% per year and has a maturity date of March 31, 2000. Under the
terms of this loan, the ITC Holding subsidiary has the right, until the maturity
date, to convert all of the principal and interest of the loan into options to
purchase shares of our Series A stock.
ITC Holding occasionally provides certain administrative services, such as
legal and tax-planning services, for us. The costs of these services are charged
to us based primarily on the salaries and related expenses for certain ITC
Holding executives and an estimate of their time spent on projects for us. For
the
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<PAGE> 61
year ended December 31, 1998, KNOLOGY Holdings recorded $102,000 in selling,
operations, administrative and rent expenses related to these services. We feel
that the methodology used to calculate the amounts charged is reasonable.
Certain of ITC Holding's other wholly owned or majority-owned subsidiaries
provide various services to us and/or receive services from us. These entities
include Intercall, Inc., which provides conference calling services to us. In
addition, we receive services from ITC DeltaCom, Inc., an affiliate of ITC
Holding, which provides long distance and related services to us and leases
capacity on certain of its fiber routes to us. ITC Holding also holds equity
investments in entities which do business with us, including Powertel, Inc.,
which provides cellular services; and MindSpring Enterprises, Inc., which is a
regional provider of Internet access and which purchases local Internet
transport services from us. For the year ended December 31, 1998, KNOLOGY
Holdings received services from these affiliated entities in the amount of
$1,681,000, which is reflected in cost of services and selling, operations, and
administrative expenses in our statement of operations. We feel that our
transactions with these affiliated entities are representative of arm's-length
transactions.
Relatives of ITC Holding' stockholders are stockholders and employees of
our insurance provider. The costs charged to KNOLOGY Holdings for insurance
services were approximately $386,000 for the year ended December 31, 1998.
SALES OF CAPITAL STOCK
In December 1995 and January 1996, in connection with its initial
capitalization, KNOLOGY Holdings issued to certain of its current stockholders
7,780 shares of its preferred stock at a purchase price of $1,000 per share, for
an aggregate amount of $7,780,000. ITC Holding contributed $4,000,000 plus all
of its direct and indirect interests in Cybernet Holding, L.L.C. and in KNOLOGY
of Columbus, Inc. in exchange for preferred stock.
In April 1996, in connection with a private placement of its preferred
stock, KNOLOGY Holdings issued to certain of its stockholders 9,312 shares of
its preferred stock for a purchase price of $1,200 per share, for an aggregate
amount of $11,174,400. In connection with this private placement, ITC Holding,
the AT&T venture funds, KNOLOGY Holdings and others entered into an Agreement
Among Stockholders, which was amended and restated as of July 28, 1997. Pursuant
to the agreement, all parties agreed to take all action within their respective
power as may be required, for as long as AT&T Venture Fund I, L.P. owns more
than 5% of KNOLOGY Holdings' equity securities, to elect one director designated
by each such 5% stockholder.
In February 1997, KNOLOGY Holdings issued 8,960 shares of preferred stock
to certain of its current stockholders for a purchase price of $1,200 per share,
for an aggregate amount of $10,752,000. As part of this private placement, ITC
Holding, Century Telephone, South Atlantic and the AT&T venture funds
contributed $4,302,000, $2,096,400, $1,000,800 and $1,416,000, respectively, in
exchange for such preferred stock. In January 1997 and July 1998, KNOLOGY
Holdings repurchased the preferred stock from Century Telephone and South
Atlantic, respectively.
KNOLOGY Holdings is a party to a Stockholders' Agreement dated December 8,
1995, as amended, with all of its stockholders. No party to the stockholders'
agreement may transfer any of KNOLOGY Holdings' capital stock, rights or options
held by such party to third parties without having offered rights of first
refusal to purchase such securities to KNOLOGY Holdings.
In October 1997, KNOLOGY Holdings issued approximately 21,400 shares of its
preferred stock to qualified investors an equity private placement for a
purchase price of $1,500 per share, for an aggregate amount of approximately
$32.2 million. ITC Holding, Century Telephone, South Atlantic, AT&T venture
funds and SCANA Communications, Inc. purchased approximately $10.0 million, $2.5
million, $5.5 million, $5.0 million and $5.0 million of preferred stock,
respectively, in an equity private placement.
In October 1997, KNOLOGY Holdings also completed a private offering of
444,100 units, each of which consisted of one 11 7/8% senior discount note and
one warrant to purchase .003734 shares of its
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<PAGE> 62
preferred stock at an exercise price of $.01 per share for $444.1 million
aggregate principal amount at maturity yielding net proceeds of approximately
$242.4 million. The senior discount notes issued in the offering were
subsequently exchanged for substantially identical exchange notes that had been
registered under the Securities Act of 1933, as amended, in an exchange offer
that expired on March 24, 1998.
In November 1999, we completed an exchange with other KNOLOGY Holdings
stockholders, including AT&T venture funds, in which we exchanged our common
stock and preferred stock for KNOLOGY Holdings common stock and preferred stock.
Through this exchange offering, we acquired 7,113 shares of Series A preferred
stock of KNOLOGY Holdings from AT&T for 4,267,800 shares of our Series A
preferred stock.
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<PAGE> 63
PRINCIPAL STOCKHOLDERS
The following table sets forth certain information as of October 1, 1999,
adjusted to reflect the November 1999 transaction in which, among other things,
ITC Holding and other stockholders of KNOLOGY Holdings exchanged their KNOLOGY
Holdings stock and certain other assets for stock in our company, and
immediately following the distribution regarding beneficial ownership of our
voting capital stock by (i) each person known by us to beneficially own more
than 5% of our outstanding voting capital stock, (ii) each or our directors,
(iii) each of our executive officers, and (iv) all of our directors and
executive officers as a group. Unless otherwise indicated, the address of each
of the named individuals is c/o KNOLOGY, Inc., 1241 O.G. Skinner Drive, West
Point, Georgia 31833.
<TABLE>
<CAPTION>
PERCENT OF VOTING
CAPITAL STOCK(3)
AMOUNT AND NATURE OF AMOUNT AND NATURE OF ---------------------------
BENEFICIAL OWNERSHIP BENEFICIAL OWNERSHIP BEFORE AFTER
NAME AND ADDRESS OF BENEFICIAL OWNER BEFORE DISTRIBUTION(1) AFTER DISTRIBUTION(1)(2) DISTRIBUTION DISTRIBUTION
- ------------------------------------ ---------------------- ------------------------- ------------ ------------
<S> <C> <C> <C> <C>
ITC Holding Company, Inc.
InterCall, Inc.(4).............. 43,918,649(5) -- 82.5% *
AT&T Venture Funds(6)........... 4,267,800(5) 4,267,800 7.9 7.8%
Richard Bodman(6)............... 4,267,800(5) 4,267,800 7.9 7.8
Felix L. Boccucci, Jr.(7)....... 58,852(5) 110,102 * *
Marcus R. Luke(8)............... 31,296(5) 91,950 * *
James T. Markle................. -- -- * *
Bret McCants(9)................. 25,800(5) 86,458 * *
Peggy A. Warner................. -- 45,000 * *
Rodger L. Johnson............... -- -- * *
Anthony J. Palermo.............. -- -- * *
Peggy B. Warner................. -- -- * *
Chad S. Wachter................. -- -- * *
Campbell B. Lanier.............. 43,918,649(5)(9) 10,627,733 82.5 19.3
Donald W. Weber................. -- 41,557 * *
Donald W. Burton................ -- 131,893 * *
L. Charles Hilton, Jr........... -- 379,033 * *
William H. Scott, III........... 43,918,649(5)(9) 1,146,804 * 2,1
Alan A. Burgess................. -- -- * *
All Named Executive Officers and
Directors as a Group (15
persons)(7)(8)................ 48,243,545 16,928,329 30.8% 31.1%
</TABLE>
- ---------------
* Less than 1%
(1) In accordance with Rule 13d-3 under the Exchange Act, a person is deemed to
be a "beneficial owner" of a security if he or she has or shares the power
to vote or direct the voting of such security or the power to dispose or
direct the disposition of such security. A person is also deemed to be a
beneficial owner of any securities of which that person has the right to
acquire beneficial ownership within 60 days from October 1, 1999. More than
one person may be deemed to be a beneficial owner of the same securities.
All persons shown in the table above have sole voting and investment power,
except as otherwise indicated. Except as otherwise noted, all voting capital
stock listed in the table above consists of our Series A preferred stock.
(2) Provides for a 600-to-1 stock split in November 1999.
(3) For the purpose of computing the percentage ownership of each beneficial
owner, any securities which were not outstanding but which were subject to
options, warrants, rights or conversion privileges held by such beneficial
owner exercisable within 60 days were deemed to be outstanding in
determining the percentage owned by such person, but were not deemed
outstanding in determining the percentage owned by any other person.
(4) The address of ITC Holding, Inc. and InterCall, Inc. is 1211 O.G. Skinner
Drive, West Point, Georgia 31833. InterCall is a wholly owned subsidiary of
ITC Holding.
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<PAGE> 64
(5) Represents shares of Series A preferred stock convertible to common stock
using a ratio of 150:1 shares of Series A preferred stock to common stock
for the purpose of this table.
(6) The address of each of the AT&T venture funds and of Mr. Bodman is 2
Wisconsin Circle, #610, Chevy Chase, Maryland 20815. Includes 325,800 shares
owned by AT&T Venture Fund I, L.P., of which Venture Management I, a general
partnership, is the general partner, of which Mr. Bodman is the managing
general partner; 2,931,600 shares owned by AT&T Venture Fund II, L.P., of
which Venture Management, L.L.C. is the general partner, of which Mr. Bodman
is a manager; includes 153,600 shares owned by Special Partners Fund, L.P.,
of which Venture Management III, L.L.C. is the general partner, of which Mr.
Bodman is a manager; and includes 856,800 shares owned by Special Partners
Fund International, L.P., of which the investment general partner is Venture
Management III, L.L.C., of which Mr. Bodman is a manager. Each of the
respective AT&T venture funds has sole voting and investment power with
respect to the shares beneficially owned by such fund.
(7) Includes options to purchase 52,852 shares of common stock which are
currently exercisable.
(8) Includes options to purchase 20,496 shares of common stock which are
currently exercisable.
(9) These are the shares owned by InterCall, Inc., of which Messrs. Lanier and
Scott are directors. Messrs. Lanier and Scott disclaim beneficial ownership
of these shares.
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<PAGE> 65
DESCRIPTION OF SECURITIES
The following summary description of our capital stock is not a complete
description and is subject to the provisions of our Certificate of Incorporation
and our Bylaws, which are included as exhibits to the Registration Statement of
which this prospectus forms a part, and the provisions of applicable law.
AUTHORIZED AND OUTSTANDING CAPITAL STOCK
We currently have 200,000,000 shares of common stock authorized and 60,000
shares of common stock outstanding. We currently have 200,000,000 shares of
preferred stock authorized of which 75,000,000 shares are designated as Series A
preferred stock and 50,000,000 shares are designated as Series B preferred
stock. We have 48,739,711 shares of Series A preferred stock outstanding and
21,052,632 shares of Series B preferred stock outstanding.
COMMON STOCK
Voting Rights. Each holder of common stock is entitled to attend all
special and annual meetings of the stockholders of our company and, together
with the holders of all other classes of stock entitled to attend and vote at
such meetings, to vote upon any matter or thing properly considered and acted
upon by the stockholders. Holders of common stock are entitled to one vote per
share.
Liquidation Rights. In the event of any dissolution, liquidation or
winding up of our company, whether voluntary or involuntary, holders of common
stock and the holders of all other classes of stock entitled to participate
therewith, are entitled to participate in the distribution of any assets of our
company remaining after we have paid, or provided for payment of, all of our
debts and liabilities and after we have paid, or set aside for payment, the full
preferential amounts to the holders of any class of stock having preference over
the common stock in the event of a dissolution, liquidation or winding up.
Dividends. Dividends may be paid on the common stock and on any class or
series of stock entitled to participate therewith when and as declared by the
board of directors out of any assets legally available for such dividends.
Transfer Restrictions. Any holder of shares of common stock that decides
to sell its shares of common stock must first offer those shares to us before it
can offer the shares to a third party. Any common stock held by one of our
employees is subject to our right to repurchase such common stock at fair market
value upon such employee's termination of employment.
AUTHORIZED PREFERRED STOCK
Our Certificate of Incorporation authorizes our board of directors to
issue, from time to time and without further stockholder action, except as
required by applicable law, one or more series of preferred stock, and to fix
the relative rights and preferences of the shares, including voting powers,
dividend rights, liquidation preferences, redemption rights, conversion
privileges and other rights. The issuance of additional preferred stock may have
the effect of delaying, deferring or preventing a change in control of our
company without further action by the stockholders. Preferred stock issued with
voting, conversion or redemption rights may adversely affect the voting power of
the holders of common stock and existing series of preferred stock, and could
discourage attempts to obtain control of our company.
SERIES A PREFERRED STOCK AND SERIES B PREFERRED STOCK
Voting Rights. Except as otherwise required by law, the holders of shares
of Series A preferred stock and Series B preferred stock are entitled to attend
all special and annual meetings of the stockholders of our company and, together
with the holders of all other classes of stock entitled to attend and vote at
such meetings, to vote upon any matter or thing properly considered and acted
upon by the stockholders. Holders of Series A preferred stock and Series B
preferred stock will vote with holders of common stock
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<PAGE> 66
on an as-converted basis. In addition, holders of Series A preferred stock and
Series B preferred stock are entitled to a separate class vote on:
- the issuance of any additional Series A preferred stock or Series B
preferred stock;
- the creation of any class or series of capital stock with preference to
the Series A preferred stock or Series B preferred stock; and
- a merger, recapitalization, liquidation, or sale of substantially all of
our assets.
Liquidation Rights. In the event of any dissolution, liquidation or
winding up of our company, whether voluntary or involuntary, the holders of
shares of our Series A preferred stock and Series B preferred stock are entitled
to receive, out of our assets legally available for distribution to
stockholders, a liquidation value equal to the greater of (1) the initial
per-share purchase price of $2,850 in the case of Series A preferred stock or
Series C preferred stock and $2,850 in the case of Series B preferred stock, or
(2) the amount such holder would have received had his Series A preferred stock
or Series B preferred stock been converted into common stock immediately before
the liquidation event. This distribution must be paid prior to any distribution
with respect to the common stock. After the Series A preferred stock and Series
B preferred stock liquidation distribution has been made and after the holders
of shares of any other class or series of stock having preference over the
common stock in the event of dissolution, liquidation or winding up have
received the full preferential amounts to which they are entitled, the holders
of shares of common stock and any other class or series of stock entitled to
participate with the common stock will participate in the distribution of any of
our remaining assets. If the assets distributable upon such dissolution,
liquidation or winding up are insufficient to pay cash in an amount equal to the
Series A preferred stock and Series B preferred stock liquidation distribution
to the holders of shares of preferred stock, then such assets or the proceeds of
such assets will be distributed among the holders of the Series A preferred
stock and Series B preferred stock ratably in proportion to the respective
amounts of the Series A preferred stock and Series B preferred stock liquidation
distributions to which they otherwise would be entitled.
Dividends. The Series A preferred stock and Series B preferred stock will
participate on an as-converted basis in all dividends payable to the holders of
our common stock.
Conversion Into Common Stock. The Series A preferred stock and Series B
preferred stock is convertible at any time at the option of the holder into the
number of shares of common stock determined by dividing the liquidation value by
the conversion price then in effect. The conversion price equals the initial
per-share purchase price of $2,850 in the case of Series A preferred stock and
$2,850 in the case of Series B preferred stock, subject to adjustments for stock
dividends, stock splits and similar transactions affecting the common stock, as
well as issuances of common stock and common stock equivalents other than
options and stock issued pursuant to employee benefit plans at less than the
conversion price then in effect. The shares of Series A preferred stock and
Series B preferred stock shall automatically be converted into fully paid and
nonassessable shares of common stock at the conversion price, as adjusted for
any stock split or reclassification, upon our completion of an underwritten
public offering of common stock resulting in proceeds to us of at least $50
million prior to expenses and underwriting commissions.
Preemptive Rights. Each holder of shares of Series A preferred stock or
Series B preferred stock that represents, on an as-converted basis, at least 5%
of our outstanding capital stock will have the right to purchase its pro-rata
share of 75% of any future offerings of our equity securities. This preemptive
right does not apply to issuances pursuant to employee benefit plans or
issuances for non-cash consideration.
Transfer Restrictions. Any holder of shares of Series A preferred stock or
Series B preferred stock that decides to sell its shares of Series A preferred
stock or Series B preferred stock must first offer those shares to us before it
can offer the shares to a third party.
Registration Rights. Shares of our common stock issued or issuable upon
the conversion of Series A preferred stock and Series B preferred stock have the
benefit of various registration rights. Holders of at least 25% of the
registrable securities may require us to effect up to two long-form
registrations, subject to
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<PAGE> 67
reasonable deferral rights on our part. Holders of Series A preferred stock and
Series B preferred stock also have unlimited piggyback rights, subject to
customary underwriter cutbacks.
Options
We have granted options to purchase 6,315,789 shares of our common stock.
CERTAIN CHARTER AND STATUTORY PROVISIONS
Certain provisions of the Delaware General Corporation Law, our Certificate
of Incorporation, our By-Laws and our stock option plans may have an
anti-takeover effect and may delay, deter or prevent a tender offer, proxy
contest or other takeover attempt. This may be true even in circumstances where
a takeover attempt might result in payment of a premium over market price for
shares held by stockholders.
Following the completion of the distribution, we will become subject to
Section 203 of the Delaware General Corporation Law. Section 203 prohibits,
subject to certain exceptions, a Delaware corporation from engaging in any
business combination with any interested stockholder for a period of three years
following the date that such stockholder became an interested stockholder. A
business combination includes mergers, asset sales and other transactions that
may result in a financial benefit to stockholders. A person will be deemed an
interested stockholder triggering this protection if the person together with
any affiliates or associates of such person, beneficially owns, directly or
indirectly, 15% or more of our outstanding voting stock. There are three
exceptions to these provisions. First, if our board of directors gives prior
approval to either the business combination or the transaction which resulted in
the stockholder becoming an interested stockholder then the restrictions do not
apply. Second, the restrictions will not apply if, upon the consummation of the
transaction which resulted in the stockholder becoming an interested
stockholder, the interested stockholder owns at least 85% of our outstanding
voting stock. Finally, the restrictions will not apply if, at the time of or
following the consummation of the transaction in which the stockholder became an
interested stockholder, our board of directors approves the business combination
and stockholders holding at least 66 2/3% of our outstanding voting stock not
owned by the interested stockholder authorize the business combination.
We may issue 50,000,000 shares of undesignated preferred stock. Under
certain circumstances, the issuance of preferred stock could be utilized as a
method of discouraging, delaying or preventing a change in control of our stock.
The provisions of our Certificate of Incorporation and By-Laws may have the
effect of delaying, deferring or preventing a non-negotiated merger or other
business combination involving us. These provisions are intended to encourage
any person interested in acquiring us to negotiate with and obtain the approval
of our board of directors in connection with the transaction. Certain of these
provisions may, however, discourage our future acquisition in a transaction not
approved by our board of directors in which stockholders might receive an
attractive value for their shares or that a substantial number or even a
majority of our stockholders might believe to be in their best interest. As a
result, stockholders who desire to participate in such a transaction may not
have the opportunity to do so. Such provisions could also discourage bids for
our common stock at a premium, as well as create a depressive effect on the
market price of our common stock.
LEGAL MATTERS
Hogan & Hartson L.L.P., of Washington, D.C., will issue an opinion about
certain legal matters with respect to our common stock.
EXPERTS
The consolidated financial statements and schedules of KNOLOGY, Inc. and
subsidiaries as of December 31, 1997 and 1998 and for the three years December
31, 1998, and KNOLOGY Holdings, Inc.
64
<PAGE> 68
as of December 31, 1997 and July 31, 1998 and for the years ended December 31,
1996 and 1997 and the period ended July 31, 1998 included in this prospectus and
in the Registration Statement have been audited by Arthur Andersen LLP,
independent accountants, as indicated in their reports with respect thereto, and
are included in reliance upon the authority of said firm as experts in
accounting and auditing.
The financial statements of Cable Alabama Corporation as of August 31, 1998
and September 30, 1997 and for the eleven month period ended August 31, 1998 and
the year ended September 30, 1997 included in this prospectus have been audited
by Deloitte & Touche LLP, independent auditors, as stated in their report
appearing herein and have been so included in reliance on the report of such
firm given on their authority as experts in accounting and auditing.
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the SEC a registration statement on Form S-1. It
includes exhibits and schedules. This prospectus is part of the registration
statement. It does not contain all of the information that is in the
registration statement. The registration statement contains more information
about our company and the common stock. Statements contained in this prospectus
concerning the provisions of documents filed as exhibits to the registration
statement are necessarily summaries of such documents. Each of these statements
is qualified in its entirety by reference to the copy of the applicable document
filed with the SEC. You may read and copy all or any portion of the registration
statement at the SEC's public reference room at 450 Fifth Street, N.W.,
Washington, D.C. 20549. You can request copies of these documents, upon payment
of a duplicating fee, by writing to the SEC. Please call the SEC at 1-800-SEC-
0330 for further information on the public reference room's operations. The
registration statement is also available to you on the SEC's Internet site
(www.sec.gov). We intend to furnish our stockholders with annual reports
containing financial statements audited by our independent accountants and
quarterly reports containing unaudited financial statements for the first three
quarters of each fiscal year.
65
<PAGE> 69
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
KNOLOGY, INC.
Report of Independent Public Accountants.................... F-2
Consolidated Balance Sheets -- December 31, 1997 and 1998
and June 30, 1999 (unaudited)............................. F-3
Consolidated Statements of Operations for the Years Ended
December 31, 1996, 1997 and 1998 and the Six Months Ended
June 30, 1998 and 1999 (unaudited)........................ F-4
Consolidated Statements of Stockholders' Equity and
Comprehensive Income for the Years Ended December 31,
1996, 1997 and 1998 and the Six Months Ended June 30, 1999
(unaudited)............................................... F-5
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1996, 1997 and 1998 and the Six Months Ended
June 30, 1998 and 1999 (unaudited)........................ F-6
Notes to Consolidated Financial Statements.................. F-7
</TABLE>
<TABLE>
KNOLOGY HOLDINGS, INC.
<S> <C>
Report of Independent Public Accountants.................... F-23
Consolidated Balance Sheets -- December 31, 1997 and July
31, 1998.................................................. F-24
Consolidated Statements of Operations for the Years Ended
December 31, 1996, 1997 and the Period Ended July 31,
1998...................................................... F-25
Consolidated Statements of Stockholders' Equity and
Comprehensive Income for the Years Ended December 31,
1996, 1997 and the Period Ended July 31, 1998............. F-26
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1996, 1997 and the Period Ended July 31,
1998...................................................... F-27
Notes to Consolidated Financial Statements.................. F-28
CABLE ALABAMA CORPORATION
Report of Independent Public Accountants.................... F-40
Balance Sheets -- August 31, 1998 and September 30, 1997.... F-41
Statements of Operations and Deficit for the Period Ended
August 31, 1998 and the Year Ended September 30, 1997..... F-42
Statements of Cash Flows for the Period Ended August 31,
1998 and the Year Ended September 30, 1997................ F-43
Notes to Financial Statements............................... F-44
PRO FORMA FINANCIAL STATEMENTS
Introduction to Pro Forma Presentation...................... F-47
Unaudited Pro Forma Statement of Operations for the Year
Ended December 31, 1998................................... F-47
</TABLE>
F-1
<PAGE> 70
AFTER THE REORGANIZATION AND THE STOCK SPLIT TRANSACTIONS REFERRED TO IN
NOTES 1 AND 11, RESPECTIVELY, TO KNOLOGY, INC. CONSOLIDATED FINANCIAL STATEMENTS
ARE EFFECTED, WE EXPECT TO BE IN POSITION TO RENDER THE FOLLOWING AUDIT REPORT.
/s/ Arthur Andersen LLP
October 15, 1999
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To KNOLOGY, Inc.:
We have audited the accompanying consolidated balance sheets of KNOLOGY,
INC.(a Delaware corporation) AND SUBSIDIARIES as of December 31, 1997 and 1998
and the related consolidated statements of operations, stockholders' equity, and
cash flows for each of the three years ended December 31, 1998, 1997 and 1996.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of KNOLOGY,
Inc. and subsidiaries as of December 31, 1997 and 1998 and the results of their
operations and their cash flows for the three years ended December 31, 1998,
1997 and 1996, in conformity with generally accepted accounting principles. As
discussed in Note 1 to the financial statements, effective August 1998, the
Company acquired a majority ownership interest in KNOLOGY Holdings, Inc. in a
business combination accounted for as a purchase. As a result of this
acquisition, the financial information for 1998 includes the accounts of KNOLOGY
Holdings, Inc. and, therefore, is not comparable to periods prior to the
acquisition.
Atlanta, Georgia
, 1999
F-2
<PAGE> 71
KNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------- JUNE 30,
1997 1998 1999
------------ ------------ ------------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................. $ 626,902 $ 5,158,774 $ 1,194,223
Marketable securities..................................... 0 66,231,397 16,954,564
Accounts receivable, net of allowance for doubtful
accounts of $108,529, and 393,767 in 1997 and 1998,
respectively............................................ 3,660,359 8,744,597 15,698,831
Accounts receivable -- affiliates......................... 0 6,785,691 4,809,088
Deferred income taxes..................................... 97,872 0 0
Prepaid expenses.......................................... 54,798 500,022 815,662
------------ ------------ ------------
Total current assets................................ 4,439,931 87,420,481 39,472,368
------------ ------------ ------------
PROPERTY, PLANT, AND EQUIPMENT:
System and installation equipment......................... 27,924,111 188,753,702 231,023,172
Test and office equipment................................. 1,038,956 8,539,784 10,500,815
Automobiles and trucks.................................... 765,114 3,777,458 4,914,290
Production equipment...................................... 0 857,028 852,528
Land...................................................... 300,975 2,750,244 2,750,244
Buildings................................................. 641,563 10,902,460 12,382,746
Inventory................................................. 255,225 32,417,006 31,453,310
Leasehold improvements.................................... 407,778 1,145,184 1,231,648
------------ ------------ ------------
31,333,722 249,142,866 295,108,753
Less accumulated depreciation and amortization............ (20,072,876) (37,257,198) (46,641,804)
------------ ------------ ------------
Property, plant, and equipment, net................. 11,260,846 211,885,668 248,466,949
------------ ------------ ------------
OTHER LONG-TERM ASSETS:
Intangible and other assets, net.......................... 0 87,642,180 79,211,361
Investments............................................... 14,283,627 825,072 825,072
Other..................................................... 309,960 593,663 599,287
------------ ------------ ------------
Total assets........................................ $ 30,294,364 $388,367,064 $368,575,037
============ ============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt......................... $ 0 $ 25,094 $ 25,094
Accounts payable.......................................... 2,804,112 8,877,925 5,730,080
Accounts payable -- affiliates............................ 132,329 218,367 14,683,807
Accrued liabilities....................................... 1,835,707 23,076,341 6,679,820
Unearned revenue.......................................... 810,091 3,231,232 3,567,301
------------ ------------ ------------
Total current liabilities........................... 5,582,239 35,428,959 30,686,102
NONCURRENT LIABILITIES:
Notes payable............................................. 0 109,150 106,656
Accrued interest payable.................................. 0 21,036,541 30,768,843
Advances from affiliates.................................. 0 2,025,604 1,900,181
Unamortized investment tax credits........................ 513,605 441,989 406,181
Deferred income taxes..................................... 658,345 321,658 321,658
Bonds payable, net of discount............................ 0 255,020,209 262,702,729
------------ ------------ ------------
Total liabilities................................... 6,754,189 314,384,110 326,892,350
------------ ------------ ------------
COMMITMENTS AND CONTINGENCIES (NOTE 5)
MINORITY INTEREST........................................... 0 22,623,713 17,980,922
------------ ------------ ------------
WARRANTS (NOTE 3)........................................... 0 2,486,960 2,486,960
------------ ------------ ------------
STOCKHOLDERS' EQUITY:
Series A Preferred stock, $.01 par value per share;
75,000,000 shares authorized, 0 shares issued and
outstanding at December 31, 1997 and 1998 and June 30,
1999.................................................... 0 0 0
Series B Preferred stock, $.01 par value per share;
50,000,000 shares authorized, 0 shares issued and
outstanding at December 31, 1997 and 1998 and June 30,
1999.................................................... 0 0 0
Common stock, $.01 par value per share; 200,000,000 shares
authorized, 60,000 shares issued and outstanding at
December 31, 1997 and 1998 and June 30, 1999............ 600 600 600
Additional paid-in capital................................ 20,358,396 70,259,279 70,259,279
Retained earnings (accumulated deficit)................... 3,181,179 (21,389,986) (49,018,606)
Unrealized gains (losses)................................. 0 2,388 (26,468)
------------ ------------ ------------
Total stockholders' equity.......................... 23,540,175 48,872,281 21,214,805
------------ ------------ ------------
Total liabilities and stockholders' equity.......... $ 30,294,364 $388,367,064 $368,575,037
============ ============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-3
<PAGE> 72
KNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, SIX MONTHS ENDED JUNE 30,
---------------------------------------- ---------------------------
1996 1997 1998 1998 1999
----------- ----------- ------------ ------------ ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING REVENUES:
Telephone............................ $17,527,208 $17,633,313 $ 22,318,344 $ 10,008,360 $ 13,401,983
Cable................................ 0 0 22,527,403 8,527,225 17,145,085
Other................................ 0 0 286,775 62,746 661,750
----------- ----------- ------------ ------------ ------------
Total operating revenues...... 17,527,208 17,633,313 45,132,522 18,598,331 31,208,818
----------- ----------- ------------ ------------ ------------
OPERATING EXPENSES:
Cost of services..................... 2,991,412 3,121,108 12,739,540 3,691,377 9,796,850
Selling, operations, and
administrative..................... 8,331,795 9,498,461 37,323,345 15,897,426 25,514,407
Depreciation and amortization........ 3,022,056 2,781,800 17,914,537 5,564,836 19,694,361
----------- ----------- ------------ ------------ ------------
Total operating expenses...... 14,345,263 15,401,369 67,977,422 25,153,639 55,005,618
----------- ----------- ------------ ------------ ------------
OPERATING INCOME (LOSS)................ 3,181,945 2,231,944 (22,844,900) (6,555,308) (23,796,800)
----------- ----------- ------------ ------------ ------------
OTHER INCOME (EXPENSE):
Interest income...................... 0 0 9,639,050 6,133,417 1,108,536
Interest expense..................... (9,933) (12,431) (29,033,088) (14,056,277) (16,071,565)
Affiliate interest income (expense),
net................................ 193,495 467,815 (34,115) 3,810 10,935
Equity losses in subsidiaries........ (1,052,227) (2,444,706) 0 0 0
Other income (expense), net.......... 488,776 (59,184) 782,954 564,081 (71,308)
----------- ----------- ------------ ------------ ------------
Total other expense........... (379,889) (2,048,506) (18,645,199) (7,354,969) (15,023,402)
----------- ----------- ------------ ------------ ------------
INCOME (LOSS) BEFORE INCOME TAXES,
MINORITY INTERESTS, AND CUMULATIVE
EFFECT OF CHANGE IN ACCOUNTING
PRINCIPLE............................ 2,802,056 183,438 (41,490,099) (13,910,277) (38,820,202)
MINORITY INTERESTS..................... 0 0 13,294,079 9,199,846 4,642,791
----------- ----------- ------------ ------------ ------------
INCOME (LOSS) BEFORE INCOME TAXES AND
CUMULATIVE EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE................. 2,802,056 183,438 (28,196,020) (4,710,431) (34,177,411)
INCOME TAX (PROVISION) BENEFIT......... (1,371,865) (1,010,779) 5,631,618 (530,270) 6,548,791
----------- ----------- ------------ ------------ ------------
INCOME (LOSS) BEFORE CUMULATIVE EFFECT
OF CHANGE IN ACCOUNTING PRINCIPLE.... 1,430,191 (827,341) (22,564,402) (5,240,701) (27,628,620)
CUMULATIVE EFFECT OF A CHANGE IN
ACCOUNTING PRINCIPLE (NOTE 2)........ 0 0 (582,541) (582,541) 0
----------- ----------- ------------ ------------ ------------
NET INCOME (LOSS)...................... 1,430,191 (827,341) (23,146,943) (5,823,242) (27,628,620)
SUBSIDIARY PREFERRED STOCK DIVIDENDS... 0 (4,193,276) (1,424,222) 0 0
----------- ----------- ------------ ------------ ------------
NET INCOME (LOSS) ATTRIBUTABLE TO
COMMON STOCKHOLDERS.................. $ 1,430,191 $(5,020,617) $(24,571,165) $ (5,823,242) $(27,628,620)
=========== =========== ============ ============ ============
BASIC AND DILUTED NET INCOME (LOSS) PER
SHARE ATTRIBUTABLE TO COMMON
SHAREHOLDERS......................... $ 23.84 $ (83.68) $ (409.52) $ (97.05) $ (460.48)
=========== =========== ============ ============ ============
BASIC AND DILUTED WEIGHTED AVERAGE
NUMBER OF SHARES OUTSTANDING......... 60,000 60,000 60,000 60,000 60,000
=========== =========== ============ ============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-4
<PAGE> 73
KNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
AND COMPREHENSIVE INCOME
<TABLE>
<CAPTION>
RETAINED
PREFERRED STOCK COMMON STOCK ADDITIONAL EARNINGS UNREALIZED TOTAL
--------------- --------------- PAID-IN (ACCUMULATED GAINS STOCKHOLDERS'
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT) (LOSSES) EQUITY
------ ------ ------ ------ ----------- ------------ ---------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE, December 31, 1995......... 0 $0 60,000 $600 $ 5,174,403 $ 8,168,034 $ 184,854 $ 13,527,891
Comprehensive Loss:
Net income attributable to common
stockholders................... 0 0 0 0 0 1,430,191 0 1,430,191
Unrealized loss on marketable
securities..................... 0 0 0 0 0 0 (184,854) (184,854)
------------
Comprehensive Loss......... 1,245,337
------------
Additional infusion of equity.... 0 0 0 0 874,493 0 0 874,493
------ -- ------ ---- ----------- ------------ --------- ------------
BALANCE, December 31, 1996......... 0 0 60,000 600 6,048,896 9,598,225 0 15,647,721
Comprehensive Loss:
Net loss attributable to common
stockholders................... 0 0 0 0 0 (5,020,617) 0 (5,020,617)
------------
Comprehensive Loss......... (5,020,617)
------------
Acquisition of subsidiary
stock.......................... 0 0 0 0 14,310,000 0 0 14,310,000
Merger of subsidiary out of
consolidated group............. 0 0 0 0 (500) (1,396,429) 0 (1,396,929)
------ -- ------ ---- ----------- ------------ --------- ------------
BALANCE, December 31, 1997......... 0 0 60,000 600 20,358,396 3,181,179 0 23,540,175
Comprehensive Loss:
Net loss attributable to common
stockholders................... 0 0 0 0 0 (24,571,165) 0 (24,571,165)
Unrealized gain on marketable
securities..................... 0 0 0 0 0 0 2,388 2,388
------------
Comprehensive Loss......... (24,568,777)
------------
Issuance of subsidiary common
stock.......................... 0 0 0 0 3,152 0 0 3,152
Acquisition of minority
interests...................... 0 0 0 0 46,864,658 0 0 46,864,658
Additional infusion of equity.... 0 0 0 0 3,033,073 0 0 3,033,073
------ -- ------ ---- ----------- ------------ --------- ------------
BALANCE, December 31, 1998......... 0 0 60,000 600 70,259,279 (21,389,986) 2,388 48,872,281
Comprehensive Loss:
Net loss attributable to common
stockholders................... 0 0 0 0 0 (27,628,620) 0 (27,628,620)
Unrealized loss on marketable
securities..................... 0 0 0 0 0 0 (28,856) (28,856)
------------
Comprehensive Loss......... (27,657,476)
------ -- ------ ---- ----------- ------------ --------- ------------
BALANCE, June 30, 1999
(unaudited)...................... 0 $0 60,000 $600 $70,259,279 $(49,018,606) $ (26,468) $ 21,214,805
====== == ====== ==== =========== ============ ========= ============
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-5
<PAGE> 74
KNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, SIX MONTHS ENDED JUNE 30,
------------------------------------------ ---------------------------
1996 1997 1998 1998 1999
----------- ------------ ------------- ------------ ------------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss).................................. $ 1,430,191 $ (827,341) $ (23,146,943) $ (5,823,242) $(27,628,620)
----------- ------------ ------------- ------------ ------------
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Depreciation and amortization.................... 3,022,056 2,781,800 17,914,537 5,564,836 19,694,361
Amortization of bond discount.................... 0 0 13,651,778 6,449,607 7,682,520
Gain (loss) on disposition of assets............. 0 0 71,378 0 (5,416)
Loss on sale of investments...................... (273,725) (13,315) (515,903) (515,903) 0
Cumulative effect of change in accounting
principle...................................... 0 0 582,542 582,542 0
Deferred income taxes............................ 10,231 (764,802) (238,815) 0 0
Amortization of deferred investment tax credit... (71,616) (71,616) (71,616) (35,808) (35,808)
Equity in net loss of subsidiary................. 1,052,227 2,444,706 0 0 0
Minority interest in net loss of subsidiary...... 0 0 (13,294,079) (9,199,846) (4,642,791)
Changes in operating assets and liabilities:
Accounts receivable............................ 487,157 (811,787) (10,262,070) (1,246,693) (4,977,631)
Prepaid expenses............................... (15,772) 5,580 (408,164) (205,815) (315,640)
Accounts payable............................... (2,056,062) 2,111,164 (110,228) (2,172,285) 11,317,595
Accrued liabilities and interest............... 1,373,123 (1,283,101) 37,437,445 13,830,386 (6,664,219)
Unearned revenue............................... 15,155 59,934 1,514,093 261,439 336,069
Other.......................................... (202,235) 48,894 (88,467) (161,049) (49,956)
----------- ------------ ------------- ------------ ------------
Total adjustments............................ 3,340,539 4,507,457 46,182,431 13,151,411 22,339,084
----------- ------------ ------------- ------------ ------------
Net cash provided by (used in) operating
activities................................. 4,770,730 3,680,116 23,035,488 7,328,169 (5,289,536)
----------- ------------ ------------- ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures............................... (995,320) (1,727,079) (120,227,057) (48,885,972) (47,870,456)
Purchase of investments and acquisitions, net of
cash acquired.................................... 0 (14,310,000) (80,065,198) (10,177,234) 0
Organizational cost expenditures................... 0 0 (251,815) (109,002) 43,695
Proceeds from sale of investments.................. 797,958 118,711 162,264,322 35,470,390 49,276,833
Dividends from affiliate/return of capital......... 0 (4,193,276) (1,424,222) 0 0
Accounts payable-capital related................... 0 (2,112,296) 0 0 0
Investment in ClearSource, Inc..................... 0 0 (825,072) 0 0
Proceeds from sale of property..................... 0 0 32,075 0 54,361
Other.............................................. 0 0 (234,417) 0 0
----------- ------------ ------------- ------------ ------------
Net cash (used in) provided by investing
activities................................. (197,362) (22,223,940) (40,731,384) (23,701,818) 1,504,433
----------- ------------ ------------- ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments on debt and short-term
borrowings....................................... (911,326) 0 (11,654) (2,656) (2,494)
Expenditures related to issuance of debt and credit
facility......................................... 0 0 (1,498,817) (283,650) (51,531)
Proceeds from the issuance of subsidiary common
stock............................................ 0 0 3,152 0 0
Additional infusion of equity...................... 874,493 14,310,000 15,564,902 12,477,013 0
(Advances to) repayments from affiliate............ (4,420,343) 4,416,407 2,025,604 892,987 (125,423)
----------- ------------ ------------- ------------ ------------
Net cash (used in) provided by financing
activities................................. (4,457,176) 18,726,407 16,083,187 13,083,694 (179,448)
----------- ------------ ------------- ------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS........................................ 116,192 182,583 (1,612,709) (3,289,955) (3,964,551)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD.... 328,127 444,319 6,771,483 6,771,483 5,158,774
----------- ------------ ------------- ------------ ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD.......... $ 444,319 $ 626,902 $ 5,158,774 $ 3,481,528 $ 1,194,223
=========== ============ ============= ============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for interest........... $ 9,933 $ 12,431 $ 46,162 $ 8,507 $ 3,647
=========== ============ ============= ============ ============
Cash paid during the period for income taxes....... $ 167,038 $ 1,145,805 $ 1,742,947 $ 0 $ 0
=========== ============ ============= ============ ============
Merger of subsidiary out of consolidated group..... $ 0 $ 108,108 $ 0 $ 0 $ 0
=========== ============ ============= ============ ============
Subsidiary preferred stock dividends............... $ 0 $ 4,193,276 $ 1,424,222 $ 0 $ 0
=========== ============ ============= ============ ============
Detail of investments and acquisitions:
Property, plant, and equipment................... $ 0 $ 0 $ 30,133,876 $ 0 $ 0
Intangible assets................................ 0 0 55,009,395 3,401,355 0
Minority Interest................................ 0 0 20,912,251 6,775,879 0
Common and/or Preferred Stock received
(issued)....................................... 0 14,310,000 (34,532,324) 0 0
Bond discount.................................... 0 0 8,542,000 0 0
----------- ------------ ------------- ------------ ------------
Net cash paid for acquisitions................... $ 0 $ 14,310,000 $ 80,065,198 $ 10,177,234 $ 0
=========== ============ ============= ============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-6
<PAGE> 75
KNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1997, AND 1998
1. ORGANIZATION, NATURE OF BUSINESS, AND BASIS OF PRESENTATION
ORGANIZATION
KNOLOGY, Inc. (the "Company") was incorporated under the laws of the State
of Delaware in September 1998. The purpose of incorporating the Company was to
enable ITC Holding Company, Inc. ("ITC Holding"), the Company's parent company
and majority stockholder, to complete a reorganization of certain of its wholly
owned and majority owned subsidiaries on , 1999 (the
"Reorganization"), as follows:
a. ITC Holding contributed all of the outstanding capital stock of
Interstate Telephone, Inc; Valley Telephone, Inc.; Globe Telecom, Inc.; and
ITC Globe, Inc. to the Company (collectively, "Telephone Operations
Group").
b. ITC Holding contributed its 85% interest in KNOLOGY Holdings, Inc.
("KNOLOGY Holdings") to the Company.
c. ITC Holding contributed its 6% interest of ClearSource, Inc. to the
Company.
d. Other minority shareholders exchanged the remaining 15% of KNOLOGY
Holdings for shares of stock of the Company.
As a result of the Reorganization, the Telephone Operations Group and
KNOLOGY Holdings and subsidiaries are now wholly owned subsidiaries of the
Company.
The Reorganization has been accounted for in a manner similar to a pooling
of interest for the Telephone Operations Group. KNOLOGY Holdings and
subsidiaries have been treated as an equity investment in subsidiary in 1996 and
1997 in relation to the Company's 29% and 41% ownership interest, respectively.
KNOLOGY Holdings and subsidiaries have been consolidated with the Company in
1998 in relation to the 85% controlling interest obtained in July 1998 (Note 9)
which was recorded at ITC Holding's historical cost with the remainder treated
as an acquisition of minority interest. In accordance with Accounting Principles
Board Opinion No. 16, the fair value of acquired minority interest, $19,356,060,
is included in goodwill at December 31, 1998.
The November 1999 stock split (Note 11) has been retroactive reflected in
the financial statements.
NATURE OF BUSINESS
The Telephone Operations Group is wholly owned and provides a full line of
local telephone and related services and broadband services. Certain of the
Telephone Operations Group subsidiaries are subject to regulation, by state
public service commissions of applicable states, for intrastate
telecommunications services. For applicable interstate matters related to
telephone service, certain Telephone Operations Group subsidiaries are subject
to regulation by the Federal Communications Commission.
KNOLOGY Holdings and its subsidiaries own and operate advanced hybrid
fiber-coaxial networks and provide residential and business customers broadband
communications services, including analog and digital cable television, local
and long-distance telephone, high-speed Internet access, and broadband carrier
services to various markets in the southeastern United States.
The Company has experienced operating losses as a result of the expansion
of the advanced broadband communications networks and services into new and
existing markets. The Company expects to continue to focus on increasing its
customer base and expanding its broadband operations. Accordingly, the Company
expects that its operating expenses and capital expenditures will continue to
increase as it extends its broadband communications networks in the existing and
new markets in accordance with its
F-7
<PAGE> 76
KNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
business plan. On December 22, 1998, KNOLOGY Holdings entered into a $50 million
four-year senior secured credit facility, which may be used for working capital
and other purposes, including capital expenditures and permitted acquisitions
(Note 3). The Company also plans to complete a private placement of Series B
preferred stock to a small group of institutional investors to provide
additional funds for its expansion plans (Note 11). While management expects its
expansion plans will result in profitability, there can be no assurance that
growth in the Company's revenue or customer base will continue or that the
Company will be able to achieve or sustain profitability and/or positive cash
flow.
BASIS OF PRESENTATION
The consolidated financial statements are prepared on the accrual basis of
accounting and include the accounts of the Company and its wholly owned and
majority-owned subsidiaries. Investments in which the Company does not exercise
significant control are accounted for using the cost method of accounting.
Investments in which the Company does exercise significant control and owns less
than 50% are accounted for using the equity method. All significant intercompany
balances have been eliminated.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ACCOUNTING ESTIMATES
The preparation of financial statements, in conformity with generally
accepted accounting principles, requires management to make estimates and
assumptions that affect the reported amount of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS
The Company considers all short-term, highly liquid investments with an
original maturity date of three months or less to be cash equivalents. Cash and
cash equivalents are stated at cost, which approximates fair value.
MARKETABLE SECURITIES
The Company's marketable securities are categorized as available-for-sale
securities, as defined by Statement of Financial Accounting Standards ("SFAS")
No. 115, "Accounting for Certain Investments in Debt and Equity Securities."
Unrealized holding gains and losses are reflected as a net amount in a separate
component of stockholders' equity until realized. For the purpose of computing
realized gains and losses, cost is identified on a specific identification
basis. Securities available for sale at December 31, 1998 are primarily
comprised of commercial paper.
F-8
<PAGE> 77
KNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
PROPERTY, PLANT, AND EQUIPMENT
Property, plant, and equipment are stated at cost. Depreciation and
amortization are calculated using the straight-line method over the estimated
useful lives of the assets, commencing when the asset is installed or placed in
service. Maintenance, repairs, and renewals are charged to expense as incurred.
The cost and accumulated depreciation of property and equipment disposed of are
removed from the related accounts, and any gain or loss is included in or
deducted from income. Depreciation and amortization (excluding telephone plant)
are provided over the estimated useful lives as follows:
<TABLE>
<CAPTION>
YEARS
-----
<S> <C>
Buildings................................................... 25
System and installation equipment........................... 7-10
Production equipment........................................ 7
Test and office equipment................................... 3-7
Automobiles and trucks...................................... 5
Leasehold improvements...................................... 5
</TABLE>
Depreciation of telephone plant is provided on a straight-line method,
using class or overall group rates acceptable to regulatory authorities. Such
rates range from 2% to 24%.
Inventories are valued at the lower of cost or market (determined on a
weighted average basis) and include customer premise equipment and certain plant
construction materials. These items are transferred to system and installation
equipment when installed.
Interest is capitalized in connection with the construction of the
Company's broadband networks. The capitalized interest is recorded as part of
the asset to which it relates and is amortized over the asset's estimated useful
life. In 1998, approximately $2,469,000 of interest costs was capitalized.
For the six months ended June 30, 1998 and 1999, approximately $1,054,000
and $1,539,000, respectively of interest costs were capitalized (unaudited).
INTANGIBLE ASSETS
Intangible assets include the excess of the purchase price of acquisitions
over the fair value of net assets acquired as well as various other acquired
intangibles and costs associated with the issuance of debt and the consummation
of a credit facility. Intangible assets and the related useful lives and
accumulated amortization at December 31, 1998 are as follows:
<TABLE>
<CAPTION>
AMORTIZATION
PERIOD
1998 (YEARS)
----------- ------------
<S> <C> <C>
Goodwill.................................................... $47,681,301 10-40
Subscriber base............................................. 34,863,072 3
Debt issuance costs (Note 3)................................ 9,382,124 4-10
Noncompete agreement........................................ 1,500,000 3
Other....................................................... 102,979 10-15
-----------
93,529,476
Less accumulated amortization............................... 5,887,296
-----------
Intangibles, net............................................ $87,642,180
===========
</TABLE>
During 1998, the Company adopted the provisions of AICPA Statement of
Position 98-5, "Reporting on the Costs of Start-Up Activities," which requires
that all nongovernmental entities expense costs of
F-9
<PAGE> 78
KNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
start-up activities, including pre-operating, preopening, and organization
activities, as the costs are incurred. Adoption of this statement resulted in a
cumulative effect of accounting change of $582,541.
LONG-LIVED ASSETS
In 1995, the Company adopted SFAS No. 121, "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." SFAS No. 121
establishes accounting standards for the impairment of long-lived assets,
certain identifiable intangibles, and cost in excess of net assets acquired
related to those assets to be held and used and for long-lived assets and
certain identifiable intangibles to be disposed of. The effect of adopting SFAS
No. 121 was not material.
The Company periodically reviews the values assigned to long-lived assets,
such as inventory, property and equipment, and goodwill to determine whether any
impairments are other than temporary. Management believes that there is no
impairment of long-lived assets included in the accompanying balance sheets.
INVESTMENTS
Investments and equity ownership in associated companies consisted of the
following at December 31, 1997 and 1998:
<TABLE>
<CAPTION>
1997 1998
----------- -----------
<S> <C> <C>
Equity ownership in associated companies:
KNOLOGY Holdings preferred stock, 14,267 shares in 1997... $14,184,734 $ 0
Nonmarketable investments, at cost:
ClearSource, Inc. common and preferred stock, 0 and
333,444 shares in 1997 and 1998, respectively.......... 0 825,072
Other nonmarketable investments........................... 98,893 0
----------- -----------
$14,283,627 $ 825,072
=========== ===========
</TABLE>
At December 31, 1998, KNOLOGY Holdings, Inc. owned approximately 11% of
ClearSource, Inc. ("ClearSource"). ClearSource was formed during 1998 to build
and operate advanced broadband networks offering a bundle of communications
services to residential and business customers. The Company's investment in
ClearSource is accounted for under the cost method of accounting.
As of December 31, 1997 and 1998, the Company owned approximately 29% and
85%, respectively, of KNOLOGY Holdings. The Company's ownership interest in
KNOLOGY Holdings was accounted for using the equity method during 1997. The
Company's equity in KNOLOGY Holdings' losses included in the accompanying
statements of operations was $1,052,227 and $2,444,706 for the years ended
December 31, 1996 and 1997, respectively. KNOLOGY Holdings' results of
operations and its cash flows are included in the accompanying financial
statements for the year ended December 31, 1998 excluding preacquisition losses
and minority interest.
F-10
<PAGE> 79
KNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following summarizes the assets, liabilities and equity as of December
31, 1997 and the results of operations for the years ended December 31, 1996 and
1997 of associated companies in which the Company's investments were accounted
for by the equity method.
<TABLE>
<CAPTION>
1997
------------
<S> <C>
ASSETS:
Current assets............................................ $235,670,423
Property and other noncurrent assets...................... 80,527,677
------------
Total assets...................................... $316,198,100
============
LIABILITIES AND EQUITY:
Current liabilities....................................... $ 8,840,263
Noncurrent liabilities.................................... 253,232,923
Warrants.................................................. 2,486,960
Equity.................................................... 51,637,954
------------
Total liabilities and equity...................... $316,198,100
============
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------
1996 1997
----------- -----------
<S> <C> <C>
RESULTS OF OPERATIONS:
Operating revenues........................................ $ 5,334,183 $10,355,068
Operating loss............................................ (2,703,273) (5,511,386)
Net loss.......................................... (3,125,428) (9,091,533)
</TABLE>
REVENUE RECOGNITION
The Company's revenues are recognized when services are provided,
regardless of the period in which they are billed. Fees billed in advance are
included in the accompanying balance sheets as unearned revenue and are deferred
until the month the service is provided.
ADVERTISING COSTS
The Company expenses all advertising costs as incurred. Approximately
$1,000, $9,000, and $587,000 of advertising expense are recorded in the
Company's statements of operations for the years ended December 31, 1996, 1997,
and 1998, respectively.
Approximately $282,000 and $679,000 of advertising expense are recorded in
the Company's statements of operations for the six months ended June 30, 1998
and 1999, respectively (unaudited).
SOURCES OF SUPPLIES
The Company purchases customer premise equipment and plant materials from
outside vendors. Although numerous suppliers market and sell customer premise
equipment and plant materials, the Company currently purchases each customer
premise component from a single vendor and has several suppliers for plant
materials. If the suppliers are unable to meet the Company's needs as it
continues to build out its network infrastructure, then delays and increased
costs in the expansion of the Company's network could result, which would
adversely affect operating results.
CREDIT RISK
The Company's accounts receivable potentially subject the Company to credit
risk, as collateral is generally not required. The Company's risk of loss is
limited due to advance billings to customers for
F-11
<PAGE> 80
KNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
services and the ability to terminate access on delinquent accounts. The
potential for material credit loss is mitigated by the large number of customers
with relatively small receivable balances. The carrying amount of the Company's
receivables approximates their fair values.
INCOME TAXES
The Company utilizes the liability method of accounting for income taxes,
as set forth in SFAS No. 109, "Accounting for Income Taxes." Under the liability
method, deferred taxes are determined based on the difference between the
financial and tax bases of assets and liabilities using enacted tax rates in
effect in the years in which the differences are expected to reverse. Deferred
tax benefit represents the change in the deferred tax asset and liability
balances (Note 6).
For the years ended December 31, 1997 and 1998, the Telephone Operations
Groups was included in the consolidated tax returns of the Company's parent
company, ITC Holding. Effective August 1998, KNOLOGY Holdings was included in
the consolidated federal income tax return of ITC Holding. The Company and its
subsidiaries file separate state income tax returns. Under a tax sharing
arrangement, the Company recorded an income tax benefit of $5,631,618 and an
affiliate receivable in the amount of $6,785,691 at December 31, 1998 for the
utilization of net operating losses included in the consolidated tax return of
ITC Holding. For the period from January 1, 1998 to July 31, 1998, KNOLOGY
Holdings filed a separate federal income tax return.
Investment tax credits related to telephone plant have been deferred and
are being amortized as a reduction of federal income tax expense over the
estimated useful lives of the assets giving rise to the credits.
COMPREHENSIVE INCOME
In 1998, the Company adopted SFAS No. 130, "Reporting Comprehensive
Income." This statement establishes standards for reporting and display of
comprehensive income and its components in a full set of general purpose
financial statements. The Company has chosen to disclose comprehensive income,
which consists of net income and unrealized appreciation, in the statements of
stockholders' equity. Prior years have been restated to conform to the SFAS No.
130 requirements.
NET INCOME (LOSS) PER SHARE
In 1997, the Company adopted SFAS No. 128, "Earnings Per Share." That
statement requires the disclosure of basic net income (loss) per share and
diluted net income (loss) per share. Basic net income (loss) per share is
computed by dividing net income (loss) available to common shareholders by the
weighted-average number of common shares outstanding during the period. Diluted
net loss per share gives effect to all potentially dilutive securities. The
Company did not have any potentially dilutive securities during the periods
presented.
F-12
<PAGE> 81
KNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. LONG-TERM DEBT
Long-term debt at December 31, 1998 consists of the following:
<TABLE>
<CAPTION>
1998
------------
<S> <C>
Senior Discount Notes, with a face value of $444,100,000,
bearing interest at 11.875% beginning October 15, 2002,
payable semiannually beginning April 15, 2003 with
principal and any unpaid interest due
October 15, 2007.......................................... $255,020,209
Capitalized lease obligation, at a rate of 10%, payable in
quarterly installments of $6,304 through December 2006,
secured................................................... 134,244
------------
255,154,453
Less current maturities..................................... 25,094
------------
$255,129,359
============
</TABLE>
Following are maturities of long-term debt for each of the next five years
as of December 31, 1998:
<TABLE>
<S> <C>
1999........................................................ $ 25,094
2000........................................................ 13,438
2001........................................................ 14,833
2002........................................................ 16,374
2003........................................................ 18,074
Thereafter.................................................. 444,146,431
------------
Total............................................. $444,234,244
============
</TABLE>
The fair values of long-term debt, including current maturities, at
December 31, 1998 are estimated to be approximately $280,804,000, based on a
valuation technique that considers cash flows discounted at current rates.
On December 22, 1998, KNOLOGY Holdings entered into a $50 million four-year
senior secured credit facility with First Union National Bank and First Union
Capital Markets Corp., which may be used for working capital and other purposes,
including capital expenditures and permitted acquisitions. At KNOLOGY Holdings'
option, interest will accrue based on either the Alternate Base Rate plus
applicable margin or the LIBOR rate plus applicable margin. Obligations under
the credit facility will be secured by substantially all tangible and intangible
assets of KNOLOGY Holdings and its current and future subsidiaries. The credit
facility includes a number of covenants, including, among others, covenants
limiting the ability of KNOLOGY Holdings and its subsidiaries and their present
and future subsidiaries to incur debt, create liens, pay dividends, make
distributions or stock repurchases, make certain investments, engage in
transactions with affiliates, sell assets, and engage in certain mergers and
acquisitions. The credit facility also includes covenants requiring compliance
with certain operating and financial ratios on a consolidated basis. The credit
facility allows KNOLOGY Holdings to borrow up to five times certain individual
subsidiary's "consolidated adjusted cash flow" as defined in the credit
facility. In connection with the initiation of the revolving credit facility,
KNOLOGY Holdings incurred approximately $1,256,000 in related costs which are
being amortized on a straight-line basis over the five year term.
In the fourth quarter of 1997, KNOLOGY Holdings issued units consisting of
senior discount notes due 2007 and warrants to purchase Preferred Stock for
gross proceeds of approximately $250 million. The notes were offered at a
substantial discount from face value, with no interest payable for the first
five years. Approximately $2.5 million of the gross proceeds has been allocated
to the warrants. Each warrant allows the holder to purchase .003734 shares of
KNOLOGY Holdings' preferred stock. KNOLOGY
F-13
<PAGE> 82
KNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Holdings incurred approximately $7.9 million in costs to issue the senior
discount notes. These costs are being amortized at an effective rate over the
life of the notes. The indenture relating to the notes contains certain
covenants that, among other things, limit the ability of KNOLOGY Holdings to
incur indebtedness, pay dividends, prepay subordinated indebtedness, repurchase
capital stock, make investments, engage in transactions with stockholders and
affiliates, create liens, sell assets, and engage in mergers and consolidations.
The proceeds from the offering of the units have been, and will be, used to
repay certain indebtedness of KNOLOGY Holdings, to fund expansion of KNOLOGY
Holdings' business, and for additional working capital and general corporate
purposes.
4. OPERATING LEASES
The Company leases office space, utility poles, and other assets for
varying periods. Leases that expire are generally expected to be renewed or
replaced by other leases.
Future minimum rental payments required under the operating leases that
have initial or remaining noncancelable lease terms in excess of one year as of
December 31, 1998 are as follows:
<TABLE>
<S> <C>
1999........................................................ $293,493
2000........................................................ 198,888
2001........................................................ 166,181
2002........................................................ 155,199
2003 and thereafter......................................... 125,575
--------
Total minimum lease payments...................... $939,336
========
</TABLE>
Total rental expense for all operating leases was approximately $0, $0 and
$259,000 for the years ended December 31, 1996, 1997, and 1998, respectively.
Total rental expense for all operating leases was approximately $176,000
and $253,000 for the six months ended June 30, 1998 and 1999 (unaudited).
5. COMMITMENTS AND CONTINGENCIES
PURCHASE COMMITMENTS
The Company has entered into contracts with various entities to provide
programming to be aired by KNOLOGY Holdings. The Company pays a monthly fee as
cost for the programming services, generally based on the number of average
subscribers to the program, although some fees are adjusted based on the total
number of subscribers to the system and/or the system penetration percentage.
Certain contracts have minimum monthly fees. The Company estimates that it will
pay approximately $6.5 million in programming fees under these contracts during
1999.
LEGAL PROCEEDINGS
In the normal course of business, the Company is subject to various
litigation; however, in management's opinion, there are no legal proceedings
pending against the Company which would have a material adverse effect on the
financial position, results of operations, or liquidity of the Company.
F-14
<PAGE> 83
KNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
6. INCOME TAXES
The (provision) benefit for income taxes from continuing operations
consisted of the following for the years ended December 31, 1996, 1997 and 1998:
<TABLE>
<CAPTION>
1996 1997 1998
----------- ----------- ------------
<S> <C> <C> <C>
Current........................................ $(1,361,634) $(1,775,581) $ 5,392,803
Deferred....................................... 347,527 1,596,002 10,662,185
Increase in valuation allowance................ (357,758) (831,200) (10,423,370)
----------- ----------- ------------
Income tax provision (benefit)................. $(1,371,865) $(1,010,779) $ 5,631,618
=========== =========== ============
</TABLE>
Deferred income taxes reflect the net tax effect of temporary
differences between the carrying amount of assets and liabilities for
financial reporting purposes and the amounts used for income tax purposes.
The significant components of deferred tax assets and liabilities as of
December 31, 1997 and 1998 are as follows (in thousands):
<TABLE>
<CAPTION>
1997 1998
----------- ------------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards......................... $ 0 $ 8,923,583
Equity in losses of subsidiaries......................... 1,188,958 1,188,958
Deferred charges......................................... 170,704 0
Deferred bond interest................................... 0 12,919,184
Deferred revenues........................................ 426,910 190,918
Other.................................................... 85,978 1,841,404
Valuation allowance...................................... (1,188,958) (15,777,328)
----------- ------------
Total deferred tax assets........................ 683,592 9,286,719
Deferred tax liabilities:
Depreciation and amortization............................ 1,244,065 9,608,377
----------- ------------
560,473 321,658
Portion included in current assets....................... 97,872 0
----------- ------------
Net deferred income taxes.................................. $ 658,345 $ 321,658
=========== ============
</TABLE>
At December 31, 1997 the Company had deferred tax assets related to equity
losses of subsidiaries. Management has recorded a 100% valuation allowance in
1997 against these deferred tax assets, as the Company has determined it is more
likely than not that the deferred tax assets will not be realized. The Company
has available, at December 31, 1998, unused net operating loss carryforwards of
approximately $23,657,000, expiring in various years from 2005 to 2013, unless
utilized. Management has recorded a total valuation allowance of $15,777,328 in
1998 on these operating loss carryforwards, the majority of which contain
limitations on utilization, and the equity losses of subsidiaries.
A reconciliation of the income tax provision computed at statutory tax
rates to the income tax provision for the years ended December 31, 1996, 1997,
and 1998 is as follows:
<TABLE>
<CAPTION>
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Income tax (provision) benefit at statutory rate............ (34)% (34)% 34%
State income taxes, net of federal benefit.................. (4) (4) 4
Other....................................................... 2 (60) 1
Increase in valuation allowance............................. (13) (453) (25)
--- ---- ---
(49)% (551)% 14%
=== ==== ===
</TABLE>
F-15
<PAGE> 84
KNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
7. EQUITY INTERESTS
CAPITAL TRANSACTIONS
The Company has authorized 200,000,000 shares of $.01 par value common
stock, 75,000,000 shares of $.01 par value Series A convertible preferred stock,
and 50,000,000 shares of $.01 par value Series B convertible preferred stock.
KNOLOGY HOLDINGS' STOCK OPTION PLAN
Under KNOLOGY Holdings' 1995 stock option plan (the "Stock Option Plan"),
as adopted in December 1995 and amended in February 1998, 700,000 shares of
KNOLOGY Holdings' common stock are reserved and authorized for issuance upon the
exercise of the options. All employees of KNOLOGY Holdings are eligible to
receive options under the Stock Option Plan. The Stock Option Plan is
administered by the compensation and stock option committee of the board of
directors. Options granted under the Stock Option Plan are intended to qualify
as "incentive stock options" under Section 422 of the Internal Revenue Code of
1986, as amended. All options were granted at an exercise price equal to the
estimated fair value of the common stock at the dates of grant as determined by
the board of directors based on equity transactions and other analyses. The
options expire ten years from the date of grant.
STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 123
During 1995, the Financial Accounting Standards Board issued SFAS No. 123,
"Accounting for Stock-Based Compensation," which defines a fair value-based
method of accounting for an employee stock option or similar equity instrument
and encourages all entities to adopt that method of accounting for all of their
employee stock compensation plans. However, it also allows an entity to continue
to measure compensation cost for those plans using the method of accounting
prescribed by Accounting Principles Board ("APB") Opinion No. 25, "Accounting
for Stock Issued to Employees." Entities electing to remain with the accounting
methodology required by APB Opinion No. 25 must make pro forma disclosures of
net income and, if presented, earnings per share as if the fair value-based
method of accounting defined in SFAS No. 123 had been applied.
The Company accounts for KNOLOGY Holdings' stock-based compensation plans
under APB Opinion No. 25, under which no compensation cost has been recognized
by the Company. However, the Company has computed, for pro forma disclosure
purposes, the value of all options for shares of KNOLOGY Holdings' common stock
to employees of KNOLOGY Holdings using the Black-Scholes option pricing model
and the following weighted average assumptions in 1996, 1997, and 1998:
<TABLE>
<CAPTION>
1996 1997 1998
----------- ----------- -----------
<S> <C> <C> <C>
Risk-free interest rate......................... 6.31% 6.43% 5.42%
Expected dividend yield......................... 0% 0% 0%
Expected lives.................................. Seven years Seven years Seven years
Expected volatility............................. 30% 30% 30%
</TABLE>
F-16
<PAGE> 85
KNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The weighted average fair value of options granted was $8.00, $8.44, and
$10.21 for 1996, 1997, and 1998, respectively. The total value of options for
KNOLOGY Holdings' stock granted to employees of KNOLOGY Holdings during 1996,
1997, and 1998 was computed as approximately $154,000, $304,000, and $1,832,000,
respectively, which would be amortized on a pro forma basis over the five-year
vesting period of the options. If the Company had accounted for these plans in
accordance with SFAS No. 123, the Company's net income (loss) for the periods
presented would be as follows:
<TABLE>
<CAPTION>
AS
REPORTED PRO FORMA
------------ ------------
<S> <C> <C>
Net income (loss) attributable to common stockholders for
the years ended December 31:
1996.................................................... $ 1,430,191 $ 1,140,468
1997.................................................... (5,020,617) (5,117,946)
1998.................................................... (24,571,165) (24,601,654)
Earnings (loss) per share attributable to common
stockholders for the years ended December 31:
1996.................................................... 23.84 19.01
1997.................................................... (83.68) (85.30)
1998.................................................... (409.52) (410.03)
</TABLE>
A summary of the status of KNOLOGY Holdings' stock option plan at December
31, 1998 is presented in the following table:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
EXERCISE
PRICE PER
SHARES SHARE
------- ---------
<S> <C> <C>
Outstanding at December 31, 1996:........................... 52,797 8.00
Granted................................................... 126,384 8.44
Forfeited................................................. (15,939) 8.00
-------
Outstanding at December 31, 1997:........................... 163,242 8.34
Granted................................................... 565,376 10.18
Forfeited................................................. (36,056) 9.52
Exercised................................................. (394) 8.00
-------
Outstanding at December 31, 1998............................ 692,168
=======
Exercisable shares as of December 31:
1996...................................................... 0 $ 0.00
=======
1997...................................................... 6,606 8.00
=======
1998...................................................... 30,006 8.00
=======
</TABLE>
TELEPHONE OPERATIONS GROUP STOCK OPTION PLAN
The Company's parent, ITC Holding, sponsors a stock option plan which
provides for the granting of stock options to substantially all employees of the
Telephone Operations Group. Options are generally granted at a price
(established by ITC Holding's board of directors based on equity transactions
and other analyses) equal to at least 100% of the fair market value of the ITC
Holding's common stock on the option grant date. Options granted generally
become exercisable 40% after two years and 20% per annum for the next three
years and remain exercisable for ten years after the option grant date.
F-17
<PAGE> 86
KNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 123
ITC Holding accounts for its stock-based compensation plans under APB
Opinion No. 25, under which no compensation cost has been recognized by the
Company. However, the Company has computed, for pro forma disclosure purposes,
the value of all options for shares of ITC Holding's common stock granted to
employees of the Telephone Operations Group using the Black-Scholes option
pricing model prescribed by SFAS No. 123 and the following weighted average
assumptions:
<TABLE>
<CAPTION>
1996 1997 1998
--------- --------- ---------
<S> <C> <C> <C>
Risk-free interest rate..................................... 6.3% 6.0% 5.3%
Expected dividend yield..................................... 0% 0% 0%
Expected lives.............................................. Ten years Ten years Ten years
Expected volatility......................................... 50% 60% 50%
</TABLE>
The weighted average fair value of options granted was $4.91, $4.54, and
$9.58 for 1996, 1997, and 1998, respectively. The total value of options for ITC
Holding's stock granted to employees of the Telephone Operations Group during
1996, 1997, and 1998 was computed as approximately $407,000, $2,427,000, and
$382,000, respectively, which would be amortized on a pro forma basis over the
five-year vesting period of the options. If the Company had accounted for these
plans in accordance with SFAS No. 123, the Company's net income (loss) for the
periods presented would be as follows:
<TABLE>
<CAPTION>
AS
REPORTED PRO FORMA
------------ ------------
<S> <C> <C>
Net income (loss) attributable to common shareholders for
the years ended December 31:
1996...................................................... $ 1,430,191 1,216,808
1997...................................................... (5,020,617) (7,015,805)
1998...................................................... (24,571,165) (24,940,748)
Earnings (loss) per share attributable to common
stockholders for the years ended December 31:
1996...................................................... $ 23.84 $ 21.59
1997...................................................... (83.68) (107.16)
1998...................................................... (409.52) (415.68)
</TABLE>
A summary of the status of the Telephone Operations Group's portion of ITC
Holding's stock option plan at December 31, 1998 is presented in the following
table:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
EXERCISE
PRICE PER
SHARES SHARE
-------- ------------
<S> <C> <C>
Outstanding at December 31, 1996:........................... 479,756 $ 0.15-$3.36
Granted................................................... 188,732 $ 3.36-$7.75
Forfeited................................................. (33,800) $ 0.49-$7.75
Exercised................................................. (31,000) $ 0.28-$2.73
--------
Outstanding at December 31, 1997:........................... 603,688 $ 0.15-$7.75
Granted................................................... 86,968 $8.38-$12.50
Forfeited................................................. (93,172) $1.26-$12.50
Exercised................................................. (149,372) $ 0.28-$3.36
--------
Outstanding at December 31, 1998............................ 448,112 $0.15-$12.50
========
</TABLE>
F-18
<PAGE> 87
KNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table sets for the exercise price range, number of shares,
weighted average exercise price and remaining contractual lives by groups of
similar price and grant date:
<TABLE>
<CAPTION>
WEIGHTED
SHARES AVERAGE
EXERCISABLE AT WEIGHTED REMAINING
EXERCISE PRICE DECEMBER 31, AVERAGE CONTRACTUAL
RANGE 1998 PRICE LIFE(YEARS)
-------------- -------------- -------- -----------
<S> <C> <C> <C> <C>
$ 1.58-$2.21 145,154 1.70 5.45
$ 2.73-$4.01 21,472 2.73 7.20
</TABLE>
TELEPHONE OPERATIONS GROUP SAVINGS PLAN
The Telephone Operations Group has a savings plan (the "Savings Plan") that
qualifies as a deferred salary arrangement under Section 401(k) of the Internal
Revenue Code. Under the Savings Plan, participating employees may defer a
portion of their pretax earnings, up to the Internal Revenue Service annual
contribution limit. Annually, the Telephone Operations Group determines whether
to make a discretionary matching contribution equal to a percentage, determined
by the Telephone Operations Group, of the employee's deferred compensation
contribution. Employer contributions to the Savings Plan of approximately
$118,000, $96,000, and $125,000 were made for the years ended December 31, 1996,
1997, and 1998, respectively.
8. RELATED-PARTY TRANSACTIONS
ITC Holding occasionally provides certain administrative services, such as
legal and tax planning services, for the Company. The costs of these services
are charged to the Company based primarily on the salaries and related expenses
for certain of the ITC Holding executives and an estimate of their time spent on
projects specific to the Company. For the years ended December 31, 1996, 1997,
and 1998, the Company recorded approximately $1,547,000, $3,459,000, and
$3,230,000, respectively, in selling, operations, and administrative expenses
related to these services. In the opinion of management, amounts charged to the
Company are consistent with costs that would be incurred from third party
providers.
Certain of ITC Holding's affiliates provide the Company with various
services and/or receive services provided by the Company. These entities include
InterCall, Inc., which provides conference calling services. In addition, we
receive services from ITCODeltaCom, Inc., an affiliate of ITC Holding which
provides wholesale long-distance and related services and which leases capacity
on certain of its fiber routes. ITC Holding also holds equity investments in the
following entities which do business with the Company: Powertel, Inc., which
provides cellular services, and MindSpring Enterprises, Inc., which is a
national provider of Internet access. In management's opinion, the Company's
transactions with these affiliated entities are representative of arm's-length
transactions.
For the years ended December 31, 1996, 1997, and 1998, the Company received
services from these affiliated entities in the amounts of approximately
$620,000, $707,000, and $1,570,000, respectively, which are reflected in cost of
services and selling, operations, and administrative expenses in the Company's
statements of operations.
F-19
<PAGE> 88
KNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company also provides switching, programming, and other services for
various affiliated companies on a contracted or time and materials basis. Total
amounts paid by the affiliated companies for these services approximated
$1,616,000, $1,517,000, and $2,186,000, respectively, for the years ended
December 31, 1996, 1997, and 1998 and are reflected in operating revenues in the
Company's statements of operations.
During 1998, the Company leased office space to ITCODeltaCom, Inc. and
Powertel, Inc. Approximately $234,000 of lease income related to these
transactions is recorded as other income in the Company's statement of
operations for the year ended December 31, 1998.
Relatives of the stockholders of ITC Holding are stockholders and employees
of the Company's insurance provider. The costs charged to the Company for
insurance services were approximately $222,000, $221,000, and $628,000 for the
years ended December 31, 1996, 1997, and 1998, respectively.
9. BUSINESS ACQUISITIONS
KNOLOGY HOLDINGS ACQUISITIONS
In January 1998, the Company acquired an additional 6,747 shares of KNOLOGY
Holdings preferred stock, representing an approximate 13% ownership interest in
KNOLOGY Holdings, in exchange for cash of $10,177,234. The acquisition of the
additional interest was accounted for as a step acquisition. The fair value of
net assets acquired totaled $6,775,879, resulting in goodwill of $3,401,355.
Effective July 1998, the Company acquired an additional 42,565 shares,
representing approximately 43% of KNOLOGY Holdings' outstanding stock.
The Company recorded its acquisition of this additional ownership interest
under the purchase method of accounting as a step acquisition. Accordingly, the
Company recorded the pro rata share of net assets acquired at fair value. The
Company determined that the book value of the pro rata share of assets and trade
liabilities acquired approximated fair value. The fair value of KNOLOGY
Holdings' senior discount notes (Note 4) was determined to be less than book
value at the date of acquisition based on quoted market prices. As a result, a
debt discount of approximately $8,542,000 was recorded to adjust the book value
of the pro rata share of senior notes acquired to fair value (Note 4).
The total value paid by the Company was $36,687,424, including cash of
$2,155,100, common and preferred stock valued at $34,532,324. The fair value of
net assets acquired totaled $22,678,372, resulting in goodwill of $14,009,052.
Prior to the acquisition, the Company owned more stock than any other single
KNOLOGY Holdings stockholder, owning approximately 42% of the outstanding stock.
As a result of the acquisition, the Company owns approximately 85% of the
outstanding stock of KNOLOGY Holdings at December 31, 1998.
CABLE ALABAMA ACQUISITION
On October 30, 1998, KNOLOGY Holdings acquired substantially all of the
assets of Cable Alabama Corporation ("Cable Alabama") for approximately
$60,733,000 in cash and also purchased for $5,000,000 in cash certain real
property located in Huntsville, Alabama. Cable Alabama owned and operated a
cable television system serving the Huntsville, Alabama area. KNOLOGY Holdings
plans to upgrade the existing Cable Alabama plant is being upgraded to provide
local and long-distance telephone service and high-speed Internet access
services. The acquisition has been accounted for under the purchase method of
accounting.
F-20
<PAGE> 89
KNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
TTE, INC. ACQUISITION
On June 1, 1998, KNOLOGY Holdings acquired TTE, Inc., a non-facilities
based reseller of local, long distance and operator services to small and
medium-sized business customers throughout South Carolina, for a purchase price
of $1.3 million. The acquisition has been accounted for under the purchase
method of accounting.
PRO FORMA RESULTS OF OPERATIONS
The assets of TTE, Inc. and Cable Alabama have been included in the
Company's consolidated financial statements effective June 1, 1998 and September
1, 1998, respectively. The following unaudited pro forma results of operations
for the year ended December 31, 1998 assume that the acquisitions occurred on
January 1, 1998. The pro forma information is presented for informational
purposes only and may not be indicative of the actual results of operations had
the acquisitions occurred on the assumed date, nor is the information
necessarily indicative of future results of operations.
<TABLE>
<CAPTION>
1998
------------
<S> <C>
Operating revenues.......................................... $ 55,359,204
Loss before extraordinary items............................. (38,261,475)
Net loss attributable to common stockholders................ (34,636,620)
Net loss per share attributable to common stockholders
(a)....................................................... (577.28)
</TABLE>
(a) Loss per share is computed using 60,000 as the number of shares outstanding
in 1998.
10. SEGMENT INFORMATION
Effective January 1998, the Company adopted SFAS No. 131, "Disclosures
About Segments of an Enterprise and Related Information," which established
revised standards for the reporting of financial and descriptive information
about operating segments in financial statements.
The Company owns and operates advanced hybrid fiber-coaxial networks and
provides residential and business customers broadband communications services,
including analog and digital cable television, local and long-distance
telephone, and data and broadband carrier services ("BCS"). Data services
include high-speed Internet access via cable modems. BCS includes local
transport services, such as local Internet transport, special access, local
private line, and local exchange transport services.
<TABLE>
<CAPTION>
CABLE TELEPHONE DATA AND BCS
----------- ----------- ------------
<S> <C> <C> <C>
1996
Operating revenues.................................... $ 0 $17,527,208 $ 0
Cost of services...................................... 0 2,991,412 0
----------- ----------- ------------
Gross margin.......................................... $ 0 $14,535,796 $ 0
=========== =========== ============
1997
Operating revenues.................................... $ 0 $17,633,313 $ 0
Cost of services...................................... 0 3,121,108 0
----------- ----------- ------------
Gross margin.......................................... $ 0 $14,512,205 $ 0
=========== =========== ============
1998
Operating revenues.................................... $22,527,403 $22,318,344 $ 286,775
Cost of services...................................... 8,750,858 3,890,799 97,883
----------- ----------- ------------
Gross margin.......................................... $13,776,545 $18,427,545 $ 188,892
=========== =========== ============
</TABLE>
F-21
<PAGE> 90
KNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
11. SUBSEQUENT EVENTS (UNAUDITED)
DISTRIBUTION AND PRIVATE PLACEMENT
The Company is in the process of registering with the Securities and
Exchange Commission shares of its common stock in order to complete a
distribution of its Series A convertible preferred stock to the stockholders of
ITC Holding and to SCANA. Shortly following this distribution, the Company
intends to complete a private placement of its Series B preferred stock to a
small group of institutional investors for approximately $100 million. There can
be no assurance that this offering will be completed.
STOCK SPLIT
On , 1999, the Company effected a 600-for-1 stock split of the
outstanding shares of common stock in the form of a stock dividend. Accordingly,
all data shown in the accompanying financial statements and notes has been
retroactively adjusted to reflect the stock split.
F-22
<PAGE> 91
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To KNOLOGY Holdings, Inc.:
We have audited the accompanying consolidated balance sheets of KNOLOGY
HOLDINGS, INC. (a Delaware corporation) AND SUBSIDIARIES as of December 31, 1997
and July 31, 1998 and the related consolidated statements of operations,
stockholders' equity, and cash flows for the years ended December 31, 1996 and
1997 and the period ended July 31, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of KNOLOGY
Holdings, Inc. and subsidiaries as of December 31, 1997 and July 31, 1998 and
the results of their operations and their cash flows for the years ended
December 31, 1996 and 1997 and the period ended July 31, 1998, in conformity
with generally accepted accounting principles.
Atlanta, Georgia
October 15, 1999
F-23
<PAGE> 92
KNOLOGY HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, JULY 31,
1997 1998
------------ ------------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................. $ 6,144,581 $ 5,483,929
Marketable securities..................................... 227,880,923 181,290,428
Accounts receivable -- trade, net of allowance of $108,529
and $270,854 at December 31, 1997 and July 31, 1998,
respectively............................................ 1,607,859 3,035,380
Accounts receivable - affiliates.......................... 0 21,000
Prepaid expenses.......................................... 37,060 297,101
------------ ------------
Total current assets................................ 235,670,423 190,127,838
------------ ------------
PROPERTY, PLANT, AND EQUIPMENT:
System and installation equipment......................... 56,909,159 93,481,398
Test and office equipment................................. 1,628,485 3,658,597
Automobiles and trucks.................................... 837,490 2,035,893
Production equipment...................................... 297,286 440,954
Land...................................................... 0 300,975
Buildings................................................. 1,936,035 4,575,330
Inventory................................................. 5,806,320 18,507,889
Leasehold improvements.................................... 324,270 489,787
------------ ------------
67,739,045 123,490,823
Less accumulated depreciation and amortization............ (5,171,309) (11,424,440)
------------ ------------
Property, plant, and equipment, net................. 62,567,736 112,066,383
------------ ------------
OTHER LONG-TERM ASSETS:
Intangible and other assets, net (Note 2)................. 17,896,146 18,014,255
Investments............................................... 0 825,072
Other..................................................... 63,795 63,795
------------ ------------
Total assets........................................ $316,198,100 $321,097,343
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long-term debt......................... $ 25,094 $ 25,094
Accounts payable.......................................... 5,817,733 4,429,417
Accounts payable--affiliate............................... 452,346 0
Accrued liabilities....................................... 1,638,042 8,854,827
Unearned revenue.......................................... 907,048 1,362,263
------------ ------------
Total current liabilities........................... 8,840,263 14,671,601
NONCURRENT LIABILITIES:
Notes payable (Note 3).................................... 120,804 115,426
Accrued interest payable.................................. 3,201,688 13,353,765
Bonds payable, net of discount of $194,189,569 and
$186,621,207 at December 31, 1997 and July 31, 1998,
respectively............................................ 249,910,431 257,478,793
------------ ------------
Total liabilities................................... 262,073,186 285,619,585
------------ ------------
COMMITMENTS AND CONTINGENCIES
WARRANTS (NOTE 3)........................................... 2,486,960 2,486,960
------------ ------------
STOCKHOLDERS' EQUITY:
Convertible preferred stock, $.01 par value per share;
50,000 and 100,000 shares authorized, 49,985 and 49,851
shares issued and outstanding at December 31, 1997 and
July 31, 1998, respectively (Note 7).................... 500 499
Common stock, $.01 par value per share; 200,000 and
16,000,000 shares authorized, 0 and 394 shares issued
and outstanding at December 31, 1997 and July 31, 1998,
respectively (Note 7)................................... 0 4
Additional paid-in capital................................ 65,060,712 64,864,366
Accumulated deficit....................................... (13,402,495) (31,858,376)
Unrealized losses on marketable securities (Note 2)....... (20,763) (15,695)
------------ ------------
Total stockholders' equity.......................... 51,637,954 32,990,798
------------ ------------
Total liabilities and stockholders' equity.......... $316,198,100 $321,097,343
============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-24
<PAGE> 93
KNOLOGY HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, SEVEN MONTHS
------------------------- ENDED JULY 31,
1996 1997 1998
----------- ----------- --------------
<S> <C> <C> <C>
OPERATING REVENUES..................................... $ 5,334,183 $10,355,068 $ 11,150,159
OPERATING EXPENSES:
Cost of services..................................... 2,513,693 4,758,730 4,932,239
Selling, operations, and administrative.............. 3,883,738 7,392,540 10,548,058
Depreciation and amortization........................ 1,640,025 3,715,184 4,335,794
----------- ----------- ------------
Total operating expenses..................... 8,037,456 15,866,454 19,816,091
----------- ----------- ------------
OPERATING LOSS......................................... (2,703,273) (5,511,386) (8,665,932)
----------- ----------- ------------
OTHER INCOME (EXPENSE):
Interest income...................................... 46,221 2,774,909 7,054,380
Interest expense..................................... (1,055,498) (6,226,023) (16,449,898)
Affiliate interest income, net....................... 273,799 0 0
Other (expense) income, net.......................... (60,000) (129,033) 188,110
----------- ----------- ------------
Total other expense.......................... (795,478) (3,580,147) (9,207,408)
----------- ----------- ------------
LOSS BEFORE INCOME TAXES AND CUMULATIVE
EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE............... (3,498,751) (9,091,533) (17,873,340)
INCOME TAX BENEFIT..................................... 373,323 0 0
----------- ----------- ------------
LOSS BEFORE CUMULATIVE EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE................................... (3,125,428) (9,091,533) (17,873,340)
CUMULATIVE EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE (NOTE 2).......................... 0 0 (582,541)
----------- ----------- ------------
NET LOSS............................................... $(3,125,428) $(9,091,533) $(18,455,881)
=========== =========== ============
BASIC AND DILUTED NET LOSS PER SHARE................... $ (1.53) $ (2.10) $ (2.46)
=========== =========== ============
WEIGHTED AVERAGE SHARES OUTSTANDING.................... 2,043,900 4,325,250 7,497,696
=========== =========== ============
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-25
<PAGE> 94
KNOLOGY HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME
<TABLE>
<CAPTION>
UNREALIZED
PREFERRED STOCK COMMON STOCK ADDITIONAL (LOSS) GAIN ON TOTAL
--------------- --------------- PAID-IN ACCUMULATED MARKETABLE STOCKHOLDERS'
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT SECURITIES EQUITY
------ ------ ------ ------ ----------- ------------ -------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE, December 31, 1995...... 7,520 $ 75 0 $ 0 $ 7,454,615 $ (1,185,534) $ 0 $ 6,269,156
Comprehensive Loss
Net loss...................... 0 0 0 0 0 (3,125,428) 0 (3,125,428)
------------
Comprehensive Loss............ (3,125,428)
------------
Issuance of preferred stock,
net of related offering
expenses of $379,701........ 9,572 96 0 0 11,054,603 0 0 11,054,699
------ ---- --- ------ ----------- ------------ -------- ------------
BALANCE, December 31, 1996...... 17,092 171 0 0 18,509,218 (4,310,962) 0 14,198,427
Comprehensive Loss:
Net loss...................... 0 0 0 0 0 (9,091,533) 0 (9,091,533)
Unrealized loss on marketable
securities.................. 0 0 0 0 0 0 (20,763) (20,763)
------------
Comprehensive Loss............ (9,112,296)
------------
Issuance of preferred stock,
net of related offering
expenses of $99,677......... 30,408 304 0 0 42,824,019 0 0 42,824,323
Purchase of Beach Cable
(Note 9).................... 2,485 25 0 0 3,727,475 0 0 3,727,500
------ ---- --- ------ ----------- ------------ -------- ------------
BALANCE, December 31, 1997...... 49,985 500 0 0 65,060,712 (13,402,495) (20,763) 51,637,954
Comprehensive Loss:
Net loss...................... 0 0 0 0 0 (18,455,881) 0 (18,455,881)
Unrealized gain on marketable
securities.................. 0 0 0 0 0 0 5,068 5,068
------------
Comprehensive Income........ (18,450,813)
------------
Issuance of common stock under
stock options............... 0 0 394 4 3,148 0 0 3,152
Beach Cable purchase price
adjustment.................. (134) (1) 0 0 (199,494) 0 0 (199,495)
------ ---- --- ------ ----------- ------------ -------- ------------
BALANCE, July 31, 1998.......... 49,851 $499 394 $ 4 $64,864,366 $(31,858,376) $(15,695) $ 32,990,798
====== ==== === ====== =========== ============ ======== ============
</TABLE>
The accompanying notes are an integral part of these consolidated statements.
F-26
<PAGE> 95
KNOLOGY HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, SEVEN MONTHS
------------------------------ ENDED JULY 31,
1996 1997 1998
------------ --------------- --------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.................................................. $ (3,125,428) $ (9,091,533) $(18,455,881)
------------ --------------- ------------
Adjustments to reconcile net loss to net cash (used in)
provided by operating activities:
Depreciation and amortization........................... 1,640,025 3,715,184 4,335,794
Amortization of bond discount........................... 0 2,386,856 7,568,362
Gain on disposition of assets........................... 21,370 23,464 0
Cumulative effect of change in accounting principle..... 0 0 582,541
Deferred income taxes................................... (373,323) 0 0
Changes in operating assets and liabilities:
Accounts receivable................................... (512,337) (721,396) (1,448,521)
Prepaid expenses...................................... (180,950) 244,199 (260,041)
Accounts payable...................................... (39,648) 4,302,245 (1,840,662)
Accrued liabilities and interest...................... 293,394 163,317 17,368,862
Unearned revenue...................................... 278,757 243,007 455,215
Other................................................. 133 1,345 5,068
------------ --------------- ------------
Total adjustments................................... 1,127,421 10,358,221 26,766,618
------------ --------------- ------------
Net cash (used in) provided by operating
activities........................................ (1,998,007) 1,266,688 8,310,737
------------ --------------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures, net of retirements.................. (14,416,135) (39,625,408) (50,089,645)
Acquisitions, net......................................... 0 0 (1,014,288)
Organizational cost expenditures.......................... (20,133) (470,923) (248,433)
Purchase of investments................................... (5,000) (1,346,150,712) 0
Proceeds from sales of investments........................ 0 1,118,194,411 46,590,495
Accounts payable -- capital related....................... 0 0 (3,214,982)
Investment in ClearSource, Inc............................ 0 0 (825,072)
Proceeds from sale of property............................ 0 69,152 0
Other..................................................... 0 0 315,906
------------ --------------- ------------
Net cash used in investing activities............... (14,441,268) (267,983,480) (8,486,019)
------------ --------------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments on debt and short term borrowings...... (160,900) (29,903,385) (5,378)
Expenditures related to issuance of debt and credit
facility................................................ 0 0 (283,649)
Proceeds from the issuance of common stock................ 0 0 3,152
Proceeds from the issuance of debt and short-term
borrowings, net of discount and issue costs on bonds.... 1,258,238 257,370,383 0
Proceeds from the issuance of preferred stock, net of
related offering expenses............................... 10,868,699 42,824,323 (199,495)
Repayments from affiliates................................ 4,255,836 0 0
Proceeds from the issuance of warrants.................... 0 2,486,960 0
------------ --------------- ------------
Net cash provided by (used in) financing
activities........................................ 16,221,873 272,778,281 (485,370)
------------ --------------- ------------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS........ (217,402) 6,061,489 (660,652)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD............ 300,494 83,092 6,144,581
------------ --------------- ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD.................. $ 83,092 $ 6,144,581 $ 5,483,929
============ =============== ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for interest.................. $ 1,016,039 $ 1,543,125 $ 3,672
============ =============== ============
Cash paid during the period for income taxes.............. $ 0 $ 0 $ 0
============ =============== ============
Details of acquisitions:
Property, plant, and equipment.......................... $ 0 $ 4,756,005 $ 0
Intangible Assets....................................... 0 2,796,139 1,014,288
Liabilities Assumed..................................... 0 (3,824,644) 0
Preferred stock issued.................................. 0 (3,727,500) 0
------------ --------------- ------------
Net cash paid for acquisitions.......................... $ 0 $ 0 $ 1,014,288
============ =============== ============
</TABLE>
The accompanying notes are an integral part of these consolidated
statements.
F-27
<PAGE> 96
KNOLOGY HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1997 AND JULY 31, 1998
1. ORGANIZATION, NATURE OF BUSINESS AND BASIS OF PRESENTATION
ORGANIZATION
KNOLOGY Holdings, Inc. was incorporated in Delaware in November 1995 under
the name CyberNet Holding, Inc. In April 1997, the Company formally changed its
name to KNOLOGY Holdings, Inc.
NATURE OF BUSINESS
KNOLOGY Holdings, Inc. and its subsidiaries (the "Company") own and operate
advanced hybrid fiber-coaxial networks and provide residential and business
customers broadband communications services, including analog and digital cable
television, local and long-distance telephone, high-speed Internet access, and
broadband carrier services to various markets in the southeastern United States.
The Company has experienced operating losses as a result of the expansion
of the advanced broadband communications networks and services into new and
existing markets. The Company expects to continue to focus on increasing its
customer base and expanding its broadband operations. Accordingly, the Company
expects that its operating expenses and capital expenditures will continue to
increase as it extends its broadband communications networks in the existing and
new markets in accordance with its business plan. While management expects its
expansion plans will result in profitability, there can be no assurance that
growth in the Company's revenue or customer base will continue or that the
Company will be able to achieve or sustain profitability and/or positive cash
flow.
BASIS OF PRESENTATION
The consolidated financial statements are prepared on the accrual basis of
accounting and include the accounts of the Company and all subsidiaries. All
significant intercompany balances have been eliminated. Certain prior year
amounts have been reclassified to conform with the current year presentation.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ACCOUNTING ESTIMATES
The preparation of financial statements, in conformity with generally
accepted accounting principles, requires management to make estimates and
assumptions that affect the reported amount of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS
The Company considers all short-term, highly liquid investments with an
original maturity date of three months or less to be cash equivalents. Cash and
cash equivalents are stated at cost, which approximates fair value.
MARKETABLE SECURITIES
The Company's marketable securities are categorized as available-for-sale
securities, as defined by Statement of Financial Accounting Standards ("SFAS")
No. 115, "Accounting for Certain Investments in Debt and Equity Securities."
Unrealized holding gains and losses are reflected as a net amount in a separate
component of stockholders' equity until realized. For the purpose of computing
realized gains and
F-28
<PAGE> 97
KNOLOGY HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
losses, cost is identified on a specific identification basis. Securities
available for sale at July 31, 1998 are primarily comprised of commercial paper.
PROPERTY, PLANT, AND EQUIPMENT
Property, plant, and equipment are stated at cost. Depreciation and
amortization are calculated using the straight-line method over the estimated
useful lives of the assets, commencing when the asset is installed or placed in
service. Maintenance, repairs, and renewals are charged to expense as incurred.
The cost and accumulated depreciation of property and equipment disposed of are
removed from the related accounts, and any gain or loss is included in or
deducted from income. Depreciation and amortization are provided over the
estimated useful lives as follows:
<TABLE>
<CAPTION>
YEARS
-----
<S> <C>
Buildings................................................... 25
System and installation equipment........................... 7-10
Production equipment........................................ 7
Test and office equipment................................... 3-7
Automobiles and trucks...................................... 5
Leasehold improvements...................................... 5
</TABLE>
Inventories are valued at the lower of cost or market (determined on a
weighted average basis) and include customer premise equipment and certain plant
construction materials. These items are transferred to system and installation
equipment when installed.
Interest is capitalized in connection with the construction of the
Company's broadband networks. The capitalized interest is recorded as part of
the asset to which it relates and is amortized over the asset's estimated useful
life. For the year ended December 31, 1997 and the period ended July 31, 1998,
$676,160 and $1,954,976 of interest cost was capitalized, respectively. No
interest was capitalized prior to 1997.
INTANGIBLE AND OTHER ASSETS
Intangible and other assets include the excess of the purchase price of
acquisitions over the fair value of net assets acquired as well as various other
acquired intangibles and costs associated with the issuance of debt and the
consummation of a credit facility. Intangible and other assets and the related
useful lives and accumulated amortization at December 31, 1997 and July 31, 1998
are as follows:
<TABLE>
<CAPTION>
AMORTIZATION
DECEMBER 31, JULY 31, PERIOD
1997 1998 (YEARS)
------------ ----------- ------------
<S> <C> <C> <C>
Goodwill......................................... $ 9,875,262 $10,889,550 40
Debt issuance costs.............................. 7,883,307 8,166,956 4-10
Other............................................ 955,048 350,540 10-15
----------- -----------
18,713,617 19,407,046
Less accumulated amortization.................... 817,471 1,347,285
----------- -----------
Intangibles and other assets, net................ $17,896,146 $18,059,761
=========== ===========
</TABLE>
During 1998, the Company adopted the provisions of AICPA Statement of
Position 98-5, "Reporting on the Costs of Start-Up Activities," which requires
that all nongovernmental entities expense costs of start-up activities,
including pre-operating, preopening, and organization activities, as the costs
are incurred. Adoption of this statement resulted in a cumulative effect of
accounting change of $582,541 or $.08 per basic and diluted share.
F-29
<PAGE> 98
KNOLOGY HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
LONG-LIVED ASSETS
In 1995, the Company adopted SFAS No. 121, "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." SFAS No. 121
establishes accounting standards for the impairment of long-lived assets,
certain identifiable intangibles and cost in excess of net assets acquired
related to those assets to be held and used for long-lived assets and certain
identifiable intangibles to be disposed of. The effect of adopting SFAS No. 121
was not material.
The Company periodically reviews the values assigned to long-lived assets,
such as inventory, property and equipment, and goodwill, to determine whether
any impairments are other than temporary. Management believes that there is no
impairment of long-lived assets included in the accompanying balance sheets.
INVESTMENTS
At July 31, 1998, investments represent the Company's 11% ownership in
ClearSource, Inc. ClearSource, Inc. was formed during 1998 to build and operate
advanced broadband networks offering a bundle of communications services to
residential and business customers. The Company's investment in ClearSource,
Inc. is accounted for under the cost method of accounting.
REVENUE RECOGNITION
Subscriber revenues are recognized in the month of service. Subscriber fees
billed in advance are included in the accompanying balance sheets as unearned
revenue and are deferred until the month the service is provided.
ADVERTISING COSTS
The Company expenses all advertising costs as incurred. Approximately
$165,000, $158,000, and $237,160 of advertising expense are recorded in the
Company's statements of operations for the years ended December 31, 1996 and
1997 and the period ended July 31, 1998, respectively.
SOURCES OF SUPPLIES
The Company purchases customer premise equipment and plant materials from
outside vendors. Although numerous suppliers market and sell customer premise
equipment and plant materials, the Company currently purchases each customer
premise component from a single vendor and has several suppliers for plant
materials. If the suppliers are unable to meet the Company's needs as it
continues to build out its network infrastructure, then delays and increased
costs in the expansion of the Company's network could result, which would
adversely affect operating results.
CREDIT RISK
The Company's accounts receivable potentially subject the Company to credit
risk, as collateral is generally not required. The Company's risk of loss is
limited due to advance billings to customers for services and the ability to
terminate access on delinquent accounts. The potential for material credit loss
is mitigated by the large number of customers with relatively small receivable
balances. The carrying amount of the Company's receivables approximates their
fair values.
INCOME TAXES
The Company utilizes the liability method of accounting for income taxes,
as set forth in SFAS No. 109, "Accounting for Income Taxes." Under the liability
method, deferred taxes are determined based
F-30
<PAGE> 99
KNOLOGY HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
on the difference between the financial and tax bases of assets and liabilities
using enacted tax rates in effect in the years in which the differences are
expected to reverse. Deferred tax benefit represents the change in the deferred
tax asset and liability balances (Note 6).
Effective August 1998, the Company will be included in the consolidated
federal income tax return of its parent company, ITC Holding Company, Inc. ("ITC
Holding") (Note 7). The Company and its subsidiaries file separate state income
tax returns.
NET LOSS PER SHARE
In 1997, the Company adopted SFAS No. 128, "Earnings Per Share." That
statement requires the disclosure of basic net loss per share and diluted net
loss per share. Basic net loss per share is computed by dividing net loss
available to common shareholders by the weighted-average number of common shares
outstanding during the period. As the Company has no significant common stock
outstanding, the convertible preferred stock is assumed to be converted for
purposes of this calculation. Diluted net loss per share gives effect to all
potentially dilutive securities. The Company's potentially dilutive securities
are not included in the computation of diluted net loss per share as their
effect is antidilutive.
3. LONG-TERM DEBT
Long-term debt at December 31, 1997 and July 31, 1998 consists of the
following:
<TABLE>
<CAPTION>
1997 1998
------------ ------------
<S> <C> <C>
Senior Discount Notes, with a face value of $444,100,000,
bearing interest at 11.875% beginning October 15, 2002,
payable semiannually beginning April 15, 2003 with
principal and any unpaid interest due October 15,
2007.................................................... $249,910,431 $257,478,793
Capitalized lease obligation, at a rate of 10%, payable in
quarterly installments of $6,304 through December 2006,
secured................................................. 145,898 140,520
------------ ------------
250,056,329 257,619,313
Less current maturities................................... 25,094 25,094
------------ ------------
$250,031,235 $257,594,219
============ ============
</TABLE>
Following are maturities of long-term debt for each of the next five years
as of July 31, 1998:
<TABLE>
<S> <C>
1999....................................................... $ 25,094
2000....................................................... 13,438
2001....................................................... 14,833
2002....................................................... 16,374
2003....................................................... 18,074
Thereafter................................................. 444,159,353
------------
Total............................................ $444,234,246
============
</TABLE>
The fair values of long-term debt, including current maturities, at
December 31, 1997 and July 31, 1998 are estimated to be approximately
$253,781,000 and $270,833,000 respectively, based on a valuation technique that
considers cash flows discounted at current rates.
In the fourth quarter of 1997, the Company issued units consisting of
senior discount notes due 2007 and warrants to purchase Preferred Stock for
gross proceeds of approximately $250 million. The notes were offered at a
substantial discount from face value, with no interest payable for the first
five years. Approximately $2.5 million of the gross proceeds has been allocated
to the warrants. Each warrant allows
F-31
<PAGE> 100
KNOLOGY HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the holder to purchase .003734 shares of the Company's preferred stock. The
Company incurred approximately $7.9 million in costs to issue the senior
discount notes. These costs are being amortized at an effective rate over the
life of the notes. The indenture relating to the notes contains certain
covenants that, among other things, limit the ability of the Company to incur
indebtedness, pay dividends, prepay subordinated indebtedness, repurchase
capital stock, make investments, engage in transactions with stockholders and
affiliates, create liens, sell assets, and engage in mergers and consolidations.
The proceeds from the offering of the units have been, and will be, used to
repay certain indebtedness of the Company, to fund expansion of the Company's
business, and for additional working capital and general corporate purposes.
On June 2, 1997, the Company borrowed $3 million under a promissory note
from SCANA at 12% interest with an original maturity of June 30, 1997. In July
1997, and again in September 1997, the Company and SCANA amended the promissory
note agreement to increase the borrowings to $10 million and to extend the
maturity date until January 1, 1998. On September 29, 1997, the Company borrowed
an additional $1 million at 12% interest under an oral agreement with SCANA with
similar terms. In connection with the SCANA notes discussed above, SCANA and the
Company are negotiating warrants to purchase approximately 753 shares of the
Company's preferred stock. In October 1999, the Company executed the agreement
to issue warrants to purchase Preferred Stock of the Company. The Company will
record the fair value of the warrants as interest expense in the fourth quarter
of 1999. On October 24, 1997, the Company repaid all of these borrowings.
On May 13, 1997, the Company obtained a $3 million bridge loan facility
from First National Bank of West Point (the "Bridge Facility") to provide
additional liquidity until long-term financing could be arranged. Interest
accrued at the prime rate (as announced by SunTrust Bank, Atlanta) plus .5% per
annum on all outstanding principal amounts, plus accrued but unpaid interest. As
amended on September 18, 1997, the Bridge Facility was payable on demand, with a
final maturity date of December 15, 1997. On December 15, 1997, the Company
repaid all of these borrowings.
4. OPERATING LEASES
The Company leases office space, utility poles, and other assets for
varying periods. Leases that expire are generally expected to be renewed or
replaced by other leases.
Future minimum rental payments required under the operating leases that
have initial or remaining noncancelable lease terms in excess of one year as of
July 31, 1998 are as follows:
<TABLE>
<S> <C>
1999........................................................ $208,342
2000........................................................ 166,274
2001........................................................ 124,565
2002........................................................ 113,583
2003 and thereafter......................................... 153,150
--------
Total minimum lease payments...................... $765,914
========
</TABLE>
Total rental expense for all operating leases was approximately $70,000,
$75,000 and $97,000, for the years ended December 31, 1996 and 1997 and the
period ended July 31, 1998, respectively.
5. COMMITMENTS AND CONTINGENCIES
PURCHASE COMMITMENTS
The Company has entered into contracts with various entities to provide
programming to be aired by the Company. The Company pays a monthly fee as cost
for the programming services, generally based on the number of average
subscribers to the program, although some fees are adjusted based on the total
F-32
<PAGE> 101
KNOLOGY HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
number of subscribers to the system and/or the system penetration percentage.
Certain contracts have minimum monthly fees. The Company estimates that it will
pay approximately $6.5 million in programming fees under these contracts during
1999.
LEGAL PROCEEDINGS
In the normal course of business, the Company is subject to various
litigation; however, in management's opinion, there are no legal proceedings
pending against the Company which would have a material adverse effect on the
financial position, results of operations, or liquidity of the Company.
6. INCOME TAXES
Deferred income taxes reflect the net tax effect of temporary differences
between the carrying amount of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. The significant
components of deferred tax assets and liabilities at December 31, 1996 and 1997
and July 31, 1998 are as follows (in thousands):
<TABLE>
<CAPTION>
1996 1997 1998
------ ------ --------
<S> <C> <C> <C>
Deferred tax assets:
Net operating loss carryforwards......................... $3,875 $7,221 $ 6,987
Deferred bond interest................................... 0 0 8,792
Other.................................................... 92 279 280
Valuation allowance...................................... (2,475) (4,165) (10,270)
------ ------ --------
Total deferred tax assets........................ 1,492 3,335 5,789
Deferred tax liabilities:
Depreciation and amortization............................ (1,492) (3,335) (5,789)
------ ------ --------
Net deferred income taxes.................................. $ 0 $ 0 $ 0
====== ====== ========
</TABLE>
Effective August 1998, the Company will be included in the consolidated
federal income tax return of its parent company, ITC Holding (Note 7). The
Company and its subsidiaries file separate state income tax returns.
The Company has available, at December 31, 1996 and 1997 and July 31, 1998,
unused net operating loss carryforwards of approximately $10,273,00,
$19,144,000, and $18,523,000, respectively, expiring in various years from 2005
to 2013, unless utilized. Management has recorded a valuation allowance of
approximately $2,475,000, $4,165,000, and $10,270,000 for the years ended
December 31, 1996 and 1997 and the period ended July 31, 1998, respectively, on
these net operating loss carryforwards, the majority of which contain
limitations on utilization.
A reconciliation of the income tax benefit computed at statutory tax rates
to the income tax benefit for the years ended December 31, 1996 and 1997 and the
period ended July 31, 1998 is as follows:
<TABLE>
<CAPTION>
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Income tax benefit at statutory rate........................ 34% 34% 34%
State income taxes, net of federal benefit.................. 2 4 5
Prior year actualization.................................... 6 (3) (4)
Goodwill.................................................... 1 (1) (1)
Deferred tax valuation allowance............................ (32) (34) (34)
--- --- ---
11% 0% 0%
=== === ===
</TABLE>
F-33
<PAGE> 102
KNOLOGY HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
7. EQUITY INTERESTS
CAPITAL TRANSACTIONS
The Company has authorized 16,000,000 shares of $.01 par value common stock
and 100,000 shares of $.01 par value convertible preferred stock at December 31,
1998. In February 1998, the Company completed a 150-for-1 stock split of the
Company's common stock, par value $.01 per share, which was effected in the form
of a stock dividend of new shares of common stock. In connection with the stock
split, the Company increased the number of shares of authorized common stock
from 200,000 to 16,000,000 and changed the conversion ratio between the common
stock and the preferred stock from 1-to-1 to a ratio of 150-to-1.
In June 1998, ITC Holding made an offer to acquire outstanding shares of
the Company in exchange for $100 in cash and ITC Holding Common Stock valued at
$1,600 for each share of the Company's Preferred Stock exchanged (the
"Exchange"). The Exchange was completed effective July 31, 1998. Prior to the
exchange, ITC Holding (through its wholly owned subsidiaries) owned
approximately 42% of the outstanding stock of the Company, representing the
largest stockholder of the Company. As a result of the exchange, ITC Holding
owns approximately 85% of the outstanding stock of the Company.
In May 1998, the Company issued 394 shares of common stock, valued at $8
per share, to an employee under the Company's 1995 stock option plan. In
February 1997, the Company offered and accepted 8,960 shares of preferred stock
for subscription at $1,200 per share. Additionally, in October 1997, the Company
offered and accepted 21,448 shares of preferred stock for subscription at $1,500
per share. In December 1997, in conjunction with the acquisition of KNOLOGY of
Panama City, Inc., the Company issued 2,485 shares of preferred stock valued at
$1,500 per share. During 1998, 134 shares of preferred stock issued in
connection with the acquisition were returned to the Company as part of a
purchase price adjustment. The amount of the consideration paid in excess of the
par value, net of expenses incurred in connection with each issuance, is
included in additional paid-in capital on the accompanying balance sheets. Each
share of convertible preferred stock is automatically convertible into common
stock on a 150-for-1 basis at the earlier of either the effective date of a
public offering of common stock by the Company or on December 8, 2005. In the
event of liquidation of the Company, whether voluntary or involuntary, the
holders of convertible preferred stock are entitled to receive preferential
distributions of $1,000, $1,200, or $1,500 per share (depending on when the
stock was issued) before any distributions to common stockholders. The holders
of the preferred stock are not entitled to any other preferences, including
dividends.
STOCKHOLDERS' AGREEMENT
The Company entered into a stockholders' agreement (the "Stockholders'
Agreement"), dated as of December 8, 1995 and amended as of January 25, 1996 and
April 19, 1996, with all of the stockholders of the Company. None of the parties
to the Stockholders' Agreement may transfer any class or series of capital stock
of the Company or any right or option to acquire any share of capital stock of
the Company held by such party to third parties (subject to limited exceptions)
without having offered rights of first refusal to purchase such securities to
the Company. The Stockholders' Agreement will irrevocably terminate upon the
consummation of an initial public offering.
STOCK OPTION PLAN
Under the Company's 1995 stock option plan (the "Stock Option Plan"), as
adopted in December 1995 and amended in February 1998, 700,000 shares (after
giving effect to the 150-for-1 common stock split) of common stock are reserved
and authorized for issuance upon the exercise of the options. All employees of
the Company are eligible to receive options under the Stock Option Plan. The
Stock Option
F-34
<PAGE> 103
KNOLOGY HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Plan is administered by the compensation and stock option committee of the board
of directors. Options granted under the Stock Option Plan are intended to
qualify as "incentive stock options" under Section 422 of the Internal Revenue
Code of 1986, as amended. All options were granted at an exercise price equal to
the estimated fair value of the common stock at the dates of grant as determined
by the board of directors based on equity transactions and other analyses. The
options expire ten years from the date of grant.
STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 123
During 1995, the Financial Accounting Standards Board issued SFAS No. 123,
"Accounting for Stock-Based Compensation," which defines a fair value-based
method of accounting for an employee stock option or similar equity instrument
and encourages all entities to adopt that method of accounting for all of their
employee stock compensation plans. However, it also allows an entity to continue
to measure compensation cost for those plans using the method of accounting
prescribed by Accounting Principles Board ("APB") Opinion No. 25, "Accounting
for Stock Issued to Employees." Entities electing to remain with the accounting
methodology required by APB Opinion No. 25 must make pro forma disclosures of
net income and, if presented, earnings per share as if the fair value-based
method of accounting defined in SFAS No. 123 had been applied.
The Company accounts for its stock-based compensation plans under APB
Opinion No. 25, under which no compensation cost has been recognized by the
Company. However, the Company has computed, for pro forma disclosure purposes,
the value of all options for shares of the Company's common stock to employees
of the Company using the Black-Scholes option pricing model and the following
weighted average assumptions in 1996, 1997, and the period ended July 31, 1998:
<TABLE>
<CAPTION>
1996 1997 1998
----------- ----------- -----------
<S> <C> <C> <C>
Risk-free interest rate......................... 6.31% 6.43% 5.42%
Expected dividend yield......................... 0% 0% 0%
Expected lives.................................. Seven years Seven years Seven years
Expected volatility............................. 30% 30% 30%
</TABLE>
The weighted average fair value of options granted was $8, $8.44, and
$10.00 for the years ended December 31, 1996 and 1997 and the period ended July
31, 1998, respectively. The total value of options for the Company's stock
granted to employees of the Company for the years ended December 31, 1996 and
1997 and the period ended July 31, 1998 was computed as approximately $154,000,
$304,000, and $1,125,000, respectively, which would be amortized on a pro forma
basis over the five-year vesting period of the options. If the Company had
accounted for these plans in accordance with SFAS No. 123, the Company's net
loss for the periods presented would be as follows:
<TABLE>
<CAPTION>
AS
REPORTED PRO FORMA
------------ ------------
<S> <C> <C>
Net loss for the year ended December 31, 1996............. $ (3,125,428) $ (3,155,917)
Net loss for the year ended December 31, 1997............. (9,091,533) (9,188,862)
Net loss for the period ended July 31, 1998............... (18,455,881) (18,579,005)
Basic and diluted net loss per share for the year ended
December 31, 1996....................................... $ (1.53) $ (1.54)
Basic and diluted net loss per share for the year ended
December 31, 1997....................................... (2.10) (2.12)
Basic and diluted net loss per share for the period ended
July 31, 1998:.......................................... (2.46) (2.47)
</TABLE>
F-35
<PAGE> 104
KNOLOGY HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A summary of the status of the Company's stock option plan at July 31, 1998
is presented in the following table (after giving effect to the 150-for-1 common
stock split):
<TABLE>
<CAPTION>
WEIGHTED AVERAGE
EXERCISE PRICE
SHARES PER SHARE
------- ----------------
<S> <C> <C>
Outstanding at December 31, 1996:........................ 52,797 8.00
Granted................................................ 126,384 8.44
Forfeited.............................................. (15,939) 8.00
-------
Outstanding at December 31, 1997:........................ 163,242 8.34
Granted................................................ 348,980 10.00
Forfeited.............................................. (21,032) 8.32
Exercised.............................................. (394) 8.00
-------
Outstanding at July 31, 1998............................. 490,796
=======
Exercisable shares as of:
December 31, 1996...................................... 0 $0.00
=======
December 31, 1997...................................... 6,606 8.00
=======
July 31, 1998.......................................... 17,428 8.00
=======
</TABLE>
8. RELATED-PARTY TRANSACTIONS
ITC Holding provides certain administrative services, such as legal and tax
planning services, for the Company. The costs of these services are charged to
the Company based primarily on the salaries and related expenses for certain of
the ITC Holding executives and an estimate of their time spent on projects
specific to the Company. For the years ended December 31, 1996 and 1997 and the
period ended July 31, 1998, the Company recorded approximately $24,000, $31,000,
and $92,000, respectively, in selling, operations, and administrative expenses
related to these services. In the opinion of management, amounts charged to the
Company are consistent with costs that would be incurred from third party
providers. Additionally, during 1997, ITC Holding paid several invoices related
to the construction of the Company's building. At December 31, 1997, there is
approximately $419,000 related to these payments included in accounts
payable -- affiliate in the Company's balance sheet.
Certain of ITC Holding affiliates provide the Company with various services
and/or receive services provided by the Company. These entities include
Interstate Telephone Company, which provides switching and billing telephone
services; and InterCall, Inc., which provides conference calling services. In
addition, we receive services from ITC DeltaCom, Inc., an affiliate of ITC
Holding which provides wholesale long-distance and related services and which
leases capacity on certain of its fiber routes. ITC Holding also holds equity
investments in the following entities which do business with the Company:
Powertel, Inc., which provides cellular services, and MindSpring Enterprises,
Inc., which is a national provider of Internet access. In management's opinion,
the Company's transactions with these affiliated entities are representative of
arm's-length transactions.
For the years ended December 31, 1996 and 1997 and the period ended July
31, 1998, the Company received services from these affiliated entities in the
amounts of $48,000, $247,000, and $757,000, respectively, which are reflected in
cost of services and selling, operations, and administrative expenses in the
Company's statements of operations. In addition, in 1996 and 1997, the Company
received services from these affiliated entities in the amount of $11,000 and
$13,000, respectively, which is reflected in field and technical expenses in the
Company's statement of operations. At December 31, 1997, amounts payable for
these services of $33,000 are recorded in the Company's balance sheet as
accounts payable -- affiliate.
F-36
<PAGE> 105
KNOLOGY HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
During 1998, the Company leased office space to ITC DeltaCom, Inc. and
Powertel, Inc. Approximately $137,000 of lease income related to these
transactions is recorded as other income in the Company's statement of
operations for the year ended July 31, 1998.
In December 1996 and 1997, the Company invested $5,000 and $55,000,
respectively, in an airplane co-owned by ITC Holding and several of its
subsidiaries and other affiliated entities.
Relatives of the stockholders of ITC are stockholders and employees of the
Company's insurance provider. The costs charged to the Company for insurance
services were approximately $36,000, $134,000, and $140,000 or the years ended
December 31, 1996, 1997, and the period ended July 31, 1997, respectively.
The chief executive officer of an affiliate served from July 15, 1996 to
February 20, 1997 as president and chief executive officer of the Company. He
served in his capacity as chief executive officer and president of the Company
at the request of the Company and ITC Holding and received no compensation from
the Company for the year ended December 31, 1996. The value of his services
provided through February 20, 1997 is estimated to total approximately $20,000.
9. BUSINESS ACQUISITIONS
On June 1, 1998, the Company acquired TTE, Inc., a non-facilities based
reseller of local, long distance and operator services to small and medium-sized
business customers throughout South Carolina, for a purchase price of $1.3
million. The acquisition has been accounted for under the purchase method of
accounting.
On December 5, 1997, the Company consummated the acquisition of Beach
Cable, Inc., a Florida corporation that owned and operated a cable television
system in Panama City Beach, Florida ("Beach Cable"). The acquisition was
effected pursuant to an Agreement and Plan of Merger dated December 5, 1997 (the
"Merger Agreement") by and among the Company, KNOLOGY of Panama City, Inc.,
Beach Cable, and L. Charles Hilton, Jr., the sole stockholder of Beach Cable,
under which KNOLOGY of Panama City, Inc., a Delaware corporation and a wholly
owned subsidiary of the Company, merged (the "Merger") with and into Beach
Cable. Beach Cable, the surviving corporation in the Merger, was renamed KNOLOGY
of Panama City, Inc. as of the effective time of the Merger (the "Effective
Time") and became a wholly owned subsidiary of the Company. At the Effective
Time, all of the issued and outstanding shares of Common Stock, no par value, of
KNOLOGY of Panama City were converted into 2,485 shares of preferred stock, par
value $.01 per share, of the Company valued at approximately $3.7 million.
Immediately following the Merger, the Company also contributed cash of
approximately $3.9 million to KNOLOGY of Panama City to repay an existing note
and related accrued interest to Hilton, Inc., a holding company owned by L.
Charles Hilton, Jr. The Merger has been accounted for under the purchase method
of accounting.
As a result of the acquisition of KNOLOGY of Panama City, Inc.,
approximately one month's operations of KNOLOGY of Panama City are included in
the accompanying statement of operations for the year ended December 31, 1997.
F-37
<PAGE> 106
KNOLOGY HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following unaudited pro forma results of operations for the years ended
December 31, 1997 and 1998 assumes that the TTE, Inc. and Beach Cable, Inc.
acquisitions occurred on January 1, 1997. The pro forma information is presented
for informational purposes only and may not be indicative of the actual results
of operations had the acquisitions occurred on the assumed date, nor is the
information necessarily indicative of future results of operations.
<TABLE>
<CAPTION>
1997 1998
------------ ------------
<S> <C> <C>
Operating revenues.......................................... $ 14,264,686 $ 12,493,550
Loss before extraordinary items............................. (10,074,430) (17,909,739)
Net loss.................................................... (10,074,430) (18,492,280)
Net loss per share(a)....................................... (2.33) (2.47)
</TABLE>
(a) Net loss per share is computed using 4,325,250 and 7,497,696 as the number
of shares outstanding at December 31, 1997 and July 31, 1998, respectively.
10. SEGMENT INFORMATION
Effective January 1998, the Company adopted SFAS No. 131, "Disclosures
about segments of an Enterprise and Related Information," which established
revised standards for the reporting of financial and descriptive information
about operating segments in financial statements.
The Company owns and operates advanced hybrid fiber-coaxial networks and
provides residential and business customers broadband communications services,
including analog and digital cable television, local and long-distance
telephone, and data and broadband carrier services ("BCS"). Data services
include high-speed Internet access via cable modems. BCS includes local
transport services, such as local Internet transport, special access, local
private line, and local exchange transport services.
While management of the Company monitors the revenue generated from each of
the various broadband services, operations are managed and financial performance
is evaluated based upon the delivery of a multiple of the services to customers
over a single network. As a result of multiple services being provided over a
single network, there are many shared expenses and shared assets related to
providing the various broadband services to customers. Management believes that
any allocation of the shared expenses or assets to the broadband services would
be arbitrary and impractical.
Revenues by broadband communications service are as follows:
<TABLE>
<CAPTION>
SEVEN
MONTHS
YEAR ENDED DECEMBER 31 ENDED
------------------------ JULY 31,
1996 1997 1998
---------- ----------- -----------
<S> <C> <C> <C>
Cable............................................ $5,334,183 $10,319,495 $ 9,991,798
Telephone........................................ 0 16,490 1,077,674
Data and BCS..................................... 0 19,083 80,687
---------- ----------- -----------
Consolidated revenues............................ $5,334,183 $10,355,068 $11,150,159
========== =========== ===========
</TABLE>
11. SUBSEQUENT EVENTS
CREDIT FACILITY
On December 22, 1998, the Company entered into a $50 million four-year
senior secured credit facility with First Union National Bank and First Union
Capital Markets Corp., which may be used for working capital and other purposes,
including capital expenditures and permitted acquisitions. At the Company's
option, interest will accrue based on either the Alternate Base Rate plus
applicable margin or
F-38
<PAGE> 107
KNOLOGY HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the LIBOR rate plus applicable margin. Obligations under the credit facility
will be secured by substantially all tangible and intangible assets of the
Company and its current and future subsidiaries. The credit facility includes a
number of covenants, including, among others, covenants limiting the ability of
the Company and its subsidiaries and their present and future subsidiaries to
incur debt, create liens, pay dividends, make distributions or stock
repurchases, make certain investments, engage in transactions with affiliates,
sell assets, and engage in certain mergers and acquisitions. The credit facility
also includes covenants requiring compliance with certain operating and
financial ratios on a consolidated basis. The credit facility allows the Company
to borrow up to five times certain individual subsidiaries' consolidated
adjusted cash flow as defined in the credit facility. In connection with the
initiation of the revolving credit facility, the Company incurred $1,255,681 in
related costs which are being amortized on a straight-line basis over the five
year term.
ACQUISITIONS
On October 30, 1998, the Company acquired substantially all of the assets
of Cable Alabama Corporation ("Cable Alabama") for approximately $60,733,000 in
cash and also purchased for $5,000,000 in cash, certain real property located in
Huntsville, Alabama (the "Acquisition"). Cable Alabama owned and operated a
cable television system serving the Huntsville, Alabama area. KNOLOGY plans to
upgrade the existing Cable Alabama plant into a high-speed fiber-coaxial network
that is two-way interactive to provide additional broadband communications
services, such as local and long-distance service, digital television and
high-speed Internet access. The acquisition has been accounted for under the
purchase method of accounting.
The assets acquired are held by KNOLOGY of Huntsville, Inc. and have been
included in the Company's consolidated financial statements effective September
1, 1998. The unaudited pro forma results of operations for the years ended
December 31, 1997 and 1998 assumes the acquisition occurred on January 1, 1997.
The pro forma information is presented for informational purposes only and may
not be indicative of the actual results of operations had the Acquisition
occurred on the assumed date, nor is the information necessarily indicative of
future results of operations.
<TABLE>
<CAPTION>
1997 1998
------------ ------------
<S> <C> <C>
Operating revenues.......................................... $ 22,379,066 $ 18,914,289
Loss before extraordinary item.............................. (23,659,283) (26,648,764)
Net loss.................................................... (23,659,283) (27,231,305)
Net loss per share(a)....................................... (5.47) (3.63)
</TABLE>
(a) Loss per share is computed using 4,325,250 and 7,497,696 as the number of
shares outstanding at December 31, 1997 and July 31, 1998, respectively.
F-39
<PAGE> 108
INDEPENDENT AUDITORS' REPORT
Stockholders
CableAmerica Corporation
Phoenix, Arizona
We have audited the accompanying balance sheets of Cable Alabama
Corporation (the "Company") a wholly-owned subsidiary of CableAmerica
Corporation as of August 31, 1998 and September 30, 1997, and the related
statements of operations and deficit and of cash flows for the eleven-month
period ended August 31, 1998 and the year ended September 30, 1997. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the financial position of the Company at August 31, 1998 and September
30, 1997, and the results of its operations and its cash flows for the
eleven-month period ended August 31, 1998 and the year ended September 30, 1997
in conformity with generally accepted accounting principles.
The accompanying financial statements have been prepared from the separate
records maintained by the Company and may not necessarily be indicative of the
conditions that would have existed or the results of operations if the Company
had been operated as an unaffiliated company (see Notes 1 and 5 to the financial
statements regarding expenses allocated from CableAmerica Corporation).
As discussed in Note 6 to the financial statements, on October 30, 1998,
the Company sold substantially all of its assets.
Phoenix, Arizona
December 7, 1998
F-40
<PAGE> 109
CABLE ALABAMA CORPORATION
(A WHOLLY-OWNED SUBSIDIARY OF CABLEAMERICA CORPORATION)
BALANCE SHEETS
AUGUST 31, 1998 AND SEPTEMBER 30, 1997
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
ASSETS (Note 6)
CURRENT ASSETS:
Cash and cash equivalents................................. $ 8,640 $ 19,753
Subscriber accounts receivable -- less allowance for
doubtful accounts of $68,000 and $101,000.............. 930,026 889,105
Prepaid expenses and other assets......................... 336,126 400,037
Deferred income taxes (Note 4)............................ 2,174,000 2,340,000
------------ ------------
Total current assets.............................. 3,448,792 3,648,895
------------ ------------
CABLE TELEVISION SYSTEMS AND EQUIPMENT:
Reception and distribution facilities..................... 34,926,769 31,699,513
Land, building and improvements........................... 81,178 68,809
Vehicles, equipment and fixtures.......................... 1,321,356 1,261,170
Construction in progress.................................. 116,557 336,673
------------ ------------
Total............................................. 36,445,860 33,366,165
Less accumulated depreciation and amortization............ (22,689,797) (20,352,138)
------------ ------------
Cable television systems and equipment -- net..... 13,756,063 13,014,027
------------ ------------
TOTAL............................................. $ 17,204,855 $ 16,662,922
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY (Note 6)
CURRENT LIABILITIES:
Accounts payable.......................................... $ 868,237 $ 2,389,229
Accrued payroll........................................... 88,544 103,001
Accrued property tax...................................... 125,740 96,807
Other accrued expenses.................................... 237,939 260,961
------------ ------------
Total current liabilities......................... 1,320,460 2,849,998
------------ ------------
COMMITMENTS AND CONTINGENCIES (Notes 2, 3 and 6)
STOCKHOLDERS' EQUITY (Note 2):
Common stock, $100 par value -- authorized, 1,500 shares;
issued and outstanding, 1,500 shares................... 150,000 150,000
Additional paid-in capital................................ 20,664,426 18,886,572
Deficit................................................... (4,930,031) (5,223,648)
------------ ------------
Total stockholders' equity........................ 15,884,395 13,812,924
------------ ------------
TOTAL............................................. $ 17,204,855 $ 16,662,922
============ ============
</TABLE>
See notes to financial statements.
F-41
<PAGE> 110
CABLE ALABAMA CORPORATION
(A WHOLLY-OWNED SUBSIDIARY OF CABLEAMERICA CORPORATION)
STATEMENTS OF OPERATIONS AND DEFICIT
ELEVEN-MONTH PERIOD ENDED AUGUST 31, 1998 AND
YEAR ENDED SEPTEMBER 30, 1997
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
REVENUES:
Basic services............................................ $ 7,791,166 $ 7,540,638
Pay services.............................................. 2,096,561 2,298,352
Other services............................................ 2,153,775 2,185,008
----------- -----------
Total revenues.................................... 12,041,502 12,023,998
----------- -----------
COSTS AND EXPENSES:
Programming............................................... 4,285,888 4,103,038
Selling, general and administrative....................... 3,421,791 3,477,576
Depreciation and amortization............................. 2,415,754 2,543,540
Allocated corporate expenses (Note 5)..................... 1,458,452 1,669,996
----------- -----------
Total costs and expenses.......................... 11,581,885 11,794,150
----------- -----------
INCOME BEFORE INCOME TAX PROVISION.......................... 459,617 229,848
INCOME TAX PROVISION (Note 4)............................... 166,000 80,000
----------- -----------
NET INCOME.................................................. 293,617 149,848
DEFICIT, BEGINNING OF PERIOD................................ (5,223,648) (5,373,496)
----------- -----------
DEFICIT, END OF PERIOD...................................... $(4,930,031) $(5,223,648)
=========== ===========
</TABLE>
See notes to financial statements.
F-42
<PAGE> 111
CABLE ALABAMA CORPORATION
(A WHOLLY-OWNED SUBSIDIARY OF CABLEAMERICA CORPORATION)
STATEMENTS OF CASH FLOWS
ELEVEN-MONTH PERIOD ENDED AUGUST 31, 1998 AND
YEAR ENDED SEPTEMBER 30, 1997
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................ $ 293,617 $ 149,848
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization.......................... 2,415,754 2,543,540
Deferred income taxes.................................. 166,000 80,000
Changes in operating assets and liabilities:
Subscriber accounts receivable....................... (40,921) (226,021)
Prepaid expenses and other assets.................... 63,910 (17,876)
Accounts payable..................................... (1,520,992) 1,170,861
Accrued expenses and other liabilities............... (8,546) 24,906
----------- -----------
Net cash provided by operating activities......... 1,368,822 3,725,258
----------- -----------
CASH FLOWS USED IN INVESTING ACTIVITIES -- Purchase or
construction of cable television systems and equipment.... (3,157,789) (5,323,569)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES -- Contributions to
capital by parent company................................. 1,777,854 1,613,437
----------- -----------
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS............ (11,113) 15,126
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD.............. 19,753 4,627
----------- -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD.................... $ 8,640 $ 19,753
=========== ===========
</TABLE>
See notes to financial statements.
F-43
<PAGE> 112
CABLE ALABAMA CORPORATION
(A WHOLLY-OWNED SUBSIDIARY OF CABLEAMERICA CORPORATION)
NOTES TO FINANCIAL STATEMENTS
ELEVEN-MONTH PERIOD ENDED AUGUST 31, 1998 AND
YEAR ENDED SEPTEMBER 30, 1997
1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation -- Cable Alabama Corporation (the "Company") is a
wholly-owned subsidiary of CableAmerica Corporation ("CAC"). The accompanying
financial statements have been prepared from the separate records maintained by
the Company and may not necessarily be indicative of the conditions that would
have existed or the results of operations if the Company had been operated as an
unaffiliated company (see Note 5 regarding expenses allocated from CAC). The
Company provides cable television services to various communities within
Alabama.
Significant accounting policies are summarized below:
a. Cable Television Systems and Equipment -- Cable television systems and
equipment are stated at cost and are depreciated using the straight-line method
over the estimated useful lives as follows:
<TABLE>
<S> <C>
Reception and distribution facilities....................... 10 years
Equipment and fixtures...................................... 5-10 years
Vehicles.................................................... 3-5 years
Buildings and improvements.................................. 10-30 years
</TABLE>
Direct costs associated with the construction of new cable television
plant, the expansion of existing cable television plant, and the
rebuilding of cable television plant are capitalized. Interest allocated
from CAC is capitalized on construction-in-progress. Interest costs of
approximately $10,000 and $26,000 were capitalized in 1998 and 1997,
respectively.
b. Cash and cash equivalents include cash on hand and in banks.
c. Income Taxes -- The Company is included in the consolidated income tax
return of CAC. CAC's policy is to allocate income tax expense or benefit to
subsidiaries as if they filed separate returns. The Company follows Statement of
Financial Accounting Standards ("SFAS") No. 109 Accounting for Income Taxes.
SFAS No. 109 requires an asset and liability approach for financial accounting
and reporting for income tax purposes. This statement recognizes (a) the amount
of taxes payable or refundable for the current year, and (b) deferred tax
liabilities and assets for the future tax consequences of events that have been
recognized in the financial statements or tax returns.
d. Use of Estimates -- The preparation of financial statements in
conformity with generally accepted accounting principles necessarily requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosures of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from these
estimates.
2. STOCKHOLDERS' EQUITY
CAC has a $42,500,000 revolving line of credit agreement with two
commercial banks. At August 31, 1998 and September 30, 1997, CAC had borrowings
under the lines of credit of $42,500,000 and $37,800,000, respectively.
Borrowings are collateralized by all of the common stock of each of the wholly-
owned subsidiary companies of CAC, including the Company. The lines of credit
were paid off and terminated on October 30, 1998 (Note 6).
F-44
<PAGE> 113
CABLE ALABAMA CORPORATION
(A WHOLLY-OWNED SUBSIDIARY OF CABLEAMERICA CORPORATION)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
3. LEASES
Operating Leases -- The Company has operating leases for various offices
and warehouses under terms ranging from one to ten years. Rental expense
amounted to $163,000 and $184,000 for the eleven-month period ended August 31,
1998 and the year ended September 30, 1997, respectively, which was paid to the
shareholders of CAC, as lessors of such leases.
In connection with the sale of assets subsequent to year-end, described in
Note 6, all of the Company's lease agreements were assumed by the purchaser.
4. INCOME TAXES
A reconciliation of the difference between the provision for income taxes
and income taxes at the statutory United States federal income tax rate for the
eleven-month period ended August 31, 1998 and the year ended September 30, 1997
is as follows:
<TABLE>
<CAPTION>
1998 1997
-------- --------
<S> <C> <C>
Income tax provision at statutory United States federal
income tax rate........................................... $156,000 $ 73,000
State taxes and other....................................... 10,000 7,000
-------- --------
Income tax provision........................................ $166,000 $ 80,000
======== ========
</TABLE>
The components of the Company's deferred income tax asset are as follows:
<TABLE>
<CAPTION>
AUGUST 31, SEPTEMBER 30,
1998 1997
---------- -------------
<S> <C> <C>
Federal net operating loss carryforwards.................... $2,793,000 $2,863,000
State net operating loss carryforwards...................... 468,000 474,000
Difference in book and tax carrying basis of property and
equipment................................................. (1,626,000) (1,548,000)
Tax credits................................................. 484,000 484,000
Other....................................................... 55,000 67,000
---------- ----------
Net deferred tax asset...................................... $2,174,000 $2,340,000
========== ==========
</TABLE>
The Company has approximately $9.1 million of estimated Alabama state net
operating loss carryforwards available to offset state taxable income. These
carryforwards expire through 2012.
Additionally, the Company has been allocated the following carryforwards
available as offsets to Federal taxable income or as credits against regular
federal income taxes:
<TABLE>
<CAPTION>
NET OPERATING LOSSES ALTERNATIVE MINIMUM TAX CREDITS
EXPIRING FROM 2005 TO 2012 AND INVESTMENT TAX CREDITS
- -------------------------- -------------------------------
<S> <C>
$8,100,000 $484,000
----------- ---------
</TABLE>
5. ALLOCATED CORPORATE EXPENSES
CAC provides substantially all administration, finance and accounting
services for the Company. CAC allocates corporate expenses, including interest
(based on total assets) and other expenses (based on the number of basic
subscribers) to its subsidiaries. The total expenses allocated to the Company
for 1998 and 1997 were approximately $1,458,000 and $1,670,000, respectively.
F-45
<PAGE> 114
CABLE ALABAMA CORPORATION
(A WHOLLY-OWNED SUBSIDIARY OF CABLEAMERICA CORPORATION)
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
6. SUBSEQUENT EVENT
On October 30, 1998, the Company sold substantially all of its assets.
Proceeds of the sale were approximately $60,000,000.
F-46
<PAGE> 115
PRO FORMA FINANCIAL INFORMATION
A pro forma statement of operations for the twelve months ended December
31, 1998 is presented below. The pro forma statement of operations for the
twelve month period ended December 31, 1998 is presented assuming the
acquisition of Cable Alabama and the Reorganization had occurred effective
January 1, 1998.
The unaudited pro forma consolidated financial information is presented for
illustrative purposes only and is not necessarily indicative of the financial
position or results of operations that would have actually been reported had the
pro forma transactions occurred at the beginning of the periods presented, nor
is it indicative of future financial position or results of operations.
UNAUDITED PRO FORMA STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1998
<TABLE>
<CAPTION>
HISTORICAL (A) PRO FORMA PRO FORMA
KNOLOGY, INC. CABLE ALABAMA ADJUSTMENTS KNOLOGY, INC.
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
REVENUE............................. $ 45,132,522 $8,873,291 $ -- $ 54,005,813
OPERATING EXPENSES
Cost of services.................. 12,739,540 3,181,970 -- 15,921,510
Selling, operations and
administrative................. 37,323,345 2,463,277 (122,756)(b) 39,663,866
Depreciation and amortization..... 17,914,537 1,764,472 8,846,500(c) 28,525,509
Allocated corporate expenses...... 996,601 (734,281)(d) 262,320
------------ ---------- ------------- ------------
Total Operating
Expenses................ 67,977,422 8,406,320 7,989,463 84,373,205
OTHER INCOME (EXPENSE)
Interest income................... 9,639,050 -- (2,383,333)(e) 7,255,717
Interest expense.................. (29,033,088) -- -- (29,033,088)
Affiliate interest income
(expense)...................... (34,115) -- (34,115)
Other Income (expense)............ 782,954 -- -- 782,954
------------ ---------- ------------- ------------
(18,645,199) -- (2,383,333) (21,028,552)
INCOME (LOSS) BEFORE INCOME TAXES,
MINORITY INTERESTS, AND CUMULATIVE
EFFECT OF CHANGE IN ACCOUNTING
PRINCIPLE......................... (41,490,099) 466,971 (10,372,796) (51,395,924)
MINORITY INTEREST................... 13,294,079 -- (8,968,717)(f) 4,325,362
------------ ---------- ------------- ------------
INCOME (LOSS) BEFORE INCOME TAXES
CUMULATIVE EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE.............. (28,196,020) 466,971 (19,341,513) (47,070,562)
INCOME TAX (PROVISION) BENEFIT...... 5,631,618 (173,000) (5,458,618)(g) --
------------ ---------- ------------- ------------
INCOME (LOSS) BEFORE INCOME TAXES
AND CUMULATIVE EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE.............. (22,564,402) 293,971 (24,800,131) (47,070,562)
</TABLE>
F-47
<PAGE> 116
<TABLE>
<CAPTION>
HISTORICAL (A) PRO FORMA PRO FORMA
KNOLOGY, INC. CABLE ALABAMA ADJUSTMENTS KNOLOGY, INC.
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
CUMULATIVE EFFECT OF A CHANGE IN
ACCOUNTING PRINCIPLE, write off of
capitalized start up costs........ $ (582,541) $ -- $ -- $ (582,541)
------------ ---------- ------------- ------------
NET INCOME (LOSS)................... (23,146,943) 293,971 (24,800,131) (47,653,103)
------------ ---------- ------------- ------------
Preferred Stock Dividends........... (1,424,222) -- 1,424,222(h) --
------------ ---------- ------------- ------------
Pro Forma income (loss) attributable
to common shareholders:........... (24,571,165) 293,971 (23,375,909) (47,653,103)
============ ========== ============= ============
Basic and diluted loss per share:... (409.52) (794.22)
============ ============
Weighted average number of common
shares -- basic and diluted....... 60,000 60,000
============ ============
</TABLE>
- ---------------
(a) The effective date of the Cable Alabama acquisition was September 1, 1998.
These historical amounts related to Cable Alabama include the unaudited
results of operations for the period January 1, 1998 to August 31, 1998.
(b) Reflects the reduction of rent expense related to the purchase of real
property in connection with the Cable Alabama transaction.
(c) Reflects additional depreciation and amortization expense associated with
the increase in the basis of the acquired assets to fair market value at the
date of acquisition and the allocation of the purchase price to the acquired
subscriber base and non-compete agreement. Amounts allocated to subscriber
base, non-compete agreement, plant and building are amortized over three,
three, ten and twenty-five years, respectively.
(d) Reflects the elimination of interest expense allocated to Cable Alabama from
parent company.
(e) Reflects the elimination of interest income resulting from lower cash and
investments due to cash paid for acquisition.
(f) Represents the increase in losses applicable to the Company based on an 85%
ownership interest in KNOLOGY Holdings for the year ended December 31, 1998.
(g) Reflects the elimination of income tax provision and benefit due to the
operating losses of consolidated entity after the distribution, KNOLOGY
Holdings, Inc. will no longer participate in a tax sharing agreement with
ITC Holding.
(h) Reflects the elimination of earnings, distributed to ITC Holding related to
any excess earnings that would be allocated to business development of
KNOLOGY, Inc.
F-48
<PAGE> 117
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table sets forth the various expenses in connection with the
issuance and distribution of the securities being registered hereby, other than
underwriting discounts and commissions. All amounts are estimated.
<TABLE>
<S> <C>
Blue Sky Fees and Expenses.................................. $
Accounting Fees and Expenses................................
Legal Fees and Expenses.....................................
Printing and Engraving Expenses.............................
Total.............................................
</TABLE>
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Under Section 145 of the Delaware corporation law, a corporation may
indemnify its directors, officers, employees and agents and its former
directors, officers, employees and agents and those who serve, at the
corporation's request, in such capacities with another enterprise, against
expenses (including attorneys' fees), as well as judgments, fines and
settlements in non derivative lawsuits, actually and reasonably incurred in
connection with the defense of any action, suit or proceeding in which they or
any of them were or are made parties or are threatened to be made parties by
reason of their serving or having served in such capacity. The Delaware
Corporation Law provides, however, that such person must have acted in good
faith and in a manner such person reasonably believed to be in (or not) the best
interests of the corporation and, in the case of a criminal action, such person
must have had no reasonable cause to believe his or her conduct was unlawful. In
addition, the Delaware corporation law does not permit indemnification in an
action or suit by or in the right of the corporation, where such person has been
adjudged liable to the corporation, unless, and only to the extent that, a court
determines that such person fairly and reasonably is entitled to indemnity for
costs the court deems proper in light of liability adjudication. Indemnity is
mandatory to the extent a claim, issue or matter has been successfully defended.
Our Certificate of Incorporation and our Bylaws contain provisions that further
provide for the indemnification of our directors and officers to the fullest
extent permitted by the Delaware Corporation Law.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
We were formed in September 1998 and commencing in November 1999 we are
serving as a holding company of KNOLOGY Holdings, Inc., Interstate Telephone
Company, Inc., Valley Telephone Company, Inc., Globe Telecommunications, Inc.
and ITC Globe, Inc. In the last three years, prior to our ownership of such
companies, our subsidiaries offered and sold the following equity securities
that were not registered under the Securities Act:
In December 1995 and January 1996, in connection with its initial
capitalization, KNOLOGY Holdings issued to certain of its stockholders 7,780
shares of its preferred stock for a purchase price of $1,000 per share, for an
aggregate amount of $7,780,000. ITC Holding Company, Inc. contributed $4,000,000
plus all of its direct and indirect interests in Cybernet Holding, L.L.C. and in
KNOLOGY of Columbus, Inc. in exchange for the preferred stock.
In April 1996, in connection with a private placement of its preferred
stock, KNOLOGY Holdings issued to certain of its current stockholders 9,312
shares of preferred stock for a purchase price of $1,200 per share, for an
aggregate amount of $11,174,400.
In February 1997, KNOLOGY Holdings issued 8,960 shares of its preferred
stock to certain of its current stockholders for a purchase price of $1,200 per
share, for an aggregate amount of $10,752,000.
II-1
<PAGE> 118
In October 1997, KNOLOGY Holdings issued approximately 21,400 shares of its
preferred stock to qualified investors in a equity private placement for a
purchase price of $1,500 per share, for an aggregate amount of approximately
$32.2 million. ITC Holding, Century Telephone Enterprises, Inc., South Atlantic,
the AT&T venture funds and SCANA Communications, Inc. purchased approximately
$10.0 million, $2.5 million, $5.5 million, $5.0 million and $5.0 million of our
preferred stock, respectively, in the equity private placement. ITC Holding
subsequently repurchased all shares of KNOLOGY Holdings' preferred stock owned
by Century Telephone, South Atlantic and SCANA in 1998.
On October 22, 1997, KNOLOGY Holdings issued 444,100 units, each of which
consists of one senior discount note and one warrant to purchase .003734 shares
of its preferred stock, for net proceeds of approximately $242.4 million. The
warrants may be exercised at a price of $.01 per share, subject to adjustment,
at any time beginning one year after the date of issuance and prior to the close
of business on the tenth anniversary of such grant. Morgan Stanley & Co.
Incorporated, J.P. Morgan Securities, Inc. and First Union Capital Markets Corp.
served as KNOLOGY Holdings' placement agents in the transaction. SCANA purchased
71,050 of the units for an aggregate purchase price of $39,998,308.
Pursuant to its 1995 stock option plan, KNOLOGY Holdings granted options to
purchase its common stock to its key employees and non-employee directors and
those of its subsidiaries. As of December 31, 1998, KNOLOGY Holdings had issued
outstanding options to purchase 692,168 shares of its common stock pursuant to
the plan at exercise prices ranging from $8.00 to $11.33 per share.
In May 1998, KNOLOGY Holdings issued 394 shares of its common stock, at an
exercise price of $8 per share, to an employee who exercised options granted
under its 1995 stock option plan.
Each issuance of securities described above was made in reliance on an
exemption from registration provided by Section 4(2) or Regulation D of the
Securities Act as a transaction by an issuer not involving any public offering.
The recipients of securities in each such transaction represented their
intention to acquire the securities for investment only and not with a view to
or for distribution in connection with such transactions and appropriate legends
were affixed to the share certificates issued in such transactions. All
recipients had adequate access to information about KNOLOGY Holdings, Inc.,
through their relationships with KNOLOGY Holdings or through information about
KNOLOGY Holdings made available to them.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Exhibits
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
- -------- -------------------
<C> <C> <S>
2.1(1) -- Agreement and Plan of Merger, dated December 5, 1997, by and
among KNOLOGY Holdings, Inc., KNOLOGY of Panama City, Inc.,
Beach Cable, Inc. and L. Charles Hilton
2.2(2) -- Purchase Agreement between Cable Alabama Corporation and
KNOLOGY of Huntsville, Inc., dated as of October 19, 1998.
3.1(4) -- Certificate of Incorporation of KNOLOGY, Inc.
3.2(4) -- Bylaws of KNOLOGY, Inc.
3.3(4) -- Certificate of Designations of Series A Preferred Stock
3.4(4) -- Certificate of Designations of Series B Preferred Stock
4.1(4) -- Specimen Certificate for Shares of Common Stock, par value
$0.01, of KNOLOGY, Inc.
4.2(4) -- Specimen Certificate for Shares of Series A Preferred Stock,
par value $0.01, of KNOLOGY, Inc.
4.3(4) -- Specimen Certificate for shares of Series B Preferred Stock,
par value $0.01, of KNOLOGY, Inc.
</TABLE>
II-2
<PAGE> 119
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
- -------- -------------------
<C> <C> <S>
4.4(1) -- Indenture dated as of October 22, 1997 between KNOLOGY
Holdings, Inc. and United States Trust Company of New York,
as Trustee, relating to the 11 7/8% Senior Discount Notes
Due 2007 of KNOLOGY Holdings, Inc.
4.5(1) -- Registration Rights Agreement, dated October 22, 1997,
between KNOLOGY Holdings, Inc., the Placement Agents and
SCANA Communications, Inc.
4.6 -- Form of Senior Discount Note (contained in Indenture filed
as Exhibit 4.5)
4.7 -- Form of Exchange Note (contained in Indenture filed as
Exhibit 4.5)
5.1(4) -- Opinion of Hogan & Hartson, L.L.P.
10.1(1) -- Unit Purchase Agreement, dated as of October 16, 1997
between KNOLOGY Holdings, Inc. and SCANA Communications,
Inc.
10.2(1) -- Warrant Agreement, dated as of October 22, 1997, between
KNOLOGY Holdings, Inc. and United States Trust Company of
New York (including form of Warrant Certificate)
10.3(1) -- Warrant Registration Rights Agreement, dated as of October
22, 1997, between KNOLOGY Holdings, Inc. and United States
Trust Company of New York
10.4(1) -- Lease Agreement dated April 15, 1996 by and between D.L.
Jordan and American Cable Company, Inc.
10.5(1) -- Pole Attachment Agreement dated January 1, 1998 by and
between Gulf Power Company and Beach Cable, Inc.
10.6(1) -- Telecommunications Facility Lease and Capacity Agreement,
dated September 10, 1996, by and between Troup EMC
Communications, Inc. and Cybernet Holding, Inc.
10.7(1) -- Master Pole Attachment Agreement dated January 12, 1998 by
and between South Carolina Electric and Gas and KNOLOGY
Holdings, Inc. d/b/a/ KNOLOGY of Charleston.
10.8(1) -- License Agreement dated September 29, 1995 by and between
Montgomery Cablevision and Entertainment, Inc. and American
Communications Services of Montgomery, Inc.
10.9(1) -- License Agreement dated January 17, 1996 by and between
American Cable, Inc. and American Communication Services of
Columbus, Inc.
10.10(1) -- Addendum to License Agreement dated April 21, 1997 by and
between American Cable, Inc. and American Communication
Services of Columbus, Inc.
10.11(1) -- Lease Agreement, dated December 5, 1997 by and between The
Hilton Company and KNOLOGY of Panama City, Inc.
10.12(1) -- Billing and Collection Services Agreement dated April 2,
1997 by and between Interstate Telephone Company and
Cybernet Holding, Inc.
10.13(1) -- Certificate of Membership with National Cable Television
Cooperative, dated January 29, 1996, of Cybernet Holding,
Inc.
10.14(1) -- Stockholders' Agreement dated as of December 8, 1995 among
KNOLOGY Holdings, Inc. and Certain Stockholders thereof
10.15(1) -- Amendment No. 1 to Stockholders' Agreement dated as of
January 25, 1996.
10.16(1) -- Amendment No. 2 to Stockholders' Agreement dated as of April
18, 1996.
10.17(1) -- Amended and Restated Agreement dated as of July 28, 1997
among KNOLOGY Holdings, Inc. and Certain Stockholders
thereof
10.18(2) -- Ordinance No. 99-16 effective March 16, 1999 between
Columbus consolidated Government and KNOLOGY of Columbus,
Inc.
10.19(1) -- Ordinance No. 16-90 (Montgomery, Alabama) dated March 6,
1990.
10.20(1) -- Ordinance No. 50-76 (Montgomery, Alabama)
</TABLE>
II-3
<PAGE> 120
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
- -------- -------------------
<C> <C> <S>
10.21(1) -- Ordinance No. 9-90 (Montgomery, Alabama) dated January 16,
1990.
10.22(1) -- Resolution No. 58-95 (Montgomery, Alabama) dated April 6,
1995.
10.23(1) -- Resolution No. 92-7 (Panama City Beach, Florida) dated July
23, 1992.
10.24(1) -- License (Bay County, Florida) dated January 5, 1993.
10.25(1) -- Resolution No. 97-22 (Panama City Beach, Florida) dated
December 3, 1997.
10.26(1) -- Resolution No. 2075 (Bay County, Florida) dated November 18,
1997.
10.27(3) -- Ordinance No. 5999 (Augusta, Georgia) dated January 20,
1998.
10.28(3) -- Ordinance No. 1723 (Panama City, Florida) dated March 10,
1998.
10.30(2) -- Ordinance No. 98054 (Mount Pleasant, South Carolina) dated
March 9, 1999.
10.31(2) -- Franchise Agreement (Charleston County, South Carolina)
dated December 15, 1998.
10.32(2) -- Ordinance No. 1998-47 (North Charleston, South Carolina)
dated May 28, 1998.
10.33(2) -- Ordinance No. 1998-77 (Charleston, South Carolina) dated
April 28, 1998.
10.34(2) -- Ordinance No. 98-5 (Columbia County, Georgia) dated August
18, 1998.
10.35(2) -- Switching Agreement dated May 1, 1998 between Interstate
Telephone Company and KNOLOGY Holdings, Inc.
10.36(2) -- Network Access Agreement dated July 1, 1998 between SCANA
Communications, Inc., f/k/a MPX Systems, Inc. and KNOLOGY
Holdings, Inc.
10.37(2) -- Internet Access Contract dated September 1, 1998 between ITC
Data Com Communications, Inc. and KNOLOGY Holdings, Inc.
10.38(2) -- Collocation Agreement for Multiple Sites dated on or about
June 1998 between Interstate FiberNet, Inc. and KNOLOGY
Holdings, Inc.
10.39(2) -- Lease Agreement dated October 12, 1998 between Southern
Company Services, Inc. and KNOLOGY Holdings, Inc.
10.40(2) -- Facilities Transfer Agreement dated February 11, 1998
between South Carolina Electric and Gas Company and KNOLOGY
Holdings, Inc., d/b/a KNOLOGY of Charleston.
10.41(2) -- License Agreement dated March 3, 1998 between BellSouth
Telecommunications, Inc. and KNOLOGY Holdings, Inc.
10.44(2) -- Pole Attachment Agreement dated February 18, 1998 between
KNOLOGY Holdings, Inc. and Georgia Power Company
10.46(2) -- Assignment Agreement dated March 4, 1998 between Gulf Power
Company and KNOLOGY of Panama City, Inc.
10.47(2) -- Adoption Agreements dated March 1, 1999 between KNOLOGY
Holdings, Inc. and BellSouth Telecommunications, Inc.
10.48(2) -- Lease Switching Agreement between South Carolina Net for TTE
Inc. and KNOLOGY Holdings, Inc.
10.50(2) -- Carrier Services Agreement dated September 30, 1998 between
Business Telecom, Inc. and KNOLOGY Holdings, Inc.
10.51(2) -- Reseller Services Agreement dated September 9, 1998 between
Business Telecom, Inc. and KNOLOGY Holdings, Inc.
10.52(2) -- Private Line Services Agreement dated September 10, 1998
between BTI Communications Corporation and KNOLOGY Holdings,
Inc.
10.53(2) -- Credit Facility Agreement between First Union National Bank,
First Union Capital Markets Corp. and KNOLOGY Holdings, Inc.
dated December 22, 1998.
10.54(2) -- Ordinance No. 284 (Cedar Grove, Florida) dated June 9, 1998.
</TABLE>
II-4
<PAGE> 121
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
- -------- -------------------
<C> <C> <S>
10.55(2) -- License Agreement dated January 5, 1993 between County
Commissioners of Bay County Florida and Beach Cable, Inc.
10.56(2) -- Ordinance No. 647 (Lynn Haven, Florida) dated May 12, 1998
between KNOLOGY of Panama City, Inc. and the City of Lynn
Haven.
10.57(2) -- Ordinance No. 1723 (Panama City, Florida) dated March 10,
1998 between KNOLOGY of Panama City, Inc. and the City of
Panama City.
10.58(2) -- Resolution No. 97-22 (Panama City Beach, Florida) dated
December 3, 1997 between Panama City Beach, Florida and
KNOLOGY Holdings, Inc.
10.59(4) -- Form of Tax Separation Agreement between ITC Holding and
KNOLOGY, Inc.
10.60(4) -- Services Agreement between ITC Service Company and
Interstate Telephone Company, Inc.
10.61(4) -- Residual Note from KNOLOGY, Inc. to ITC Holding Company,
Inc.
12.1(4) -- Statement regarding Computation of Ratio of Earnings to
Fixed Charges.
21.1(4) -- Subsidiaries of KNOLOGY, Inc.
23.1(5) -- Consent of Arthur Andersen LLP.
23.2(5) -- Consent of Deloitte & Touche LLP.
24.1(5) -- Power of Attorney.
27.1(5) -- Financial Data Schedule for year ended 1997 (for SEC use
only).
27.2(5) -- Financial Data Schedule for year ended 1998 (for SEC use
only).
99.1(4) -- Consent of Richard Bodman to his nomination to be director
of KNOLOGY, Inc.
99.2(4) -- Consent of Alan A. Burgess to his nomination to be director
of KNOLOGY, Inc.
99.3(4) -- Consent of Donald W. Burton to his nomination to be director
of KNOLOGY, Inc.
99.4(4) -- Consent of L. Charles Hilton, Jr. to his nomination to be
director of KNOLOGY, Inc.
99.5(4) -- Consent of Donald W. Weber to his nomination to be director
of KNOLOGY, Inc.
</TABLE>
- ---------------
(1) Filed previously in connection with KNOLOGY Holdings, Inc.'s Registration
Statement on Form S-4, (File No. 333-43339) and incorporated herein by
reference.
(2) Filed previously in connection with KNOLOGY Holdings, Inc.'s Annual Report
on Form 10-K in the year ended December 31, 1998 and incorporated herein by
reference.
(3) Filed previously in connection with KNOLOGY Holdings, Inc.'s Annual Report
on Form 10-K in the year ended December 31, 1997 and incorporated herein by
reference.
(4) To be filed by amendment.
(5) Filed herewith.
(b) Financial Statement Schedules
Schedules have been omitted because the information required to be set
forth therein is not applicable or is included elsewhere in the Financial
Statements or the notes thereto.
ITEM 17. UNDERTAKINGS
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Act and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by the registrant of expenses incurred
or paid by a director, officer or controlling person of the registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in
II-5
<PAGE> 122
connection with the securities being registered, the registrant will, unless in
the opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Act and will
be governed by the final adjudication of such issue.
II-6
<PAGE> 123
SIGNATURES
Pursuant to the requirements of the Securities Act, the Company has
reasonable grounds to believe that it meets all of the requirements for filing
on Form S-1 and has duly caused this Registration Statement to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of Washington,
D.C., on this 15th day of October, 1999.
KNOLOGY, Inc.
By: /s/ RODGER L. JOHNSON*
------------------------------------
Rodger L. Johnson
President and Chief Executive
Officer
Pursuant to the requirements of the Securities Act, this Registration
Statement has been signed by the following persons, in the capacities indicated
below, on this 15th day of October, 1999.
<TABLE>
<CAPTION>
SIGNATURE TITLE
--------- -----
<C> <S>
/s/ RODGER L. JOHNSON* President, Chief Executive Officer and Director
- ---------------------------------------------------
Rodger L. Johnson
/s/ FELIX L. BOCCUCCI, JR. Chief Financial Officer and Vice President of
- --------------------------------------------------- Business Development (Principal Financial and
Felix L. Boccucci, Jr. Accounting Officer)
/s/ CAMPBELL B. LANIER, III* Chairman of the Board of Directors
- ---------------------------------------------------
Campbell B. Lanier, III
/s/ WILLIAM H. SCOTT, III* Director
- ---------------------------------------------------
William H. Scott, III
* By Attorney-in-Fact
/s/ CHAD WACHTER
- ---------------------------------------------------
Chad Wachter
</TABLE>
II-7
<PAGE> 124
SCHEDULE II
KNOLOGY, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1997, AND 1998
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31,
1996 1997 1998
------------ ------------ ------------
<S> <C> <C> <C>
Allowance for doubtful accounts, balance at beginning of
year................................................... $ 17,113 $ 23,342 $ 108,528
Addition charged to cost and expense..................... 81,082 367,527 1,303,372
Deductions............................................... (74,853) (282,341) (1,018,234)
-------- --------- -----------
Allowance for doubtful accounts, balance at end of
year................................................... $ 23,342 $ 108,528 $ 393,766
======== ========= ===========
</TABLE>
S-1
<PAGE> 125
After the reorganization and the stock split transactions referred to in
Notes 1 and 11, respectively, to KNOLOGY, Inc. consolidated financial statements
are effected, we expect to be in the position to render the following audit
report.
Arthur Andersen LLP
October 15, 1999
S-2
<PAGE> 126
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS AS TO SCHEDULE
To KNOLOGY, Inc.:
We have audited in accordance with generally accepted auditing standards,
the financial statements of KNOLOGY, Inc. (a Delaware corporation) and
subsidiaries as of December 31, 1997 and 1998 and for each of the three years in
the period ended December 31, 1998, and have issued our report thereon dated
. Our audits were made for the purpose of forming an opinion on
those statements taken as a whole. The schedule listed under Schedule II herein
as it relates to KNOLOGY, Inc. and subsidiaries is the responsibility of the
Company's management and is presented for purposes of complying with the
Securities and Exchange Commission's rules and is not part of the basic
financial statements. This schedule has been subjected to the auditing
procedures applied in the audits of the basic financial statements and, in our
opinion, fairly states in all material respects the financial data required to
be set forth therein in relation to the basic financial statements taken as a
whole.
Atlanta, Georgia
, 1999
S-3
<PAGE> 1
Exhibit 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the use of our reports
and to all references to our firm included in or made part of this registration
statement.
ARTHUR ANDERSEN LLP
Atlanta, Georgia
October 15, 1999
<PAGE> 1
EXHIBIT 23.2
INDEPENDENT AUDITORS' CONSENT
We consent to the use in this Registration Statement of Knology, Inc. on Form
S-1 of our report dated December 7, 1998 on the financial statements of Cable
Alabama Corp. appearing in the Prospectus, which is part of this Registration
Statement.
We also consent to the reference to us under the heading "Experts" in such
Prospectus.
DELOITTE & TOUCHE LLP
Phoenix, Arizona
October 14, 1999
<PAGE> 1
EXHIBIT 24.1
POWER OF ATTORNEY
Each person whose signature appears below constitutes and appoints Rodger
L. Johnson and Felix L. Boccucci, Jr. and Chad Wachter and each of them, with
the power to act without the other, his true and lawful attorneys-in-fact and
agents, with full power of substitution and resubstitution, for him in his name,
place and stead, in any and all capacities, to sign on his behalf individually
and in each capacity state below any or all amendments or post-effective
amendments to this Registration Statement, and to file the same, with all
exhibits thereto, and other documents in connection therewith, with the
Securities and Exchange Commission, granting unto said attorneys-in-fact and
agents, and each of them, full power and authority to do and perform each and
every act and thing requisite and necessary to be done in and about the
premises, as fully to all intents and purposes as he might or could do in
person, hereby ratifying and confirming all that said attorneys-in-fact and
agents, or either of them, or their substitutes, may lawfully do or cause to be
done by virtue hereof.
Pursuant to the requirements of the Securities Act, this Registration
Statement has been signed by the following persons, in the capacities indicated
below, on this 15th day of October, 1999.
<TABLE>
<CAPTION>
SIGNATURE TITLE
--------- -----
<C> <S>
/s/ RODGER L. JOHNSON President, Chief Executive Officer and Director
- ---------------------------------------------------
Rodger L. Johnson
/s/ CAMPBELL B. LANIER, III Chairman of the Board of Directors
- ---------------------------------------------------
Campbell B. Lanier, III
/s/ WILLIAM H. SCOTT, III Director
- ---------------------------------------------------
William H. Scott, III
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS FINANCIAL DATA SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED
FROM THE BALANCE SHEET OF KNOLOGY, INC. AS OF DECEMBER 31, 1997 AND THE RELATED
COMBINED STATEMENTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1997. THIS
INFORMATION IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 626,902
<SECURITIES> 0
<RECEIVABLES> 3,660,359
<ALLOWANCES> 108,529
<INVENTORY> 255,225
<CURRENT-ASSETS> 4,439,931
<PP&E> 31,333,722
<DEPRECIATION> 20,072,876
<TOTAL-ASSETS> 30,294,364
<CURRENT-LIABILITIES> 5,582,239
<BONDS> 0
0
600
<COMMON> 4
<OTHER-SE> 23,539,575
<TOTAL-LIABILITY-AND-EQUITY> 30,294,364
<SALES> 17,633,313
<TOTAL-REVENUES> 17,633,313
<CGS> 3,121,108
<TOTAL-COSTS> 15,401,369
<OTHER-EXPENSES> 2,048,506
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 12,431
<INCOME-PRETAX> 183,438
<INCOME-TAX> (1,010,779)
<INCOME-CONTINUING> (827,341)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (5,020,617)
<EPS-BASIC> (83.68)
<EPS-DILUTED> (83.68)
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS FINANCIAL DATA SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED
FROM THE BALANCE SHEET OF KNOLOGY, INC. AS OF DECEMBER 31, 1998 AND THE RELATED
COMBINED STATEMENTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1998. THIS
INFORMATION IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 5,158,774
<SECURITIES> 66,231,397
<RECEIVABLES> 8,744,597
<ALLOWANCES> 393,767
<INVENTORY> 32,417,006
<CURRENT-ASSETS> 87,420,481
<PP&E> 249,142,866
<DEPRECIATION> 37,257,198
<TOTAL-ASSETS> 388,367,064
<CURRENT-LIABILITIES> 35,428,959
<BONDS> 255,020,209
0
0
<COMMON> 600
<OTHER-SE> 48,871,681
<TOTAL-LIABILITY-AND-EQUITY> 388,367,064
<SALES> 45,132,522
<TOTAL-REVENUES> 45,132,522
<CGS> 12,739,540
<TOTAL-COSTS> 67,977,422
<OTHER-EXPENSES> 18,645,199
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 29,033,088
<INCOME-PRETAX> (28,196,020)
<INCOME-TAX> 5,631,618
<INCOME-CONTINUING> (22,564,402)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> (582,541)
<NET-INCOME> (23,146,943)
<EPS-BASIC> (409.52)
<EPS-DILUTED> (409.52)
</TABLE>
